An oligopoly model of free banking: Theory and tests

Summary The paper demonstrates that in an environment of free banking where some agents have imperfect information regarding the circulation and debasement rates of alternative money suppliers, the equilibrium supply of money involves mixed strategies. It follows that the circulation and debasement rates are intrinsically stochastic, but that their averages are below the rates set by a monopoly bank. Empirical tests reveal that these predictions are consistent with the free banking era of the United States. The paper is also relevant for the discussion about the future monetary union in the EC. We are grateful to J. Carlson, D. Jansen, R. van der Ploeg and the referees for their stimulating comments, to L.T. Gordon of the Krannert Economics Library for providing the data, and to J.G. Song for his able computational assistance.