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The Bank of Amsterdam and the limits of fiat money

Working paper 764
Working Papers

Published: 02 February 2023

By: Wilko Bolt Jon Frost Hyun Song Shin Peter Wierts

Central banks can operate with negative equity, and many have done so in history without undermining trust in fiat money. However, there are limits. How negative can central bank equity be before fiat money loses credibility? We address this question using a global games approach motivated by the fall of the Bank of Amsterdam (1609–1820). We solve for the unique break point where negative equity and asset illiquidity renders fiat money worthless. We draw lessons on the role of fiscal support and central bank capital in sustaining trust in fiat money.

Keywords: central banks; negative equity; fiat money; trust
JEL codes E42; E58; N13

Working paper no. 764

764 - The Bank of Amsterdam and the limits of fiat money

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Research highlights:

  • Rising interest rates and losses on central bank balance sheets draw back attention to old questions about the relevance of central bank equity;
  • Central banks can operate with negative equity for a time but there are limits. We model the failure of the Bank of Amsterdam (1609-1820) using a global games approach. Our analysis indicates that trust in fiat money is more likely to evaporate when central bank equity is more deeply negative, assets are more illiquid, alternatives to fiat money are more readily available and when economic fundamentals are weaker;
  • Although there are many differences with the current situation of above-target inflation and losses on central bank portfolios, our analysis strongly suggests that credible fiscal backing remains critical.

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