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BANKNOTES AND ECONOMIC GROWTH William D Lastrapes Professor of Economics Terry College of Business University of Georgia Athens GA 30602 last terry uga edu and George Selgin Professor of Economics Terry College of Business University of Georgia Athens GA 30602 selgin terry uga edu November 29 2007 ABSTRACT Modern paper currency contributes little to productive investment This shortcoming is not inherent to paper money It stems from the fact that currency today is monopolistically supplied by public monetary authorities that are poor intermediaries Commercial banknotes in contrast support efficient intermediation The holding of private banknotes promotes economic growth just as the holding of private bank deposits does We demonstrate this advantage in an 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 Keywords Endogenous growth economic development financial repression fiat money currency JEL Codes E5 G2 O1 O4 Historically local banks of issue have played an important role not only in habituating the populace to the use of financial instruments and institutions but also in the development of small scale local industry and agriculture Conceivably this can be done by means of deposit money but in relatively primitive conditions where laborers and entrepreneurs alike have but little sophistication in the use of modern financial instruments there is much to be said for local banks of issue Rondo Cameron 1967 p 319 Introduction Paper money forms a far from trivial part of the world s money stock As of 2004 international balances of paper money excluding sums held by banks were worth 3 2 trillion A disproportionate share of this paper circulates among poor persons The official currency stocks of many less developed countries exceed 10 percent of their GDP



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