This book describes our efforts to discover the origins of a principle that central banks now routinely use to manage a country’s supplies of coins and notes. Because that principle cured what had been widespread and enduring problems of monetary management, our search revealed much about broader historical monetary and fiscal problems and about the origins of the general principles that most experts now think should govern monetary policy.
Today almost all governments use a “standard formula” for supplying and pricing coins and currency. A government’s monetary authority sets prices; the public chooses the quantities. The monetary authority sets the prices by offering to convert unlimited quantities of different denominations of currency and coins at fixed exchange rates (e.g., the U.S. government stands ready to buy or sell a quarter for five nickels). With an eye toward controlling an overall index of the price of goods and services, the monetary authority also sets the total quantity of government currency and coins (the supply of “base money”), but it does not choose its composition across denominations. The public determines the composition of base money by exchanging coins and currency with the government. Today coins and currency of all denominations are “tokens”: they are valued not because of their constituent paper or metal, but because of the goods that people can exchange for them.
This standard formula for determining the relative prices and quantities of denominations of coins and currency has worked well for over a century. But for hundreds of years before 1850, other and less reliable principles regulated the denomination structure of coins. Governments did not offer to convert one denomination for others at fixed prices. Instead the market set those prices, but in ways that troubled monetary authorities. For centuries, monetary authorities and traders complained about undesirable fluctuations in both the quantities and the relative prices of coins of different denominations. Monetary policy experts struggled with these problems for a long time before they eventually adopted the modern standard formula in the mid-nineteenth century. That put in place an essential piece of our modern fiat money system, as well as of the gold standard that preceded it.
Work on this book began after a conversation between the authors in August 1996 about the discovery of the modern standard formula. Carlo Cipolla told how centuries of monetary problems and trials and errors in monetary policy preceded the standard formula, but did not reveal how it was discovered. Sargent conjectured that before the standard formula, public policies for supplying small change were flawed because policy makers had the wrong model; the inventors of the standard formula revealed a better model and thereby made better policy possible. Citing Redish (1990), Velde countered that to implement the standard formula requires a reliable technology for making coins that are difficult to counterfeit, and that technological limitations, not ignorance of good monetary theory, could just as well have been responsible for the monetary difficulties that were observed before policy makers implemented the standard formula.
So this book began with the question: Was it poor economic theory or inadequate technology that long delayed the proper implementation of the standard formula? We now think that it was both. We eventually identified an early proponent of the standard formula, Sir Henry Slingsby in 1661. But we also found that Slingsby did not work in a vacuum, that he must have learned from earlier theorists and monetary experiments, and that there were formidable technological impediments to implementing Slingsby’s policy recommendations. We discovered how ideas about supplying small change contributed much to the development of modern monetary doctrines.
We came to this project as modern monetary economists whose curiosity was aroused by reading Carlo Cipolla’s (1956) account of monetary puzzles from the fourteenth and fifteenth centuries. We sought to understand Cipolla’s observations about renaissance Florence with monetary theories constructed mostly during the 1980s. As we returned to Cipolla’s account during the process of building our model, and as we listened to what our model told us, we came more and more to respect and appreciate Cipolla’s account, and how his selection of facts and his interpretations reflected modern monetary theories. But Cipolla wrote before modern theories were developed. Late in our research, we recognized the likely identity of Cipolla’s teachers: the commentators and discoverers from long ago, some of whose works we cite in this book. Much of the novelty of the monetary theory of the 1980s is in its formal style, not the ideas that it represents, which were created partly through the process to be described in this book.