So, after a week's hiatus, mainly due to busyness but also due to paying too much attention to the election, I'm back with another academic article review :)
This time, we'll be taking a look at "Money is an experience good: Competition and trust in the private provision of money" (2012), by Ramon Marimon, Juan Pablo Nicolini, and Pedro Teles.
The paper is published in the Journal of Monetary Economics. JME, as its name suggests, is one of the top journals in the world about monetary economics, so this paper's got some serious cachet!
Review
This paper asks a question that should be of interest to any Bitcoiner: "Can privately issued currency be efficiently provided by a competitive market for currency?"
This question is of interest to Bitcoiners because Bitcoin is exactly that: privately issued currency competing in a marketplace of currencies (shitcoins, fiat, gift cards... these all count.)
This paper shows that competitive markets cannot generally provide currency efficiently unless the currency issuers can commit to a future monetary policy path (i.e. they can commit to no inflation, or a fixed and scheduled inflation of the money supply.)
Now, what does that freakin' sound like? It sounds like Bitcoin! Bitcoin is a privately issued currency with a fixed monetary policy path. As long as Bitcoin's commitment to its predefined path remains credible, Bitcoin allows for an efficient monetary equilibrium to emerge. (More on credible commitment later.)
The argument is basically that without a credible commitment mechanism, currency issuers will always have an incentive to inflate the money supply once some people in the economy are holding their currency. They have an incentive to do so in order to reduce their nominal liabilities. Even if an issuer has no plans to inflate the money supply, they cannot credibly signal this to the market. Thus, zero nominal rate (a condition for efficiency) cannot be sustained in a competitive equilibrium without credible commitment.
This brings us back to Bitcoin. How does Bitcoin credibly commit to its monetary policy path?
In theory, there is no credible commitment mechanism, even in Bitcoin, because the core developers may at some point in the future decide on a new monetary policy path, for example by issuing tail emissions.
In practice, however, Bitcoin's decentralization offers users some assurance of monetary policy stability. This leads us to the debate on ossification. As Jimmy Song has discussed, Bitcoin is not just a technology, it is money, and this paper confirms Jimmy's intuition that ossification is an important feature of high quality, reliable money.
Since I started reviewing academic economics papers related to Bitcoin, I've been pleasantly surprised at how often they confirm many of Bitcoiners' key intuitions, including Bitcoin's utility for international transfers, Bitcoin's disciplining effect on government deficits, and now the importance of Bitcoin's fixed supply schedule.
More and more, the evidence is piling up that Bitcoin is not just sound money in the minds of Bitcoiners, but it is sound money according to economic theory.
Do the authors understand Bitcoin?
Irrelevant, as the paper is not directly about Bitcoin.
Takeaways for Bitcoiners
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Competitive currency markets are not efficient unless issuers can credibly commit to future monetary policy paths.
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Bitcoin's decentralization offers some credible commitment about its future monetary policy path.
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Ossification is an important feature of high quality money, and high quality (trustworthy) money is needed for efficient currency markets.
Selected quotes
(Some quotes modified for readability)
Can currency be efficiently provided by competitive markets? A traditional laissez-faire view--as has been expressed, for example, by Hayek--argues that competition drives the price of money (the nominal interest rate) to zero and private provision of currency is efficient.
We show that there is a major flaw in this competition argument, when applied to fiat money: If suppliers of currency cannot commit to their future actions, then competition loses its bite. Once agents hold a particular currency, there may be an incentive for the issuer to inflate the price of goods in terms of this currency, thereby reducing its outstanding liabilities.
Does competition still drive promised rates of return to the efficient level? Not if issuers of currencies are not trusted.
With commitment, currency competition achieves the efficient (Friedman rule) monetary equilibrium, as Hayek envisioned.
Without commitment, negative inflation cannot be sustained... (and) Hayek's conjecture that efficient monetary equilibria can be achieved through currency competition is not verified.
In one sense, money is also an experience good. The quality of money is the amount of goods that money can buy, which can only be observed ex post... The mechanism that can sustain high quality is trust, not competition.