Private vs Public Nominalism, and Interest on Money

Suppose I want to borrow money. So I issue a financial asset I call "NRUnits". You can buy NRUnits from me at $1 each.

I consider two different policies to give people sufficient incentive to want to hold NRUnits:

1. I promise to peg the exchange rate between NRUnits and the dollar, so they are always worth $1 each. And I pay 5% interest on holdings of NRUnits, and I pay that interest in the form of NRUnits, so someone who holds 100 NRUnits worth $100 will hold 105 NRUnits worth $105 one year later.
2. I pay no interest, but promise to have a crawling peg exchange rate between NRUnits and the dollar that appreciates at 5% per year, so someone who holds 100 NRUnits initially worth $100 will hold 100 NRUnits worth $105 one year later.

Nobody (including me) cares which of those two different policies I choose.

Now suppose that NRUnits have no physical existence. My IOUs are not written on bits of paper that I sell to people who want to lend me money. I simply keep a record on a silicon ledger. It's much easier that way. If someone wants to sell his NRUnits to someone else, he just notifies me, and I change the record on the silicon ledger.

The NRUnit is just a name. But at this point it's a name that doesn't even refer to anything that physically exists. If I change the crawling peg exchange rate, but at the same time change the interest rate to exactly offset that change, the only thing I'm doing is changing a couple of lines of code in my computer program. Nobody cares. And no outside observer can even see the difference. The NRUnit is worth whatever I say it is worth. And nobody cares what I say it is worth, as long as I adjust the interest rate paid on NRUnits accordingly.

[Aside: If NRUnits are an imperfect substitute for other assets, there is an imperfectly-elastic downward-sloping demand curve for NRUnits, and the total dollar value of NRUnits that people are willing to hold will be a positive function of the rate of return on holding NRUnits (capital gains plus interest), relative to other rates of return.]

Now suppose that the NRUnit replaces the dollar as medium of exchange. Because I manage it so well that it's just more convenient to buy and sell everything else for NRUnits than use dollars or anything else. And since NRUnits are the medium of exchange, it's more convenient for firms to set prices and wages in terms of NRUnits too. The NRUnit has replace the dollar as the unit of account as well. I am now running the central bank. I choose monetary policy.

[Aside: The demand curve for holding NRUnits shifts up, because NRUnits are now more liquid than other financial assets. So I can issue more NRUnits at the same rate of return, or else reduce the rate of return below that paid by less liquid assets, and even make it negative.]

Is it still true that the NRUnit is worth whatever I say it is worth, and nobody cares, and it doesn't matter, as long as I adjust the interest rate paid on NRUnits accordingly?

I think the answer to that question is "No".

"NRUnit" is just a name. But before it became the unit of account, it was a name that only I used. It was a private name. It could mean whatever I wanted it to mean. I wrote the dictionary. Now that the NRUnit has become the unit of account, it is a name that everyone uses. It is now a public name. Any dictionary becomes descriptive of common usage, rather than prescriptive.

And public names tend to be sticky, because language is a coordination game, where each individual wants to use the same name to refer to the same thing that everyone else uses it to refer to. Like choosing which side of the road to drive on. If I raise my inflation target by 1%, so the NRUnit depreciates 1% more quickly, and at the same time raise the interest rate I pay by the same 1%, it shouldn't make any difference.  But it will make a difference if the people who use the NRUnit as a unit of account to set prices don't all immediately adjust to the new meaning of the name.

Comments

[Ralph Musgrave]

Strikes me a more serious “naming sleight of hand” is the one perpetrated by private banks. They create what they call “dollars” out of thin air when they lend. Actually those so called dollars are not real central bank dollars. They are promises by the private bank to pay central bank dollars to whoever.

However, everyone (apart from other banks) treats privately created dollars as real dollars. There’s no trouble using “fake dollars” to buy stuff at shops.

The big question is this. Why do we allow money lenders (aka banks) to bolster their businesses by letting them print their own funny money? Why can’t car manufacturers or restaurants do the same? That’s an unjustified subsidy for money lenders, seems to me.

