Working Paper: CEPR ID: DP7362
Authors: Oren Levintal; Joseph Zeira
Abstract: This paper tells the story of how paper money evolved as a result of lending by banks. While lending commodity money requires holding large reserves of commodity money to ensure liquidity, issuing convertible paper money reduces these costs significantly. The paper also examines the possibility of issuing inconvertible notes and shows that while they further reduce the cost of borrowing they also have adverse effects on the stability of the banking system. As a result, governments often intervened, either outlawing the issuance of such notes, or monopolizing them for themselves by issuing fiat money. The paper examines the process of creation of paper money, but also sheds light on more general issues, like the relation between money and financial intermediation.
Keywords: banks; convertibility; fiat money; financial intermediation; liquidity; paper money
JEL Codes: E4; E5; N1; N2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Banks' lending practices (G21) | Evolution of paper money (E42) |
| Issuing convertible paper money (E42) | Reduces costs of holding reserves (G21) |
| Issuing convertible paper money (E42) | Facilitates lending (G21) |
| Issuing convertible paper money (E42) | Lowers interest rates (E43) |
| Inconvertible notes (G19) | Reduce borrowing costs (G21) |
| Inconvertible notes (G19) | Introduce instability into the banking system (F65) |
| Potential for banks to inflate the money supply (E51) | Instability in the banking system (F65) |
| Government monopolizing issuance of paper money (E42) | Stabilizes the monetary system (E42) |
| Government monopolizing issuance of paper money (E42) | Captures inflation tax revenues (H29) |