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Redemption Costs and Interest Rates under the U.S. National Banking System

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  • Champ, Bruce
  • Freeman, Scott
  • Weber, Warren E

Abstract

Interest rates under the U.S. National Banking System (1863-1914) appear to imply that banks failed to exploit an arbitrage opportunity for two reasons: yields on government bonds exceeded the tax rate on note issue by approximately 150 basis points, and short-term interest rates varied seasonally. This paper examines whether note redemption costs can explain observed interest rates. We present a model in which redemption costs create a spread between the tax rate on note issue and bond yields and in which temporary seasonal fluctuations in currency demand generate seasonal movements in short-term interest rates. Calibration of the model to actual data lends support to the model's implications. Further, interest rates are shown not to vary seasonally when banks do not incur the costs of note redemption.

Suggested Citation

  • Champ, Bruce & Freeman, Scott & Weber, Warren E, 1999. "Redemption Costs and Interest Rates under the U.S. National Banking System," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 568-589, August.
    • Handle: RePEc:mcb:jmoncb:v:31:y:1999:i:3:p:568-89
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    Cited by:

    1. Asaf Bernstein & Eric Hughson & Marc D. Weidenmier, 2008. "Can a Lender of Last Resort Stabilize Financial Markets? Lessons from the Founding of the Fed," NBER Working Papers 14422, National Bureau of Economic Research, Inc.
    2. Leo Ferraris, 2002. "Money and credit in random matching models of money," Working Papers in Public Economics 59, University of Rome La Sapienza, Department of Economics and Law.
    3. Antoine Martin & Cyril Monnet & Warren E. Weber, 2000. "Costly banknote issuance and interest rates under the national banking system," Working Papers 601, Federal Reserve Bank of Minneapolis.
    4. Bruce A. Champ & Neil Wallace, 2003. "Resolving the National Banking System note-issue puzzle," Working Papers (Old Series) 0316, Federal Reserve Bank of Cleveland.
    5. Wallace, Neil & Zhu, Tao, 2007. "Float on a note," Journal of Monetary Economics, Elsevier, vol. 54(2), pages 229-246, March.
    6. Bullard, James & Smith, Bruce D., 2003. "Intermediaries and payments instruments," Journal of Economic Theory, Elsevier, vol. 109(2), pages 172-197, April.
    7. Tao Zhu & Neil Wallace, 2004. "Float on a Note," 2004 Meeting Papers 342, Society for Economic Dynamics.
    8. Bruce A. Champ, 2007. "The National Banking System: the national bank note puzzle," Working Papers (Old Series) 0722, Federal Reserve Bank of Cleveland.

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