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Nick, I think this is exactly right, and it's why Scott Sumner says over and over that the critical role of "money" is as a "medium of account". The medium-of-exchange role is ancillary, and it matters little (from a monetary economics point of view) whether currency, checks, credit cards, or bitcoin are used as the medium of exchange. From an anti-racketeering point of view, the medium of exchange is crucial, but from a monetary economics point of view, all that matters is the medium of account, for exactly the reason you've given. Here is an article that does not mention bitcoin but poses an example basically the same as the one in your post, explaining why the medium of exchange doesn't matter:



Kenneth Duda
Menlo Park, CA

Nick, I have a question that maybe you can answer. I apologize in advance if it is a dumb question.

I have been thinking about the fact that Bitcoin is infinitely divisible, i.e. you can set a price of 1 Bitcoin, 0.1 Bitcoin, 0.01, 0.001, 0.0001, and so on... There is no limit to its divisibility because, unlike paper currency, it is a Real Number.

How might we expect the infinite divisibility of digital currency to impact inflation? I would expect it to slightly reduce the rate of increase of inflation (ceteris paribus) because there are no denomination contraints. That is, the smallest possible inflation increase for the USD is 0.01 USD; whereas, there is no limit to how small an increase of inflation in BTC can get. It can get arbitrarily, asymptotically small.

Do you think this is a significant issue, or is it merely an insignificant mathematical curiosity? I myself genuinely do not know. I would appreciate reading your thoughts, if you have any here. And again, I apologize if this question is just plain silly.

Kenneth: I differ slightly from Scott on this. I think it is *both* the MOA and MOE functions that matter, but only when they come together.

RPLong: I don't think it's significant. Empirically, abolishing the penny doesn't seem to make much difference to inflation.

Interesting. I didn't realize that was empirically consistent with pennies/small coins. Thanks!

This analysis makes sense, but then it raises another question: how can a shortage of conventional MOE occur during a period of globally loose monetary policy? Are conventional currencies unsuited for the types of exchanges bitcoins are being used for, or is monetary policy failing to supply the MOE to the people who are demanding it?

Majromax: good question. I think it depends on how easy it is to substitute between different currencies. Network effects and all that.

RPLong, it is not literally infinitely divisible. The smallest possible unit is called a "Satoshi".

Kenneth, bitcoin is only divisible up to 8 decimal points. Thus 0.00000001 BTC is the smallest it can go.

Nick: "Quite probably, someone else has already said this"

I believe Izabella Kaminska has made the same argument.

Three notes unrelated to each other but related to the post:

1. If I remember right Brazil did an experiment where it had one specially-created currency that served as a unit of account (by law, even though this currency did not exist physically until later) while the original currency continued to serve as medium of exchange. The aim was to curb the momentum of rising inflation.

2. Perhaps individual people like price stickiness (even though it can cause demand-driven recessions in aggregate). There is something comforting when you're secure in the knowledge that a dollar bill can buy you the same amount of stuff tomorrow as today. Or that the the sticky wage you get (in nominal terms at least and in real terms too, if prices are sticky as well) is going to be the same today and tomorrow. In the model above, Bitcoin prices will be very volatile which is great for making the real value of money flexible, but will make Bitcoins less attractive to people who dislike volatility.

3. What if all exchanges were made directly from the portfolio/mutual fund of the buyer to the portfolio/mutual fund of the seller while dollars were the unit of account? Would that have a similar impact in terms of dampening recessions?

"Suppose dollars are the medium of account, and the price of goods in terms of dollars is sticky. An excess demand for dollars will mean that some people are unable to sell goods for dollars. But if the price of Bitcoin in terms of dollars is perfectly flexible, and hence the price of goods in terms of Bitcoin is perfectly flexible, there cannot be an excess demand for Bitcoin. People will still be able to sell goods for Bitcoin. Some will choose to do so, and will then buy other goods with Bitcoin. Which means the recession will be smaller than it otherwise would be. Which is a good thing."

Good stuff, Nick. If bitcoin is used as an intermediary, dollars define the unit, and bitcoin prices are perfectly flexible in terms of dollars, then we have no more sticky price problem, right? Wouldn't this mean that we'd never get monetary-driven recessions? (You say they'd be smaller). It wouldn't matter what incompetent things a central banker did (hyperinflation/ultradeflation) since the bitcoin:dollar margin would take the brunt of any adjustment. (I wrote a similar piece on MOE/MOA divergence and stickiness, although having to do with Chile's Unidad do Fomento).

