Private and Public Circulating Liabilities

Legal and technological changes have made private banknote issue, or its electronic equivalent, possible. We construct a model where private liabilities circulate, either by themselves or alongside outside money. We provide results on existence and multiplicity of equilibria and characterize dynamics near steady states. Our results support Friedman in that circulating private 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 government should leave currency creation to "the market") also is often constrained-suboptimal. Both public and private circulating liabilities are required for optimality. Journal of Economic Literature Classification Numbers: E3, E4, E5.