A model of the BFH payments system.

• Author: Woolsey, W. William

1. Introduction The BFH payments system was introduced by Robert L. Greenfield and Leland B. Yeager in "A Laissez-Faire Approach to Monetary Stability" |6~. The key element of their proposal is to dispense with base money and instead tie the means of payment to a nearly-comprehensive bundle of goods and services by the institution of indirect convertibility. Their system promises to be free from inflation and several sources of recession.

   While BFH was named to credit Fischer Black |1~, Eugene Fama |3; 4~, and Robert Hail |10; 11~, it must not be confused with their specific institutions or arguments. Greenfield and Yeager modified their ideas and have continued to develop the system |20; 5; 21; 8; 9~.

   The purpose of this paper is to present a model of BFH consistent with simple textbook macroeconomics. Contrary to first impressions, BFH is best understood using the concept of money. But the absence of base money makes the "quantity theory" inappropriate for analysis. Instead, a simple "Keynesian" model illustrates the determination of interest rates, real income, the price level, and the quantity of money. Aggregate supply, the "IS" relationship, and money demand are conventional. Only the money supply process is unusual.

2. Money and BFH

   Sophisticated Barter?

   Fischer Black, Eugene Fama, and Robert Hall claimed their systems are best understood without the concept of money |1, 15; 3, 44; 11, 1553~. Greenfield and Yeager agreed, describing BFH as "a sophisticated system of barter" |6, 314~. Claiming an absence of money can cause unnecessary confusion.

   Payments are made much as they are in a conventional money and banking system. Prices are quoted and contracts are made in terms a common unit of account, and this amount is written on the checks used to make payment. Sellers and creditors accept checks drawn on many banks in payment at par because the banks accept each others' checks for deposit at par. Some formal clearing arrangement allows the banks to cancel offsetting claims and settle net clearings |1, 10; 4, 10; 6, 307~.

   Unusual Checkable Accounts

   One reason Black, Fama, Hall, and Greenfield and Yeager may have found the concept of money inappropriate is their focus on unusual checkable accounts. Black described accounts that are similar to conventional deposit accounts if the balance is positive and similar to conventional credit card accounts if the balance is negative |1, 10-1~. While this is nothing more than the "over-draft" protection provided by conventional banks, Black assumed that any "credit card" balance is directly credited (decreased) when a customer deposits a check.

   By assuming all accounts take this form, Black described a system where the quantity of money is irrelevant. For example, it would be conceivable for each person to match daily payments and receipts. The balances in what appear to be conventional deposit accounts (positive balances) would be zero each evening and morning.

   Rather than pursue Black's approach, Greenfield and Yeager followed Fama and Hall, emphasizing checkable mutual fund share accounts |6, 307~. Fama went so far as to suggest that checks could be drawn on personalized security accounts |3, 41~. While the unit-of-account values of all the various assets could be summed, aggregating the demands for a variety of assets (each with a different maturity, return, and risk) to find a demand for money seems questionable.

   Supply and Demand Determination of Amounts of Means of Payment

   A second reason Black, Fama, Hall, and Greenfield and Yeager may have found the concept of money inappropriate is a supposed supply and demand determination of the amounts of the means of payment. Markets for the various means of payment are supposed to clear like the markets for other financial assets |1, 17; 3, 46; 6, 310-2~.

   They explicitly or implicitly assumed that banks must offer an interest rate on checkable accounts so that depositors are willing to hold the amounts outstanding |1, 11; 3, 46; 6, 311~. Given this assumption, the difference between the yields on other assets and the yields on checkable accounts is a market "price" that directly adjusts so that quantities demanded and supplied are equal. In equilibrium, this "yield differential" must be equal to the marginal cost of providing intermediation services.

   Their assumption is implausible, at least without further explanation (such as that given below). A single bank must pay competitive yields because it will suffer a shortage of funds if its depositors transfer their funds to competing banks. But the banking system cannot suffer a similar shortage of funds because there is no base money for depositors to withdraw.

   Some Special Characteristics of Money

   To understand why the concept of money is useful for understanding BFH, it is necessary to review some essential characteristics of money. Money is accepted in exchange for goods, services, and assets or in settlement of debts even when sellers or creditors have no intention of increasing their money holdings |18, 43~. They usually accept money with the intention of spending it on goods, services, or other assets.

   And since money is often transacted with no intention to change money holdings, there is little reason to negotiate a price and yield on money with each transaction |18, 53~. This is convenient because it simplifies transactions. But it also implies special problems.

   Banks can lend new money into existence because those receiving the new money usually intend to spend it on goods, services, or other assets. They have no reason to insist on a yield sufficient for them or anyone else to choose to hold the new money |19, 4~.

   And if an excess supply of money develops, those with excess money holdings do not need to offer money for "sale" at a lower price and higher yield. They purchase goods, services, and other assets. The sellers do not insist on a lower price and higher yield on money because they intend to spend the additional funds on goods, services, and other assets.

   Similarly, if there is an excess demand for money, those with deficient money holdings do not go to a money shop and offer to pay a higher price or accept a lower yield for newly-issued money. Nor do they go to banks and ask to borrow money. They sell goods, services, and other assets. And because incomes are usually paid in the form of money, they simply can refrain from customary purchases of goods, services, and other assets |18, 56~. Those who buy the assets or fail to make customary sales make up for their now deficient money holdings by also selling goods, services, or other assets and refraining from customary purchases.

   Unusual Checkable Accounts and the Special Characteristics of Money

   The essential characteristics of money would apply even if all means of payment were in the form of checkable mutual fund share accounts. Usually, sellers would accept checks without intending to increase their holdings of mutual fund shares, so they would have little interest in negotiating a price or yield for shares with each transaction. Mutual funds could spend new shares into existence, using checks drawn on their own account to purchase primary securities. Excessive share holdings would result in checks being written to buy goods, services, or other assets. And inadequate share holdings would result in sales and restrictions on customary purchases of goods, services, and other assets.

   The prices and yields on mutual fund shares do depend on market forces, but they do not directly adjust enough to clear the "market" for checkable mutual fund shares. Instead, the supplies of and demands for the primary securities in the mutual funds' asset portfolios determine the net asset values and yields on the shares |14, 63-76~.

   Even Black's unusual checkable accounts provide the advantages and suffer the disadvantages implied by the essential characteristics of money. Sellers accept checks even when they have no intention of adding to a positive or decreasing a negative balance. There is no reason to negotiate with the buyers (or some bank) about appropriate interest rates on either sort of balance when payments are made.

   If the interest rates banks charge and pay are too low, customers will increase expenditures (by check) in an attempt to increase negative and decrease positive balances. And if the interest rates are too high, they will restrict expenditures in an effort to decrease negative and increase positive balances. But credits always match debits, so positive and negative balances are always equal. No shortage or surplus of funds forces the banks or anyone else to adjust interest rates.

   Conventional Checkable Deposits in BFH

   Unusual checkable accounts make the concept...