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Demandable debt as a means of payment: banknotes versus checks

  • Charles M. Kahn
  • William Roberds

We examine the question of whether transactable forms of privately issued, demandable debt are better used as "banknotes" or "checks." The distinction between the two is that a check must be redeemed by the issuing bank with each use, whereas a banknote can circulate. We find that the answer to the question depends critically on the cost of early redemption. If this cost is small, banknotes will not circulate, so the question is moot. If this cost is large, incentive problems will prevent the issue of banknotes. For intermediate values of the early redemption cost, the option of early redemption limits the bank's risk-taking behavior, so that banknotes will be preferred over checks.

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Paper provided by Federal Reserve Bank of Atlanta in its series FRB Atlanta Working Paper with number 98-5.

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Date of creation: 1998
Date of revision:
Publication status: Published in Journal of Money, Credit, and Banking, August 1999
Handle: RePEc:fip:fedawp:98-5
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  1. Barbara A. Good, 1997. "Electronic money," Working Paper 9716, Federal Reserve Bank of Cleveland.
  2. Mark J. Flannery, 1991. "Debt maturity and the deadweight cost of leverage: optimally financing banking firms," Proceedings, Federal Reserve Bank of San Francisco, issue Nov.
  3. Calomiris, Charles W & Kahn, Charles M, 1991. "The Role of Demandable Debt in Structuring Optimal Banking Arrangements," American Economic Review, American Economic Association, vol. 81(3), pages 497-513, June.
  4. Arthur J. Rolnick & Warren E. Weber, 1992. "Explaining the demand for free bank notes," Staff Report 97, Federal Reserve Bank of Minneapolis.
  5. Champ, Bruce & Wallace, Neil & Weber, Warren E., 1994. "Interest rates under the U.S. national banking system," Journal of Monetary Economics, Elsevier, vol. 34(3), pages 343-358, December.
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  7. Ernst Maug, 1998. "Large Shareholders as Monitors: Is There a Trade-Off between Liquidity and Control?," Journal of Finance, American Finance Association, vol. 53(1), pages 65-98, 02.
  8. Rockoff, Hugh, 1985. "New Evidence on Free Banking in the United States [New Evidence on the Free Banking Era]," American Economic Review, American Economic Association, vol. 75(4), pages 886-89, September.
  9. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
  10. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
  11. Gorton, Gary, 1996. "Reputation Formation in Early Bank Note Markets," Journal of Political Economy, University of Chicago Press, vol. 104(2), pages 346-97, April.
  12. Williamson, Stephen D., 1992. "Laissez-faire banking and circulating media of exchange," Journal of Financial Intermediation, Elsevier, vol. 2(2), pages 134-167, June.
  13. Rockoff, Hugh, 1974. "The Free Banking Era: A Reexamination," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 6(2), pages 141-67, May.
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