[Nick Rowe]

Ralph: "Hey, I just print IOU's that I call NRUnits. I don't have any control over what people do with them! If people only sell my IOUs for central bank money, or sell them for cars and groceries, that's none of my business!"

[Ralph Musgrave]

Nick, I'm sure it's none of your business. Likewise people who produce counterfeit dollar bills adopt the same attitude: once they've printed their dollar bills and bought stuff with them, they don't want to see those dollar bills again. But this whole area is very much the business of society as a whole.

What private banks do is to take over the business of supplying the nation's currency from central banks and governments. Thanks to, 1, bribes paid by bankers to politicians, 2, politicians complete ignorance about matters monetary, and 3, sob stories spun by private banks about economic growth being hit if they aren't allowed to issue their own money, the whole private money printing business is backed by governments (e.g. in the form of deposit insurance).

Nick Rowe printing NRUnits isn't a problem. Likewise local currencies aren't a big problem. But when private banks issue the large majority of a country's money supply, the rights and wrongs of that need thinking about.

[dlr]

I think this description is much more to the point than "asymmetric redeemability." I think the latter is more of a consequence or a provincial way to describe one aspect of the key underlying phenomenon, which is about owning the locus of the network effect; i.e. the public name. Now, of course, this doesn't mean that all parties have an equal chance of owning the dictionary. The government has some big advantages there, or at least most governments do. But it's important not to notice those advantages (power, credibility, visibility) and think they vitiate the importance of the public name. Because public names, once arisen, are still a thing unto themselves.

[Nick Rowe]

Ralph: yep. My tongue was in cheek when I wrote that comment above.

dlr: thanks. I hesitated before posting this, leaving it to sit for a couple of days. I think the asymmetric redeemability answer is a lot clearer, and more in tune with standard economics, than this one about who controls the dictionary. But there's gotta be something to this answer too.

[Roger Sparks]

Your narrative begins with BORROWING money in exchange for NRUnits. The narrative continues with you doing such a good job of managing NRUnits that NRUnits completely replace money.

This narrative is a simple exchange of one property (money) for another (NRUnits). I see no reason that would render this scenario improbable.

However, the continuing narrative has you issuing more and more NRUnits. Presumably you are still borrowing from someone in exchange for NRUnits. WHAT ARE YOU BORROWING when all the money has been displaced?

At some point in time, the continuing displacement of MONEY by NRUnits will begin breaking VALUE links to real physical needs. The public will begin thinking that you are absorbing real physical products and paying with nothing (NRUnits).

Which should (as you suggest) cause prices to rise in terms of NRUnits.

With this narrative in hand, we need to consider what economic dynamics will DRIVE prices either higher or lower. And we need to decide WHICH PRICES we want to go higher or lower. To give an example of what we dealing with, it would be easier to drive up the price of NEW cars than the price of OLD cars. Similarly, it is easier to drive up-or-down the price of SKILLED LABOR than the price of UNSKILLED LABOR.

Perhaps, the narrative continues, you (as the presumptive replacement central bank) can set monetary policy and guide inflation rates. Frankly speaking, I see nothing in the narrative that would give any clue as to which prices would inflate first or why. It seems to me that prices relate more to the previous MONEY economy and less to the newly-installed NRUnit economy.

[Majromax]

@Nick Rowe:

> The NRUnit is just a name. But at this point it's a name that doesn't even refer to anything that physically exists. If I change the crawling peg exchange rate, but at the same time change the interest rate to exactly offset that change, the only thing I'm doing is changing a couple of lines of code in my computer program. Nobody cares. And no outside observer can even see the difference.

I disagree here. If you borrow from me and I own NRUnits, I have to be aware of the difference. If NRUnits are entirely imaginary but I check in with you to remind myself of how much I own, then the difference between the interest rate and crawling peg is the difference between you saying I own 100 NRUnits or 105 NRUnits, and it matters if I promise to pay someone else 10 NRUnits next year.

