DP7362 The Evolution of Paper Money

Author(s): Oren Levintal , Joseph Zeira

Publication Date: July 2009

Keyword(s): Banks , Convertibility , Fiat Money , Financial Intermediation , Liquidity , Paper Money

JEL(s): E4 , E5 , N1 , N2

Programme Areas: Financial Economics , International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP7362.asp.asp

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.