This very interesting paper by Randy Kroszner has two parts. The first part sketches a novel theory, namely that competition from foreign currencies (such as the U.S. dollar and the deutschmark) has helped to reduce worldwide inflation in recent years. The second part speculates on the future of financial innovation and the potential for private monies to become an increasingly important substitute for central bank money. In my comments, I will focus on the first part of the paper.

As I understand it, Kroszner's theoretical story goes something like this: Governments like to raise revenue through seigniorage. When private agents have no alternatives to domestic central bank money for their transactional needs, it is easy for the government to engage in seigniorage. In contrast, when agents can switch to dollars, for example, when making transactions, the government cannot raise as much seigniorage revenue for a given amount of inflation. If we further assume that the government trades the benefits of seigniorage against some other (unspecified) costs of inflation in a fixed way, it should inflate less.

An example may help to illustrate the logic behind the theory. In scenario A, imagine that Russian households initially hold 100 rubles as their only form of transaction balance, and the only good in the Russian economy is 100 units of corn. The price of corn is one ruble. Starting from this position, suppose the Russian central bank prints 100 more rubles. The government will extract real seigniorage revenue equal to 50 units of corn and the price level will double, so that each unit of corn now costs two rubles.