If you do the conversion yourself and report the difference to me in dollars ($105, in both cases, after a year), then your NRUnits do only exist in your computer program – but then they cannot be exchanged as-is.

Before a unit is a medium of exchange, it has to be exchangeable. Currency is a bearer instrument.

@Roger Sparks:

> However, the continuing narrative has you issuing more and more NRUnits. Presumably you are still borrowing from someone in exchange for NRUnits. WHAT ARE YOU BORROWING when all the money has been displaced?

That doesn't follow. As soon as people mark prices in NRUnits, Nick can issue new Units to buy things outright. He can even make own-money transactions, where he purchases bond contracts to pay X units in the future, and then he's conducting traditional open market operations.

Yes, people will only be willing to hold NRUnits (and mark prices in them) if they expect the currency to maintain its value, but that credibility does not vanish once the original promise to repay would not stand up to a bank run.

> To give an example of what we dealing with, it would be easier to drive up the price of NEW cars than the price of OLD cars. Similarly, it is easier to drive up-or-down the price of SKILLED LABOR than the price of UNSKILLED LABOR.

Nothing about NRUnits cares about cars or labour.

[Roger Sparks]

@Majromax:

A Nick began his narrative, he assumed good management of the NRUnit. Good management earned the trust of the economic players and resulted in NRUunit displacing MONEY. If we think that Gresham's law is valid, NRUnit is a weaker currency than MONEY.

With that conflicting bit of economic observation, what will happen if NRUnits are badly managed by making own-market transactions? It seems to me that the real economy for physical goods will become increasing dislocated from transactions based on exchanges of real value, becoming displaced and distorted by exchanges based on self-generation of NRUnits.

And you are right: "Nothing about NRUnits cares about cars or labour.". That is the problem with self-generated NRUnits--Price is no object when generating NRUnits--the only object is to accomplish the task used as an excuse to generate the NRUnits.

[Market Fiscalist]

I'm just trying to get my head around this post and this is my first take.

If someone is measuring the volume of transactions in terms of the Unit of Account:

- If I have a private currency that people use for some transactions then while the depreciation rate and interest rate I offer may affect people's desire to hold and use my currency , as people always convert my currency unit into the UofA, then these things will have a negligible effect on the total volume of transactions measured in the UofA. When I do neutral things like increasing both the depreciation rate and nominal interest rate it will probably have little effect on people's desire to hold my currency especially if it as electronic currency and they see no change in the value of their holdings expressed in the UoA change over time.

- If my currency becomes the UofA then the depreciation rate and interest rate I offer will affect the real economy as the expected inflation rate and interest rate will influence what transactions actually take place. Even seemingly neutral things like increasing both the inflation rate and nominal interest rate may have real effects.

Am I anywhere close ?

[Nick Rowe]

MF: close. But can I increase the inflation rate (in NRUnits) just by saying it, in the same way I could previously do so?

[Avon Barksdale]

What does the government accept for paying taxes?

[Nick Rowe]

Avon: the government (in my imaginary world) takes any commonly used medium of exchange. Just like I can pay using BMO dollars, TD dollars, etc.

In the olden days some people had to pay some taxes in their own labour. Some still do, in some countries. (Conscription)

[Avon Barksdale]

Therein lies the rub. Suppose the government only accepts dollars to pay taxes - which is usually the case.

[Nick Rowe]

Avon: but NRUnits are so much more convenient that people use them for everything, except the taxes they are forced to pay. They take the dollars they earn from working for the government, and sell them all for NRUnits. And just before tax time they go and buy some dollars so they can pay taxes.

[Avon Barksdale]

This is the coincidence problem that dollars solve. If I use NRunits I have a big problem. I have to mark to market the dollar value of the NRunits at each transaction so the government knows how much taxes are owed at the time of sale. When NRunits are sold capital gains need to be tracked at each conversion. It is so messy that I'll just use dollars in the first place. As long as the government only accepts its own currency for taxes it's pretty difficult to get another medium of exchange going.

