Henry James, T.S. Elliot famously remarked, “Had a mind so fine that no idea could violate it.” Similarly, more than a few economics papers involve formal models so fine that no facts can violate them.
Two recent examples purport to demonstrate the instability and inefficiency of “private money.” One, on “Private Money and Banking Regulation,” appeared in the September 2015 Journal of Money, Credit and Banking (JMCB). Its authors are Cyril Monnet, a Professor at the University of Bern, and Daniel Sanches, an economist at the Philadelphia Fed. The other, by Sanches alone, is called “On the Inherent Instability of Private Money,” and is about to be published in the Review of Economic Dynamics (RED, for short).
That the models in these papers are indeed “fine,” meaning first-rate, from a strictly analytical point of view, can’t be gainsaid. They meet all of the exacting requirements of those economists who insist that a model’s institutional features should be “essential” in the sense Frank Hahn had in mind when he argued that monetary GE models should provide an essential role for money. The features must, in other words, overcome frictions inherent in the model environment that would otherwise condemn optimizing agents to lower levels of utility. In particular, the models in question supply “essential” roles for indirect exchange, banks, and banknotes. Yet they are tractable enough to allow their authors to draw inferences from them concerning both the stability and the efficiency of private currency. So far as the realm of formal economic modeling is concerned, these are highly impressive achievements.