This paper comments on "The Real Bills Doctrine vs. the Quantity-Theory: a Reconsideration" by T. Sargent and N. Wallace. It argues that there exists a class of models similar to theirs that is (a) favorable to the quantity theory view of price stability, (b) supports the imposition of 100 percent reserve requirements, and (c) explains a long history of legal credit restrictions. In particular, lending restrictions stabilize price levels and result in Pareto improvements.
This paper considers a view commonly associated with the "quantity theory of money": that banks should face 100 percent reserve requirements. It argues first that the objectives of the quantity theorists' proposals were more than merely price level stability, and that in fact, price level stability was at most a secondary objective of their proposals. Second, it argues that these theorists had a world with distortions in mind with respect to their proposals. These are present in a special setting examined that (a) supports the imposition of 100 percent reserve requirements (on the basis of an unconstrained Pareto criterion), and (b) supports the view that these restrictions stabilize the price level and make its movements more "predictable."
Current approaches to monetary theory and policy owe much to the "quantity theory of money." However, recent theoretical developments suggest that the manner in which money is introduced is more important, even for price level movements, than the quantity of money. Colonial American experience provides a laboratory for discriminating between these views. It is shown here that the nature of backing, rather than the quantity of money, determined its value. Large secular inflations were ended by changing the nature of backing despite the continuance of large note issues (and despite the absence of a metallic standard). Extremely large note issues and note withdrawals are shown not to have produced inflation (currency depreciation) or deflation (currency appreciation).