The Government's Money Monopoly: Externalities or Natural Monopoly?

Abstract

SUMMARYDoes externality theory provide a basis for the government's monopoly in the production of base money? Money, as has been shown, is not a public good because it does not satisfy the non‐rivalness criterion (nor the non‐excludability criterion). Like any public decision, political agreement on a common money or unit of account (i. e., exchange rate fixity) passes the non‐rivalness test. However, whether the imposition of a common money or monetary unit is a public good or a public bad depends on whether money is a natural‐monopoly good or not. Hence, there is no independent public‐good justification for the government's money monopoly. The public good argument is redundant. Whether money is a natural monopoly good cannot be determined a priori, but only on the basis of experience. If governments are natural money monopolists, they should have gained their monopoly position by prevailing in the market. Historically, this is not the case. The only valid test of the natural monopoly argument is to abolish all barriers to entry and to admit free currency competition from private issuers on equal terms. An international cross‐section estimate of money demand functions reveals only weak evidence of social economies of scale in the use of money. By contrast, choice among currencies is shown to be strongly affected by restrictions of convertibility.