Commodity Money, Free Banking, and Nominal Income Targeting: Lessons for Monetary Policy Reform

46 Pages Posted: 13 Oct 2018 Last revised: 22 May 2019

See all articles by Joshua R. Hendrickson

Joshua R. Hendrickson

University of Mississippi; American Institute for Economic Research

Date Written: September 21, 2018

Abstract

Some have argued that nominal income targeting is desirable because it would replicate characteristics of a free banking regime. However, the degree to which this is true and desirable depends on the properties of commodity-based monetary regimes. In this paper, I provide a model of commodity money. I find that a pure commodity money regime can only generate an efficient stationary equilibrium by divine coincidence or by giving policymakers control over the supply of the commodity. The introduction of bank notes makes it much more likely that the economy will achieve an efficient equilibrium. In particular, in a commodity-based system, bank notes are equivalent to call options on the commodity and the commodity holdings are equivalent to a put option on the commodity. Assuming that there is no risk-free arbitrage in equilibrium, then both bank notes and the commodity will have an expected rate of return equal to the risk-free rate. If the risk-free rate is equal to the rate of time preference, then this commodity regime is efficient. A free banking system would therefore not only minimize deviations between the supply and demand for money, but it would also (potentially) implement the Friedman rule. Both market-based and more conventional nominal income targeting regimes are unlikely to replicate both features of a free banking system unless the nominal income target has a deflationary bias.

Keywords: Commodity Money, Free Banking, Nominal Income Targeting, Friedman Rule, Market-Based Monetary Policy, Asset Pricing

JEL Classification: E42, E58

Suggested Citation

Hendrickson, Joshua R., Commodity Money, Free Banking, and Nominal Income Targeting: Lessons for Monetary Policy Reform (September 21, 2018). Available at SSRN: https://ssrn.com/abstract=3253166 or http://dx.doi.org/10.2139/ssrn.3253166

Joshua R. Hendrickson (Contact Author)

University of Mississippi ( email )

Oxford, MS 38677
United States

American Institute for Economic Research

PO Box 1000
Great Barrington, MA 01230
United States

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