CHECK CURRENCY

CHECK CURRENCY denotes bank deposits against which the owner can write a check. Such deposits are called demand (or transaction) deposits in order to distinguish them from time deposits, against which checks cannot be written. Check currency is one of the two types of bank money, the other being bank notes. Whereas a check is an order to the bank to pay, a bank note is a promise by the bank to pay.

Although check currency was in use in New York and other large cities in the early nineteenth century, it was not until the National Banking Act of 1863 that it began to replace bank notes as the principal type of bank money. The twofold purpose of the National Banking Act was to finance the Civil War and to stop the widespread bankruptcies of state banks. State banks were failing because of the depreciation of the state bonds they held as reserves against the bank notes they issued. Both purposes of the National Banking Act could thus be accomplished by creating national banks that had to hold federal bonds as reserves for the bank notes they issued.

In March 1865, in an effort to compel state banks to become national banks, the government imposed a 10 percent tax on bank notes issued by state banks. The state banks responded by issuing check currency, which was not subject to the tax. So successful was this financial innovation that, by the end of the nineteenth century, it is estimated that from 85 to 90 percent of all business transactions were settled by means of check currency. And despite the widespread availability of electronic fund transfers, this was still true (for the volume of transactions, not their value) at the end of the twentieth century.

It is often argued that the amount of currency in circulation, including the amount of check currency, is exogenously (that is, externally) given by the government. It is then argued that the price level is determined by the amount of currency in circulation. This argument ignores the banks' capacity for financial innovations, like their creation of check currency to replace bank notes. Whenever the government tries to control one type of money (for example, bank notes with a penalty tax), the banks create another type of money (for example, check currency) that is not being controlled. Therefore, the amount of currency in circulation is endogenously (internally) determined by the banks, and the determinates of the price level must be sought elsewhere.

Until the Banking Act of 1933 (also known as the Glass-Steagall Act), banks generally paid interest on demand deposits with large minimum balances. From 1933 to 1973, there were no interest payments on demand deposits. Then money market funds came into widespread use, which in many ways marks a return to the pre-1933 situation of banks paying interest on demand deposits with large minimum balances.

BIBLIOGRAPHY

Dickens, Edwin. "Financial Crises, Innovations, and Federal Reserve Control of the Stock of Money." Contributions to Political Economy, vol. 9, pp. 1–23, 1990.

Friedman, Milton, and Anna J. Schwartz. Monetary Trends in the United States and the United Kingdom: Their Relation to Income, Prices, and Interest Rates, 1867–1975. Chicago: University of Chicago Press, 1982.

Mishkin, Frederic S. The Economics of Money, Banking, and Financial Markets. 6th ed. Boston: Addison Wesley, 2002.

Edwin T.Dickens

See alsoBanking ; Currency and Coinage ; Money .