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Two hypotheses concerning firms issuing debt for the first time are tested. The first is that new firms' debt will be discounted more heavily by lenders, compared to firms that have credit histories (but are otherwise identical), and that this excess discount declines over time as lenders observe defaults. The declining interest rate corresponds to the formation of a "reputation," a valuable asset that provides an incentive for firms not to choose risky projects. The second hypothesis is that prior to the establishment of a reputation, new firms issuing debt are monitored more intensely. The sample studied consists of new banks issuing bank notes for the first time during the American Free Banking Era (1838-60). The presence of a reputation effect in note prices is confirmed: the notes of new banks are discounted more heavily than the notes of banks with credit histories. Note holders are then motivated to monitor new banks because the excess discount provides an incentive for the notes of new banks to be redeemed. As lenders learn that new banks can redeem their notes, the discount declines as predicted for surviving banks. The precision of learning increases during the period because of technological improvements in information transmission, namely, the introduction of the telegraph and the railroad. The results explain why the pre-Civil War system of private money issuance by banks was not plagued by problems of overissuance ("wildcat banking"). [ABSTRACT FROM AUTHOR]

Since 1971, no major currency has a formal link to a commodity. For the first time in history, every currency is wholly irredeemable, not as a temporary expedient but as a permanent matter. Monetary economists have generally treated irredeemable paper money as involving negligible real resource costs compared with a commodity currency. To judge from recent experience, that view is clearly false as a result of the decline in long-term price predictability. a key question for the future is, What if any substitute for a commodity standard will emerge as a long-term anchor for the price level? [ABSTRACT FROM AUTHOR]

There are two ways in which the quantity of money may be included in a general equilibrium system: as a datum, whose value is fixed exogenously, or as an unknown, whose value is determined by the equilibrium system itself. Let them be called active money and passive money, respectively. Current monetary theory uses the first approach. The Ricardo-Walras-Keynes tradition in general equilibrium models is clearly of the active-money variety. This is also true of the more contemporary versions, such as Patinkin's well-known system (1965).[1] Apart from the main stream of thought, however, a number of analyses exist which imply passive money. The gold--standard model, as it is usually expounded, belongs to this class. The price of gold in terms of money is given, while the stock of money is endogenously determined by the set of equilibrium conditions. The form in which the quantity of money adapts to its equilibrium level differs according to the institutional mechanism: Convergence is assured through monetization and demonetization of gold in the pure gold-currency system, and through convertibiliy of notes into gold and vice versa in the gold-standard system with paper money. In either case, the money supply is allowed to conform to its equilibrium volume. This kind of monetary system, in which the money price of a certain product or commodity is a datum and the quantity of money a dependent magnitude, may be denoted in general as a commodity standard. Today the chief motivation for passive-money hypotheses stems from inflation theory. The labor standard underlies nearly all cost-inflation models. Structural inflation analyses, on the other hand, presuppose the existence of some commodity standard; they view the main strand of causation as framing from the price level to the quantity of money, rather than in the opposite way.[2] Occasionally credit-standard arguments are combined with cost- or structural-inflation theses.[3] Thus the assumption of passive mon... [ABSTRACT FROM AUTHOR]