[Nick Rowe]

Avon: my computer does all that easily, since it keeps a record of the exact time of each NRUnit transaction, and knows the market price of dollars. The government is happy to accommodate me too, since there's less tax evasion and arguments that way. Plus all the voters are my customers. Soon the government gives up, and agrees to accept taxes in NRUnits too. Why should it bother with dollars, when it only annoys the voters?

[Odie]

Nick: "Avon: the government (in my imaginary world) takes any commonly used medium of exchange. Just like I can pay using BMO dollars, TD dollars, etc."

If Nick is now really running a (beta) bank it would work a bit different. What would happen is that Nick would cancel the amount of NRUnits from the customer and then hand the government the equivalent (pegged) amount in $. (The treasury is a customer of the central bank and requires its taxes in form of a reserve deposit. People just do not realize it since they do not have direct access to reserve accounts.)

[Avon Barksdale]

No Nick, the government will not give up its monopoly on money and nor should it. Even if you could run an efficient armed posse there is no way the government will accept it over its own police forces or military. There are excellent reasons to allow a government monopoly on violence. It's for those same reasons the government will retain its monopoly on money. It will only ever accept its own currency to pay taxes (unless the government fails).

[Mike Freimuth]

Nick,

I don't think ownership of the dictionary is really the issue here. In the first case you are setting a fixed rate of redemption for some other asset at some point in the future. This rate, along with the supposed rate of interest (in NRUnits) and a market rate of return will pin down a price path. If you change the rate of interest the price path will change of course, it's identical to a bond with a coupon rate.

In the second case, if you set a fixed redemption rate relative some other asset (like gold perhaps) at some point in the future, then I suspect you will also be able to change the inflation rate "just by saying it" (either by changing the future redemption rate or by changing the nominal interest rate). Sticky prices might make the adjustment to this more interesting but in the long run, it should work the same.

Of course, I suspect that you have in mind some model with no contractual conversion rate between money and another good but if that's the case then there is the real difference, not who owns the dictionary.

[JEC]

Hi Nick,

I love these thought experiments of yours!

When you say you can set the value of the NRUnit to "anything [you] want," that's not exactly true. You're taking relative prices, denominated in the unit-of-account, as given. You can't say, "An NRUnit is exchangeable for one ham or two bowling balls," unless that happens to be the prevailing price ratio between hams and bowling balls. What you really mean is that you can set the exchange ratio between NRUnits and the unit-of-account to whatever you like.

And, of course, if the NRUnit *becomes* the unit-of-account, that's no longer true. The exchange ratio is (tautologically) fixed at 1-to-1.

[Nick Rowe]

JEC: Good to see you back here! Thanks!

Well, doesn't "An NRUnit is exchangeable for one ham or two bowling balls," mean "MaxPrice{ 1 ham, 2 bowling balls}"?
And by adjusting the interest rate paid on NRUnits, I could do that? (But, unlike bimetallism, I don't want to be buying at the max and selling at the min, because then I'm open to arbitrage.) Or I could peg it to a basket of goods (1 ham plus 2 bowling balls).

[JEC]

Ah: I omitted an "exactly." (Or two, really.) Yes, you can say that the NRUnit can purchase at least one ham and at least two bowling balls. What I had in mind guaranteeing the an NRUnit could purchase *exactly* one ham and *exactly* two bowling balls.

But that only mattered (if it ever really did) if the NRUnit being specified in nominal terms (pegged to the dollar) mattered. But I get the sense that it doesn't; you're equally happy with the NRUnit being exchangeable for (the price of) a basket of goods. So never mind.

What I'm not grasping, I guess, is the meaning of the word "worth" in the sentence "The NRUnit is worth whatever I say it is worth." I think you specifically *don't* mean that its price in an assumed secondary market would be whatever you said it was -- that would require people to care what you say it's worth, and, by construction, they don't. So I'm unclear on exactly what it is that you can do when the NRUnit is private that you cannot do when it is "public." Maybe I'm not fully understanding the terms of the "NRUnit contract." Help?