A Legal Restrictions Theory of the Demand for "Money" and the Role of Monetary Policy

Abstract

In this paper, I discuss a simple theory that explains the coexistence of alternative assets, some of which have significantly higher yields or returns than others. 1 The theory attributes such a paradoxical pattern of returns among assets to legal restrictions on private intermediation, an example being the widespread prohibition against private bank note issue.As I will show, this theory has as an almost immediate implication that monetary policycentral bank asset exchanges accomplished through open market operations or discount window lending-matters only in the presence of binding legal restrictions on private intermediation.2 In the first section, I describe obvious instances of paradoxical rate-of-return patterns and argue that these would disappear under laissez-faire-that is, in the absence of legal restrictions on private intermediation.The implication for monetary policy-that monetary policy under laissez-faire does not affect anything, not even the price level-is explained in the second section.In the third section, I discuss whether legal restrictions ought to be imposed.Although I do not arrive at a recommendation, I do discuss some of the considerations that are relevant to arriving at one. Legal Restrictions and the Coexistence of High-and Low-Return AssetsAn obvious instance of a paradoxical pattern of returns among assets is the coexistence of, on the one hand, U. S. Federal Reserve notes (U.S. currency) and, on the other

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