17 - Some unsolved problems for monetary theory

Summary

In this paper, I discuss two policy questions which I regard as unresolved: Should interest be paid on money and should currency provision be in the hands of the government? An affirmative answer to the first question stands as one of the few widely accepted general results of monetary theory. My discussion is intended to cast doubt on it. There is no widely accepted answer to the second question; some have asserted that currency provision is a public good while others have asserted that currency provision should be left to the market. My discussion of currency provision will not provide a resolution. Instead, I will discuss a way of formulating the question that seems to offer some hope for resolving it.

Payment of interest on money

The casual statement on the case for paying interest on money is familiar. Real balances are produced at zero social cost. In an equilibrium in which the real yield on other assets exceeds that on money – or, more generally, in which the marginal rate of substitution between future consumption and present consumption exceeds the real return on money – individuals face a positive alternative cost of holding money. Given the zero social cost, this positive alternative cost implies that too little money is being held. Payment of interest on money removes the positive alternative cost. I focus on one aspect of this casual statement: How does an equilibrium arise with a real return on money less than the relevant intertemporal marginal rate of substitution?