Here's a post I did on this topic:


Recessions are not just caused by sticky prices.


JP Koning: "If bitcoin is used as an intermediary, dollars define the unit, and bitcoin prices are perfectly flexible in terms of dollars, then we have no more sticky price problem, right? Wouldn't this mean that we'd never get monetary-driven recessions?"

To get any effect, don't people have to hold on to the bitcoins for long enough? Because of its volatility, if I accepted bitcoins in payment for something, I would turn around and buy dollars with them right away. If anything, buying those dollars would have a deflationary effect, right?

Now, the willingness of people to accept bitcoins in payment effectively increases the money supply. Wouldn't any anti-recessionary effect come from an increased willingness to accept bitcoins as recession looms or occurs? Otherwise, the acceptance of bitcoins as part of the supply of money would already have happened, and there is no increase to ward off recession. N'est-ce pas?

To make a slightly different point, if bitcoins are widely accepted in payment alongside dollars, won't prices in bitcoins be sticky, as well?

The problem with this set up is that the government only accepts its own currency to pay taxes. So, people can trade all they want with bitcoins, but they need dollars to pay the government. In the real world, bitcoins are considered assets and so trading with them in Canada triggers deemed dispossession rules creating capital gains taxes on the bitcoins themselves. Since every transaction (barter or not) requires dollars for tax purposes, bitcoins are not special as an asset for trading. It would make more sense to transact with shares of the Vanguard Total Stock Market Index.

Nick, I think there is a problem with your logic. For there to be a dollar price of bitcoins, there must be a market in which dollars are exchanged for bitcoins. This means there must be a demand to hold dollars for some purpose. This means we can still have an excess demand for dollars.

Another way of looking at it is that even though the dollar price of bitcoins is flexible, and the bitcoin price of goods/labor is flexible, the product of those two prices (the dollar price of goods) is still sticky by assumption, which means you should still be able to get recessions.

Avon: I'm definitely not an expert on Bitcoin. But the way I read it is that trading in Bitcoin is a lot cheaper, and more convenient, than trading in shares. But I do like the idea of using shares (or index funds) of some sort as a medium of exchange.

Alex: Yes, you could still get recessions, if dollar prices are sticky, and some people use dollars. But maybe smaller recessions.

Min: Yes, I think if Bitcoin becomes very widely used as a medium of exchange, it will also probably become used as a medium of account as well, and so Bitcoin prices will become sticky. So we are right back where we started. Only maybe much worse, given the very inelastic supply of Bitcoin?

"But if Bitcoin ever becomes a medium of account too, this won't work."

Suppose currency is MOA and MOE. Bitcoin won't become MOA unless there is a guaranteed fixed convertibility. Now the demand deposits from commercial banks is a different story.

Instead of a gold standard, I believe most countries are on a demand deposit standard.

And, "one prediction of the monetary disequilibrium theory of recessions is that we should expect to see more people resorting to barter during recessions,"

Isn't barter supposed to be taxable?

Nick: “But the way I read it is that trading in Bitcoin is a lot cheaper, and more convenient, than trading in shares.”

I think that we already have the technology to make trading shares of the an index (or index ETF) more convenient and reliable than bitcoins. Because of history, we use fixed-value claims to make transactions - it was probably the only way to provide enough liquidity for transaction purposes. No one could look up a stock index in real time to make transactions in the past, but we can do that now completely transparently (and much more transparently than with bitcoins). If you think about it, banks net most transactions today anyway, with nothing actually exchanged - so in some sense, we are already there technologically. If we want to use liquid assets in transactions, I am would not look to bitcoins as a template for a starting place.

Avon: I read this article on Bitcoin recently. It seemed to me like a good defence of Bitcoin's convenience and security. But it is not obvious to me why some regular bank cannot do something equally good. Maybe using an index fund, or something, or maybe just dollars.


I've seen you do a lot of interesting thought experiments on this blog so I thought you might be willing to put some thought into this. What would be the implications for monetary policy if the government of Canada said that Euros, Dollars, and Bitcoins would be legal tender, acceptable for paying taxes. Private businesses and individuals could accept whatever of the above currencies they desired.

What I find interesting about this is that it suddenly makes a central bank accountable to the customers, the people who use the money. There has never been consumer choice in money before. I figure if competition is good in other industries, why not in the production of money? This would at least make it very difficult for a central bank to run high inflation every year as people would just start using other another currency.

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