Paper Money Practice Problems
Prof. Sproul

1. Record each of the following actions on a balance sheet: (1) A colony is able to collect a total of 10,000s (s=shillings) in taxes. Initially there are no claims against the colony. (2) It then prints 4,000s in paper, which it uses to pay soldiers. (3) Next, the colony lends 15,000s to farmers, who use the loans to buy land. (4) Then the colony collects 1,000s in taxes, and 8,000s in loan repayments, and destroys the paper shillings collected.
2. Which, if any, of the numbered actions in question #1 would, on backing theory principles, cause inflation? On quantity theory principles? Explain.
3. As above, which actions would be recessionary? Explain.
4. In question #1, part 4, suppose the shillings paid to the colony were coins. Should the colony spend the coins? Should it destroy them? Explain.
5. A colony that lent 100s paper to a colonist and received in exchange an IOU worth 99s is following a tight money policy (T, F, explain)
6. Playing card money was denominated in ______.
7. The American colonies usually issued paper money in two ways: (1) They printed them and spent them, and (2)______.
8. Retirement of the paper shillings collected through taxation usually had what effect on economic activity in the American colonies?
9. Explain how the great French inflation of 1720 could have been caused by problems in Mississippi.
10. In retiring assignats, what would the French government pay out and what would it receive in return?
11. What is bullionism?
12. David Ricardo contended that the Bank of England had caused inflation by ______. Does this make him a quantity theorist or a backing theorist? Explain.
13. Show the balance sheet of a private bank that accepted 100 spanish silver dollars on deposit and issued $100 of notes in exchange. Then show the effect of the same bank lending $300 of deposits to a farmer. When the National Banking Act of 1863 suppressed private bank notes, the bank could have either redeemed the notes for silver dollars and destroyed the notes, or ______.

ANSWERS:

1) AssetsLiabilities

(1)10,000s taxes collectible10,000s net worth

(2)+4,000s paper

-4000s net worth

(3)+15,000s farmers’ IOU’s+15,000s paper

(4)-1,000s taxes collectible-1,000s paper

(5)-8,000s farmers’ IOU’s-8,000s paper

2) None would cause inflation on backing theory principles, since backing moves in step with the money supply in every case. On quantity theory principles, lines 2 & 3 would cause inflation because the money supply has increased. Lines 4 & 5 would cause deflation because the money supply decreased.

3) Lines 4 & 5 reduce the money supply without changing the price level. Thus they reduce the public’s spending power and cause a recession.

4) It should spend the coins and not destroy them. Coins are not the colony’s liability, but notes are; so destroying a coin would be destroying real wealth, while destroying a note just cancels a liability.

5) False; that’s an easy money policy.

6) livres—a French silver coin.

7) printed notes and lent them to colonists, who usually used them to buy land. The land served as collateral for the loans.

8) It reduced spending power and caused recessions.

9) John Law’s company held Mississippi land as an asset, and issued paper money as a liability. When the value of the land fell, the value of the paper money fell because of a loss of backing.

10) The French government would pay out the land it had taken from churches, and receive paper assignats in return. The assignats were supposed to be destroyed but they often weren’t.

11) Bullionism was Adam Smith’s theory, which held that the value of paper money would be stable if its quantity were made to correspond to the quantity of coins (‘bullion’) that would have circulated in the absence of paper money.

12) issuing too many paper pounds. This makes him a quantity theorist, since he believed that inflation occurred when the money supply increased—even if backing increased too.

13) replaced the paper dollars with deposit dollars. For example, if one person held all $100 in notes, the bank redeems the $100 notes for a $100 deposit.