We consider the problem of financing two productive sectors in an economy through bank loans, when the sectors may experience independent demands for money but when it is desirable for each to maintain an independently determined sequence of prices. An idealized central bank is compared with a collection of commercial banks that generate profits from interest rate spreads and flow those through to a collection of consumer/owners who are also one group of borrowers and lenders in the private economy. We model the private economy as one in which both production functions and consumption preferences for the two goods are independent, and in which one production process experiences a shock in the demand for money arising from an opportunity for risky innovation of its production function. An idealized, profitless central bank can decouple the sectors, but for-profit commercial banks inherently propagate shocks in money demand in one sector into price shocks with a tail of distorted prices in the other sector. The connection of profits with efficiency-reducing propagation of shocks is mechanical in character, in that it does not depend on the particular way profits are used strategically within the banking system. In application, the tension between profits and reserve requirements is essential to enabling but also controlling the distributed perception and evaluation services provided by commercial banks. We regard the inefficiency inherent in the profit system as a source of costs that are paid for distributed perception and control in economies.
We review an emerging body of work by physicists addressing questions of economic organization and function. We suggest that, beyond simply employing models familiar from physics to economic observables, remarkable regularities in economic data may suggest parts of social order that can usefully be incorporated into, and in turn can broaden, the conceptual structure of physics.
The competitive market structure of a decentralized economy is converted into a self-policing system treating the bureaucracy and enforcement of the legal system endogenously. In particular we consider money systems as constructs to make agents’ economic strategies predictable from knowledge of their preferences and endowments, and thus to support coordinated resource production and distribution from independent decision making. Diverse rule systems can accomplish this, and we construct minimal strategic market games representing government-issued fiat money and ideal commodity money as two cases. We endogenize the provision of money and rules for its use as productive activities within the society, and consider the problem of transition from generalist to specialist production of subsistence goods as one requiring economic coordination under the support of a money system to be solved. The scarce resource in a society is labor limited by its ability to coordinate (specifically, calling for the expenditure of time and effort on communication, computation, and control), which must be diverted from primary production either to maintain coordinated group activity, or to provide the institutional services supporting decentralized trade. Social optima are solutions in which the reduced costs of individual decision making against rules (relative to maintenance of coalitions) are larger than the costs of the institutions providing the rules, and in which the costs of the institutions are less than the gains from the trade they enable to take place.
In order to explain in a systematic way why certain combinations of market, financial, and legal structures may be intrinsic to certain capabilities to exchange real goods, we introduce criteria for abstracting the qualitative functions of markets. The criteria involve the number of strategic freedoms the combined institutions, considered as formalized strategic games, present to traders, the constraints they impose, and the symmetry with which those constraints are applied to the traders. We pay particular attention to what is required to make these “strategic market games” well-defined, and to make various solutions computable by the agents within the bounds on information and control they are assumed to have. As an application of these criteria, we present a complete taxonomy of the minimal one-period exchange economies with symmetric information and inside money. A natural hierarchy of market forms is observed to emerge, in which institutionally simpler markets are often found to be more suitable to fewer and less-diversified traders, while the institutionally richer markets only become functional as the size and diversity of their users gets large.
We introduce and justify a taxonomy for the structure of markets and minimal institutions which appear in constructing minimally complex trading structures to perform the functions of price formation, settlement and payments. Each structure is presented as a playable strategic market game and is examined for its efficiency, the number of degrees of freedom and the symmetry properties of the structure.