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Working Paper

Resolving the National Banking System Note-Issue Puzzle

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Under the National Banking System, 1863-1914, national banks that deposited sufficient collateral could issue notes provided they paid a tax on notes in circulation: 1 percent per year before 1900 and 1⁄2 percent thereafter. Because note issue was far below the allowed maximum, an arbitrage argument predicts that short-term nominal interest rates should have been bounded above by the tax rate. They were not. That is the note-issue puzzle. Our resolution takes the form of a model in which notes play a role, but in which the profitability of note issue is not tied to anything that resembles a market rate of interest.
12.01.2003ISSN 2573-7953 WP 03-16DOI 10.26509/frbc-wp-200316
Keywords bank notes, national banking system, interest rates, random matching model
JEL Classification Codes E42, N11

Working Papers of the Federal Reserve Bank of Cleveland are preliminary materials circulated to stimulate discussion and critical comment on research in progress. They may not have been subject to the formal editorial review accorded official Federal Reserve Bank of Cleveland publications. The views expressed in this paper are those of the authors and do not represent the views of the Federal Reserve Bank of Cleveland or the Federal Reserve System.

Suggested Citation

Champ, Bruce, and Neil Wallace. 2003. “Resolving the National Banking System Note-Issue Puzzle.” Federal Reserve Bank of Cleveland, Working Paper No. 03-16. https://doi.org/10.26509/frbc-wp-200316