The prince, who should enact that a certain proportion of his taxes should be paid in a paper money of a certain kind, might thereby give a certain value to this paper money; even though the term of its final discharge and redemption should depend altogether upon the will of the prince. If the bank which issued this paper was careful to keep the quantity of it always somewhat below what could easily be employed in this manner, the demand for it might be such as to make it even bear a premium, or sell for somewhat more in the market than the quantity of gold or silver currency for which it was issued." (Adam Smith, The Wealth of Nations. New York: Modern Library. 1937, p. 312) Assume a government requires that taxes can only be paid in the deposits issued by a particular private bank. Explain how that bank could adjust the interest rate on deposits or the availability of its deposits in order to profit from its position as the supplier of the only money that can be used for tax payments. What would be the effect on the price level (measured in units of the bank's money) over time if the bank was anticipated to pursue such a policy? Assume taxes are paid annually.

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Hayeks central point in Denationalisation of Money is that there is no innate reason for governments to have a monopoly on money He makes the case that private banks should be able to issue their own ... View the full answer