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On the inherent instability of private money

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  • Daniel R. Sanches

Abstract

Superseded by Working Paper 15-18. We show the existence of an inherent instability associated with a purely private monetary system due to the role of endogenous debt limits in the creation of private money. Because the bankers? ability to issue liabilities that circulate as a medium of exchange depends on beliefs about future credit conditions, there can be multiple equilibria. Some of these equilibria have undesirable properties: Self-fulfilling collapses of the banking system and persistent fluctuations in the aggregate supply of bank liabilities are possible. In response to this inherent instability of private money, we formulate a government intervention that guarantees that the economy remains arbitrarily close to the constrained efficient allocation. In particular, we define an operational procedure for a central bank capable of ensuring the stability of the monetary system.

Suggested Citation

  • Daniel R. Sanches, 2012. "On the inherent instability of private money," Working Papers 12-19, Federal Reserve Bank of Philadelphia.
  • Handle: RePEc:fip:fedpwp:12-19
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    Cited by:

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    2. Shao, Enchuan & Fung, Ben S.C., 2016. "Counterfeit quality and verification in a monetary exchange," Economic Modelling, Elsevier, vol. 52(PA), pages 13-25.
    3. Jess Benhabib & Jianjun Miao & Pengfei Wang, 2016. "Chaotic banking crises and regulations," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 61(2), pages 393-422, February.
    4. Olivier Hueber, 2018. "The blockchain and the sidechain innovations for the electronic commerce beyond the Bitcoin's framework," Post-Print hal-01919094, HAL.
    5. Fernández-Villaverde, Jesús & Sanches, Daniel, 2019. "Can currency competition work?," Journal of Monetary Economics, Elsevier, vol. 106(C), pages 1-15.
    6. Gronwald, Marc, 2019. "Is Bitcoin a Commodity? On price jumps, demand shocks, and certainty of supply," Journal of International Money and Finance, Elsevier, vol. 97(C), pages 86-92.
    7. Donaldson, Jason Roderick & Piacentino, Giorgia, 2019. "Money Runs," CEPR Discussion Papers 13955, C.E.P.R. Discussion Papers.
    8. Hanna Armelius & Carl Andreas Claussen & Scott Hendry, 2020. "Is Central Bank Currency Fundamental to the Monetary System?," Discussion Papers 2020-2, Bank of Canada.
    9. Jamal Bouoiyour & Refk Selmi & Olivier Hueber, 2019. "Low on Trust and High on Risks: Is Sidechain a Good Solution to Bitcoin Problems?," Working Papers hal-02348406, HAL.
    10. Waknis, Parag, 2017. "Competitive Supply of Money in a New Monetarist Model," MPRA Paper 75401, University Library of Munich, Germany.
    11. Jason R. Donaldson & Giorgia Piacentino, 2019. "Money Runs," NBER Working Papers 26298, National Bureau of Economic Research, Inc.
    12. Joshua Aizenman, 2019. "Macroeconomics Challenges and Resilience of Emerging Market Economies," NBER Working Papers 26361, National Bureau of Economic Research, Inc.

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    More about this item

    Keywords

    Banks and banking; Central;

    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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