A transaction-cost model of chronic specie scarcity and the evolution of monetary structures in constrained colonial economies

Abstract A transaction-cost model of monetary choice is used to justify colonists’ claims that specie money for executing within-colony trades and paying local taxes was chronically scarce in Britain’s pre-nineteenth century North American colonies. This scarcity is shown to be the result of individual rational maximizing choice behavior given the constraints imposed on the colonies by their mother country. By contrast, the conventional quantity-theory-of-money, specie-flow model indicates that a chronic specie scarcity equilibrium is impossible. Implicit assumptions in the quantity-theory-of-money model are shown to not apply to these colonial economies. The transaction-cost model developed here builds on the Walrasian–Arrow–Debreu general equilibrium model by incorporating transaction costs and media-of-exchange structures into the market clearing mechanism. Specie (outside money) and non-specie-money media-of-exchange structures (inside monies), which have differing transaction costs, are added to the model. Those additions, along with import substitution and trade-control constraints, identify the plausible circumstances that yield a chronic specie scarcity outcome in a colony. Whether the individual rational maximizing monetary choices that produce chronic specie scarcity in a colony lead to sub-optimal or to optimal social welfare outcomes in that colony depends on what non-specie media-of-exchange structures emerge as the inside money in that colony.