¹ These include Smith, Bruce D., “Money and Inflation in Colonial Massachusetts,” Federal Reserve Bank of Minneapolis Quarterly Review, 8 (Winter 1984), pp. 1–14Google Scholar; “Some Colonial Evidence on Two Theories of Money: Maryland and the Carolinas,” Journal of Political Economy, 93 (12 1985), pp. 1178–1211Google Scholar; “American Colonial Monetary Regimes: The Failure of the Quantity Theory and Some Evidence in Favor of an Alternative View,” Canadian Journal of Economics, 18 (08 1985), pp. 531–65Google Scholar; and “The Relationship Between Money and Prices: Some Historical Evidence Reconsidered,” Federal Reserve Bank of Minneapolis Quarterly Review, 12 (Summer 1988), pp. 18–32.Google Scholar

² Smith, , “The Relationship Between Money and Prices,” p. 24.Google Scholar

³ See Sargent, Thomas J. and Smith, Bruce D., “Irrelevance of Open Market Operations in Some Economies with Government Currency being Dominated in Rate of Return,” American Economic Review, 77 (03 1987), pp. 78–92Google Scholar; and Wallace, Neil, “A Modigliani-Miller Theorem for Open Market Operations,” American Economic Review, 71 (06 1981), pp. 267–74.Google Scholar

⁴ For purposes of clarity it will be useful to differentiate between three types of backing. Metallic backing occurs when notes can be redeemed for a specified quantity of specie, on demand. Prospective metallic backing occurs when the government promises to redeem notes for a specified quantity of specie at a future date. Prospective tax backing occurs when the government promises to implement fiscal measures that will allow for the future retirement of newly issued currency notes. This latter form of backing may be thought of as a promise to control the future time path of the currency stock.

⁵ David Laidler argued that Smith's findings did not invalidate the quantity theory of money because two of its leading proponents, Wicksell and Fisher, had both argued that the degree of real “backing” could exert an influence on the value of money independent of changes in quantity. The model discussed in this article does not require that currency have any actual, or even prospective, real backing. See Laidler, David, “Wicksell and Fisher on the ‘Backing’ of Money and the Quantity Theory: A Comment on the Debate Between Bruce Smith and Ronald Michener,” in Brunner, Karl and Meltzer, Allan H., eds., Empirical Studies of Velocity, Real Exchange Rates, Unemployment and Productivity (Amsterdam, 1987), vol. 27, pp. 325–34.Google Scholar

⁶ See Bordo, Michael D. and Marcotte, Ivan A., “Purchasing Power Parity in Colonial America: Some Evidence for South Carolina 1732–1774, A Comment,” in Brunner, Karl and Meltzer, Allan H., eds., Empirical Studies of Velocity, Real Exchange Rates, Unemployment and Productivity (Amsterdam, 1987), vol. 27, pp. 311–24Google Scholar; and Michener, Ronald, “Fixed Exchange Rates and the Quantity Theory in Colonial America,” in Brunner, Karl and Meltzer, Allan H., eds., Empirical Studies of Velocity, Real Exchange Rates, Unemployment and Productivity (Amsterdam, 1987), vol. 27, pp. 233–307.Google Scholar

⁷ See McCallum, Bennett T., “Money and Prices in Colonial America: A New Test of Competing Theories,” Journal of Political Economy, 100 (02 1992), pp. 143–61.CrossRefGoogle Scholar

⁸ Smith, , “The Relationship Between Money and Prices,” p. 28.Google Scholar

⁹ Smith, , “Some Colonial Evidence,” p. 1183.Google Scholar The reference is to Lucas, Robert E. Jr., “Two Illustrations of the Quantity Theory of Money,” American Economic Review, 70 (12 1980), pp. 1005–14.Google Scholar

