VOL. 74 NO. 3 KING AND PLOSSER: MONEY, CREDIT, AND PRICES 369 hypothetical economy developed above. In portional link between financial services(d, this section, a non-interest-bearing govern- and deposits(yd, ) the effective cost of a unit ment-supplied fiat currency(dollars)is intro- of deposit services, p, is influenced by this duced and the factors affecting its value are reserve regulation. In the absence of regula analyzed ions p,=p, where P, is the rental price of In order for currency to be a well-defined deposit services in the competitive env economic good, and thus to have a de- ment of Section I terminate price in terms of a unit of output ransactions cost minimization by house- (1/P), there must be a demand function for holds implies real demands for currency and currency that reflects the economic value as- financial services of the following forms signed to the services of currency by eco- nomic agents. For simplicity, we assume that households are the principal demanders of (6a)c1=l(R1/(1+R1),p1,w)y currency. To generate ble demand for currency, real currency is viewed as a sub stitute--but not a perfect one--for transac- (6b) dh-8(R,(1+R),P,w)y, tions services purchased from the financial ector. In particular, currency yields a real ervice flow in that there are some transac- The signs below the arguments denote the tions(either of magnitude or character)that signs of the partial derivative(for example, are more efficiently carried out using ac,/ap, >0). These signs are insured if T( rency than the accounting system of is such that currency purchasing por hange. We revise the household's time spent financial services are substitutes n transactions activities, equation (4), to re- The structure of the markets for currency flect these expanded opportunities and financial services is analogous to Fama (1980). As he points out, determinacy of the (5)nn1=T(an,/y,c1/)y price level is insured if the government fixes the nominal quantity of currency-direct or where y, is the total market transactions of indirect regulation of financial sector quanti our household, c, is the stock of currency ties and/or characteristics is not necessary. urchasing power, and dht is the flow of Nevertheless, regulations can be important inancial services purchased from the finan- for two reasons. First, regulations produce a ial industry differentiated class of suppliers of financial Thus, a household minimizing its cost services(banks) whose deposits are some transaction activities will select amounts of times described as inside money. Second, that is analo- regulations can influence the price level by gous to our earlier discussion. The demands altering the effective rental price of financial for each input will be a function of the rental services price of real currency, R /(1+R), the The analysis below focuses on the implica effective cost of financial services P, and the tions of alternative banking structures for the opportunity cost of time, w behavior of currency, deposits, and prices In formin g these rental prices, two im- For clarity, the bulk of the discussion is portant assumptions are made. First, there is conducted under the assumption that the a market for one-period nominal bonds that treasury-central bank maintains a policy of bear interest rate R. This nominal rate is the controlling the issue of nominal currency so sum of the real component, r, and an ex- that the stock of currency(C=P,,)is an pected rate of inflation, E(T). Second, if exogenous random variable. This assumption banks are required to hold non-interest-bear- means that the behavior of the price level ing reserves, the returns earned by depositors can be analyzed by investigating equilibrium may not match market rates. Given the pro- in the currency market. Other models of entral bank behavior are discussed in Part B yWe assume that T1 <0, T2<0, Tn <0, Tz< 0, and below. In all of our discussions, however,the price level is best viewed as being set in the