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Costly banknote issuance and interest rates under the national banking system

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  • Antoine Martin
  • Cyril Monnet
  • Warren E. Weber

Abstract

The behavior of interest rates under the U.S. National Banking System is puzzling because of the apparent presence of persistent and large unexploited arbitrage opportunities for note issuing banks. Previous attempts to explain interest rate behavior have relied on the cost or the inelasticity of note issue. These attempts are not entirely satisfactory. Here we propose a new rationale to solve the puzzle. Inelastic note issuance arises endogenously because the marginal cost of issuing notes is an increasing function of circulation. We build a spatial separation model where some fraction of agents must move each period. Banknotes can be carried between locations; deposits cannot. Taking the model to the data on national banks, we find it matches the movements in long-term interest rates well. It also predicts movements in deposit rates during panics. However, the model displays more inelasticity of notes issuance than is in the data.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Minneapolis in its series Working Papers with number 601.

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Date of creation: 2000
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Handle: RePEc:fip:fedmwp:601

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Related research

Keywords: Bank notes ; Interest rates ; National banks (United States);

References

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  1. Champ, B. & Snith, B.D. & Williamson, D.S., 1991. "Currency Elasticity and Banking Panics: Theory and Evidence," RCER Working Papers 292, University of Rochester - Center for Economic Research (RCER).
  2. Bruce Champ & Neil Wallace & Warren Weber, 1993. "Interest Rates Under the U.S. National Banking System," Economic History, EconWPA 9310001, EconWPA.
  3. James, John A, 1976. "The Conundrum of the Low Issue of National Bank Notes," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 84(2), pages 359-67, April.
  4. Bruce Champ & Neil Wallace & Warren E. Weber, 1992. "Resolving the national bank note paradox," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis, issue Spr, pages 13-21.
  5. Kuehlwein, Michael, 1992. "The National Bank Note Controversy Reexamined," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 24(1), pages 111-26, February.
  6. Bruce Champ & Scott Freeman & Warren E. Weber, 1999. "Redemption costs and interest rates under the U.S. National Banking System," Proceedings, Federal Reserve Bank of Cleveland, pages 568-595.
  7. Cagan, Phillip & Schwartz, Anna J, 1991. "The National Bank Note Puzzle Reinterpreted," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 23(3), pages 293-307, August.
  8. Gerald P. Dwyer, Jr. & R. Alton Gilbert, 1989. "Bank runs and private remedies," Review, Federal Reserve Bank of St. Louis, issue May, pages 43-61.
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Cited by:
  1. Weber, Warren E., 2003. "Interbank payments relationships in the antebellum United States: evidence from Pennsylvania," Journal of Monetary Economics, Elsevier, Elsevier, vol. 50(2), pages 455-474, March.
  2. Li, Yiting, 2006. "Banks, private money, and government regulation," Journal of Monetary Economics, Elsevier, Elsevier, vol. 53(8), pages 2067-2083, November.

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