¹⁰ Smith, , “The Relationship Between Money and Prices;” p. 23.Google Scholar

¹¹ In the colonial context, the term nonpermanent refers to currency emissions that last for five to fifteen years. Much of the work in this area is based on data collected in Brock, Leslie V., The Currency of the American Colonies 1700–1764: A Study in Colonial Finance and Imperial Relations (New York, 1975).Google Scholar

¹² Smith, , “Some Colonial Evidence,” p. 1192.Google Scholar The reference is to Sargent, Thomas J. and Wallace, Neil, “Some Unpleasant Monetarist Arithmetic,” Federal Reserve Bank of Minneapolis Quarterly Review, 5 (Fall 1981), pp. 1–17.Google Scholar

¹³ See Calomiris, Charles W., “Institutional Failure, Monetary Scarcity, and the Depreciation of the Continental,” this Journal, 48 (03 1988), pp. 47–68.Google Scholar

¹⁴ See Bernholz, Peter, “Inflation, Monetary Regime and the Financial Asset Theory of Money,” Kyklos, 41, fase. 1 (1988), pp. 5–34.CrossRefGoogle Scholar

¹⁵ See note 3.

¹⁶ It may seem surprising that the value of a currency lacking even a prospective metallic backing can be modeled in a fashion similar to those cases in which there is prospective metallic backing. It turns out, however, that a credible promise by the government to control the future path of the supply of currency does provide a form of “real” backing. To the extent that the future supply of currency is known, uncertainty regarding its future value would occur only to the extent that there was uncertainty regarding the future real demand for currency. This type of uncertainty is, in principle, no different from what occurs under a gold standard when unanticipated changes in the real value of gold generate uncertainty regarding the future purchasing power of gold-backed currencies.

¹⁷ See Calomiris, , “Institutional Failure,”Google Scholar and Bernholz, , “Inflation,”Google Scholar for an explicit derivation of the model.

¹⁸ Smith, , “American Colonial Monetary Regimes,” p. 562.Google Scholar

¹⁹ Behrens, Kathryn L., Paper Money in Maryland, 1727–1789 (Baltimore, 1923), p. 46.Google Scholar

²⁰ Many colonies claimed some sort of real backing. The fact that exchange rates were often flexible during redemption periods, however, casts doubt on whether these currencies were backed in the modern sense of the term. Furthermore, many treasuries lacked specie for redemption purposes.

Smith used regression analysis and found that the quantity of Maryland currency notes had no impact on the value of the notes. This is, of course, not inconsistent with the modern quantity-theory model discussed in the previous section. Smith also found that the value of money in Maryland was positively related to variables linked to the probability of redemption. Since these factors would also affect the expected future path of the currency stock, this finding is also consistent with the quantity theory (see Smith, , “Some Colonial Evidence”).Google Scholar

²¹ Ernst, Joseph A., Money and Politics in America, 1755–1775: A Study in the Currency Act of 1764 and the Political Economy of Revolution (Chapel Hill, 1973), p. 95.Google Scholar

²² Smith, , “Some Colonial Evidence,” p. 1198.Google Scholar

²³ Smith, , “The Relationship Between Money and Prices,” p. 24.Google Scholar The reference is to McCusker, John J., Money and Exchange in Europe and America, 1600–1775: A Handbook (Chapel Hill, 1978), p. 211.CrossRefGoogle Scholar

²⁴ Currency notes were issued for periods of up to 9 years. Because notes were issued over several consecutive years, however, the expanded circulation lasted for 15 years. Assuming these subsequent issuances were anticipated, 15 years is the appropriate value of n in my model. From the perspective of defenders of the quantity theory, 15 years represents the “worst case” assumption that yields the highest predicted increase in the price level.

²⁵ In many colonies the currency decrease was smaller than the previous increase. It should be noted, however, that if the currency stock grows more slowly than real income, there can still be deflationary tendencies.

²⁶ See Wicker, Elmus, “Colonial Monetary Standards Contrasted: Evidence From the Seven Years' War,” this Journal, 45 (12 1985), pp. 869–84.Google Scholar