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Demandable debt as a means of payment: banknotes versus checks

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  • Charles M. Kahn
  • William Roberds
Abstract
We examine the question of whether transactable forms of privately issued, demandable debt are better used as \"banknotes\" or \"checks.\" The distinction between the two is that a check must be redeemed by the issuing bank with each use, whereas a banknote can circulate. We find that the answer to the question depends critically on the cost of early redemption. If this cost is small, banknotes will not circulate, so the question is moot. If this cost is large, incentive problems will prevent the issue of banknotes. For intermediate values of the early redemption cost, the option of early redemption limits the bank's risk-taking behavior, so that banknotes will be preferred over checks.
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Suggested Citation

  • Charles M. Kahn & William Roberds, 1999. "Demandable debt as a means of payment: banknotes versus checks," Proceedings, Federal Reserve Bank of Cleveland, pages 500-530.
    • Handle: RePEc:fip:fedcpr:y:1999:p:500-530
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    References listed on IDEAS

    as
    1. Arthur J. Rolnick & Warren E. Weber, 1988. "Explaining the demand for free bank notes," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 12(Spr), pages 21-35.
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    5. repec:bla:jfinan:v:53:y:1998:i:1:p:99-129 is not listed on IDEAS
    6. Calomiris, Charles W & Kahn, Charles M, 1991. "The Role of Demandable Debt in Structuring Optimal Banking Arrangements," American Economic Review, American Economic Association, vol. 81(3), pages 497-513, June.
    7. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
    8. Flannery, Mark J, 1994. "Debt Maturity and the Deadweight Cost of Leverage: Optimally Financing Banking Firms," American Economic Review, American Economic Association, vol. 84(1), pages 320-331, March.
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    10. repec:bla:jfinan:v:53:y:1998:i:1:p:65-98 is not listed on IDEAS
    11. Williamson, Stephen D., 1992. "Laissez-faire banking and circulating media of exchange," Journal of Financial Intermediation, Elsevier, vol. 2(2), pages 134-167, June.
    12. Gorton, Gary, 1996. "Reputation Formation in Early Bank Note Markets," Journal of Political Economy, University of Chicago Press, vol. 104(2), pages 346-397, April.
    13. Rockoff, Hugh, 1985. "New Evidence on Free Banking in the United States [New Evidence on the Free Banking Era]," American Economic Review, American Economic Association, vol. 75(4), pages 886-889, September.
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    Cited by:

    1. Daniel Sanches, 2016. "On the Inherent Instability of Private Money," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 20, pages 198-214, April.
    2. Daniel Sanches, 2016. "On The Welfare Properties Of Fractional Reserve Banking," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 57(3), pages 935-954, August.
    3. Daniel R. Sanches, 2013. "Banking crises and the role of bank coalitions," Working Papers 13-28, Federal Reserve Bank of Philadelphia.
    4. Daniel R. Sanches, 2013. "On the welfare properties of fractional reserve banking," Working Papers 13-32, Federal Reserve Bank of Philadelphia.
    5. Daniel Sanches, 2016. "On The Welfare Properties Of Fractional Reserve Banking," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 57, pages 935-954, August.

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    Keywords

    Bank notes; Checks;

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