Private and public circulating liabilities

Legal and technological changes have made private banknote issue, or its el ectronic equivalent, possible, We construct a model where private liabiliti es circulate, either by themselves or alongside outside money. We provide r esults on existence and multiplicity of equilibria and characterize dynamic s near steady states, Our results support Friedman in that circulating priv ate liabilities are associated with endogenous volatility. But implementing Friedman's advice (the government should ban private currency substitutes) causes significant inefficiency. The proposal of Hayek (that the governmen t should leave currency creation to "the market") also is often constrained -suboptimal. Both public and private circulating liabilities are required f or optimality. (C) 2001 Academic Press.