Bank note issue and the supply of money

Abstract

The study of changes in the money supply and the effect of these changes on other important economic variables has constituted a significant portion of economic research since the establishment of economics as a separate field of inquiry. Although much of the research in money supply theory has concentrated upon macro variables, such as required reserve ratios and currency to deposit ratios, several recent efforts have analyzed demand deposit production utilizing comparative static techniques and the theory of the firm. This dissertation uses these methods to develop a theory of bank note issue. In addition, some of these theoretical results are used to explain an unsolved problem of some historical significance. A model of a perfectly competitive note issuing bank is developed, which emphasizes the importance of the costs incurred by the bank in servicing its outstanding stock of notes. Assuming that a bank would be forced by competitive pressures to replace worn notes, exchange denominations and guarantee redemption for a reserve commodity, these service costs would depend upon the velocity of the notes, the length of time a note remained in circulation and the denominations desired by the public. The profit maximizing stock of notes for an individual bank is obtained and a discussion of the effects of varying service costs on the output decisions of the bank follows. A model of a monopoly bank, which regards note denominations as a choice variable, is developed and applied to note issue by the Bank of England. Lower than expected note issue by the National Banking System is a puzzle which has remained unresolved up to this time. Given the prices of government bonds which had to be purchased before note issue could be undertaken, it appears as though note issue would have resulted in very high rates of return, but note issues remained below expected levels..