"A Legal Restrictions Theory of the Demand for Money and the Role of Monetary Policy" is the title of a 1983 paper by Neil Wallace, published in the Federal Reserve Bank of Minneapolis Quarterly Review.
In the paper, Wallace argues that, if there were free entry into financial intermediation, cash and Treasury bills would earn the same rate of return (either currency would be interest-bearing, or there would be a zero nominal return on Treasury bills). If intermediation costs are high, the difference between a zero rate of return and T-bills could not be arbitraged. Wallace says nominal interest rates are equal to intermediation costs.
Criticisms[]
It has been suggested that a liquidity premium to holding currency could explain the price differential between currency and Treasury bills. It has also been pointed out that intermediation costs could bound the price differential while not determining it entirely.
References[]
Wallace, N. (1983) "A Legal Restrictions Theory of the Demand for 'Money' and the Role of Monetary Policy." Federal Reserve Bank of Minneapolis Quarterly Review 7 (Winter): 1-7.
Lecture by Tyler Cowen, Fall 2005.