Abstract

Government Securities as Money: Legal Restrictions Theory: State of the Debate and Further Considerations

The market designed for managing transaction holdings has started to move. Money market funds are just one innovative product that exists already. In theory, there would also be other products such as interest-bearing shares of funds eligible for payment purposes. These have been the subject of a theoretical debate in the recent Anglo-Saxon literature. The question is why market participants, besides holding interest-bearing government securities, also hold non-interestbearing “government papers” for payment purposes, ordinarily called bank notes. Since both products’ financial standing and quality are equal, their existence side by side is paradoxical. Believers in the legal restrictions theory have put forward the hypothesis that legal restrictions on private intermediation of government securities in shares of funds were precisely the ones which prevented cash money from crowding out. On the other hand, the opponents of the legal restrictions theory maintained that the ultimately exorbitant costs of intermediation and transaction prevented government securities from being offered as money. This much about the debate. Further considerations show that on grounds of innovation theory the main argument of the legal restrictions theory cannot be accepted. It is to be presumed that legal restrictions on and impediments to private intermediation can be overcome by appropriate innovative financial products in the longer term. The question should thus rather be whether the cost functions used by the proponents of the legal restrictions theory in their models might not be helpful. It may be demonstrated on the basis of the demand function of network products that government securities, when used as money, generate exorbitant initial marketing costs that might nib any marketing success in the bud. The main reason therefore is the legal institute of central-bank money being legal tender. It follows therefrom that the legal restrictions applicable to the marketing of money which adequately explain the co-existence of non-interest-bearing bank notes and interestbearing government securities.