Competition and Monopoly in the Federal Reserve System, 1914-1951: A Microeconomic Approach to Monetary History.

• Author: Selgin, George

By Mark Toma.

Cambridge, UK: Cambridge University Press, 1997. Pp. xiv, 132. $49.95.

This book addresses what its author calls an important omission in monetary economics, namely, the lack of a microeconomic theory of money supply under central banking. While a relatively firm microeconomic foundation, dating back to Edgeworth (1888), exists for the theory of money supply in decentralized specie-based banking systems, studies of central banking systems typically eschew a microeconomics approach in favor of ad hoc assumptions, for example, that central bankers are discretionary decision makers, guided by objectives other than profit maximization and constrained only by money's limited ability to influence real economic variables.

In place of these standard assumptions, Toma employs a framework in which governments seek seigniorage as part of an optimal taxation scheme, enlisting central bankers as their agents. The central bankers, in turn, face competitive pressures: Competition, Toma insists, operates even where the currency industry has been nationalized. Only the degree to which competitive forces constrain central bank behavior varies with changes in the structure of the central banking system, which the government is free to alter in accordance with its changing revenue needs. So long as this structure and implied constraints are modelled accurately, "competition in the market for central bank money" can be shown to lead to "equilibrium outcomes analogous to the outcomes one typically observes in more standard market settings (p. 115)."

Working within the above-stated methodological framework, Toma proceeds to develop a general model of reserve-bank behavior. In the basic model, competition forces private, competing reserve banks to pay interest on reserves, encouraging their correspondents to remain relatively liquid and driving seigniorage to zero. A monopoly reserve bank, on the other hand, would impose a reserve-holding (opportunity) cost on the private banking system sufficient to yield maximum seigniorage profit, with the elasticity of demand for bank reserves equal to - 1. Government may act to achieve something approaching this monopoly outcome, while expropriating the resulting profits, either by restricting entry into the reserve-bank industry to a single firm or by imposing other legal restrictions aimed at enforcing a reserve-bank cartel, with the degree of anticompetitive restrictions chosen in accordance with the severity...