Banknotes and Economic Growth

Modern paper currency contributes little to productive investment. This shortcoming is not inherent to paper money. It stems from the fact that such money is monopolistically supplied by public monetary authorities that are poor intermediaries. Commercial banknotes, in contrast, are just as capable as commercial bank deposits are of supporting efficient intermediation and, through it, more rapid economic growth. We demonstrate this advantage of commercial banknotes in a modified endogenous growth model, and use the model to simulate, for a sample of developing countries, steady-state growth rate gains from various degrees of banknote deregulation. The simulated gains are large compared to those from conventional forms of financial liberalization