IDEAS home Printed from
   My bibliography  Save this paper

Float on a Note


  • Tao Zhu
  • Neil Wallace


Under the U.S. National Banking System (NBS), in effect from 1863--1914, banks with national charters could issue notes under four main restrictions: full collateral in the form of government bonds, a per-period tax on outstanding notes, redemption of notes into (outside) money on demand, and a clearing fee per issued note that is cleared through the Treasury's clearing system. The simple and predominant view of this system appeals to arbitrage to claim that the system should have produced an upper bound on the yield on collateral: the tax rate plus the product of the clearing fee and the average clearing rate of notes. However, as is well known and puzzling, yields on eligible collateral were generally higher than such a bound. We explain the puzzle by a model of note issue that includes the main features of the NBS. In the model, note issuers choose to issue notes only in trades that both produce a low clearing rate (high float) and are subject to diminishing returns, and there exists a steady state with a yield on collateral higher than the presumed bound. There are two main ingredients in our explanation: the concern about float and the inverse association between the float rate and the size of placement opportunities. The former is dictated by the rules for note issue. The latter is consistent with the notion that large placement opportunities would have been available only in organized markets, but notes used in such markets would have quickly been turned in to other banks and then been through the clearing system. To achieve high float, notes should be offered in trade to people who are infrequently connected to such markets, and such placement opportunities give rise to diminishing returns from additional note issue. We formulate the model with most of the background environment same as that of the Trejos-Wright-Shi model. For each specialization type, there is a small portion of “bankers†while the remainder is “nonbankers." There are three kinds of assets: (outside) money, notes issued by bankers, and bonds issued by government. Each date has two stages, the "morning" and the "afternoon." The morning is reserved for the random pairwise meetings. The afternoon is reserved for bankers meeting the government and is used solely for note-clearing, bond purchases, and the levying of taxes and fees. Hence, a banker’s notes have two potential uses: to purchase eligible collateral and to purchase goods or other bankers' notes in pairwise meetings. Each use gives rise to different amounts of float. We assume that government clears all notes in inventory at the start of each afternoon. As a result, a banker does not use its own notes to purchase bonds because the potential float is not enough to overcome the redemption fee. Nevertheless, a banker does use its notes in pairwise meetings to trade for goods and to trade for other bankers' notes. This use gives rise to random and higher float, and, implies a diminishing marginal return from additional note issue.

Suggested Citation

  • Tao Zhu & Neil Wallace, 2004. "Float on a Note," 2004 Meeting Papers 342, Society for Economic Dynamics.
  • Handle: RePEc:red:sed004:342

    Download full text from publisher

    File URL:
    File Function: main text
    Download Restriction: no

    References listed on IDEAS

    1. 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.
    2. Kiyotaki, Nobuhiro & Wright, Randall, 1989. "On Money as a Medium of Exchange," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 927-954, August.
    3. Zhu, Tao, 2005. "Existence of a monetary steady state in a matching model: divisible money," Journal of Economic Theory, Elsevier, vol. 123(2), pages 135-160, August.
    4. Ricardo de O. Cavalcanti & Andres Erosa & Ted Temzelides, 1999. "Private Money and Reserve Management in a Random-Matching Model," Journal of Political Economy, University of Chicago Press, vol. 107(5), pages 929-945, October.
    5. Milton Friedman & Anna J. Schwartz, 1963. "A Monetary History of the United States, 1867–1960," NBER Books, National Bureau of Economic Research, Inc, number frie63-1, June.
    6. Shi Shougong, 1995. "Money and Prices: A Model of Search and Bargaining," Journal of Economic Theory, Elsevier, vol. 67(2), pages 467-496, December.
    7. Wallace, Neil & Zhou, Ruilin, 1997. "A model of a currency shortage," Journal of Monetary Economics, Elsevier, vol. 40(3), pages 555-572, December.
    8. Ricardo de O. Cavalcanti & Neil Wallace, 1999. "Inside and outside money as alternative media of exchange," Proceedings, Federal Reserve Bank of Cleveland, pages 443-468.
    9. Taber, Alexander & Wallace, Neil, 1999. "A Matching Model with Bounded Holdings of Indivisible Money," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 40(4), pages 961-984, November.
    10. Bruce A. 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.
    11. Lacker, Jeffrey M, 1999. "Comment on Redemption Costs and Interest Rates under the U.S. National Banking System," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 590-593, August.
    12. Trejos, Alberto & Wright, Randall, 1995. "Search, Bargaining, Money, and Prices," Journal of Political Economy, University of Chicago Press, vol. 103(1), pages 118-141, February.
    13. Redish, Angela, 1999. "Comment on Redemption Costs and Interest Rates under the U.S. National Banking System," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 593-595, August.
    Full references (including those not matched with items on IDEAS)


    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.

    Cited by:

    1. Calomiris, Charles W. & Mason, Joseph R., 2008. "Resolving the puzzle of the underissuance of national bank notes," Explorations in Economic History, Elsevier, vol. 45(4), pages 327-355, September.

    More about this item


    National banking system; note issuance; matching model;

    JEL classification:

    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General

    NEP fields

    This paper has been announced in the following NEP Reports:


    Access and download statistics


    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:red:sed004:342. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christian Zimmermann). General contact details of provider: .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.