Walrasian General Equilibrium Foundations of Monetary Theory
Chapter 8: Government-Issued Fiat Money
1 One of the observations this book began with was that money is almost universally uniquely government-issued fiat money (and instruments denominated and convertible thereto) trading at a positive price though it produces no output or utility. There are two issues here: why the positive price, why the universal usage? Positive price comes from acceptability in payment in taxes (a notion that goes back to Adam Smith). Universal usage comes from the scale economy noted in Chapter 6 and government’s large scale, leading the economy to a corner solution where government money is the natural monopoly medium of exchange. 1 TAXATION AND MONEY In order to study fiat money we introduce a government with the unique power to issue fiat money. Fiat money is intrinsically worthless; it enters no one’s utility function. But government is uniquely capable of declaring it acceptable in payment of taxes. Adam Smith (1776) notes ‘A prince, who should enact that a certain proportion of his taxes be paid in a paper money of a certain kind, might thereby give a certain value to this paper money’ (Vol. I, Book II, ch. 2, p. 398). Abba Lerner (1947, p. 313) comments, The modern state can make anything it chooses generally acceptable as money and thus establish its value quite apart from any connection, even of the most formal kind, with gold or with backing of any kind. It is true that a simple declaration that such and such is money will not do, even if backed...
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