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New Methods of Payment May Help to Protect Value of U.S. Dollar

Although U.S. dollars in cash and checking accounts are still the primary means of conducting transactions in the United States, credit cards, “smart cards,” and new electronic forms of payment are expected to become increasingly competitive. According to a recent Economic Commentary published by the Federal Reserve Bank of Cleveland, the presence of these new exchange media may help to maintain the purchasing power of the dollar.

The Commentary’s author, economist Ben Craig, says the acceptability of any form of payment depends on the belief that its future purchasing power will not degrade too fast, and on sufficient supply to sustain transactions. He uses several historical examples to show how failure to protect the value of a money may cause it to lose its medium of exchange privileges.

Craig says that “fiat” money, whose value is based solely on the fact that government has declared it as money, faces special risk of losing its exchange value, because the producer of the medium has an incentive to inflate it. This incentive results from the fact that the producer realizes a net revenue gain from the production of money units whose nominal value exceeds the cost of making them.

However, Craig observes, in the presence of competing media of exchange, the costs of money inflation are higher than the benefits gained from producing more units. To the extent that policymakers are tempted to inflate their money, competition from other media of exchange may provide a necessary discipline.

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