Hey, good to see someone serious about economics around here. I'm somewhat of an amateur economist. I follow a lot of econ blogs (my favorite being Scott Sumner's), did some econ in undergrad, and read parts of econ texts in my spare time.
It sounds like the first cost you refer to would not be an issue in the case of Bitcoin, assuming its use as a % of the overall economy eventually reached a stable state. The value of the currency would be expected to rise roughly at the rate of GDP (assuming 100% of its value at that point was determined by its use in transactions).
If the latter cost dominates, then inflation rates should be set to 0.
Doesn't this depend on whether having a positive inflation rate encourages investment, and whether encouraging more investment than is ideal in the 0 inflation case has positive externalities for society?
Speaking of encouraging vs. discouraging investment, a lot of people here will argue that people hoarding bitcoins rather than investing them doesn't actually lead to more idling of productive resources, because it just increases the value of non-hoarded bitcoins, so whenever any non-hoarded bitcoins are invested, their value will be high enough to compensate for the hoarded bitcoins. What are your thoughts on that?
Even monitoring the relevant inflation rate for a crypto-currency would be difficult, because at present much of their use (if I understand correctly) is in the purchasing of goods where one or both parties don't want it made public that the transaction took place (e.g. because the good is illegal), making it very hard to build a price index
This should be no worse than things are now right? Unless you expect the black market share of the economy to grow with Bitcoin adoption. We will still have grocery stores, department stores, car dealerships, etc, who will all need to be transparent with the government and will have to report sales accurately, even if the relevant data couldn't be harvested directly from the block chain.
the creator of the crypto-currency would create a (ideally, decentralised) platform for the exchange of repurchase agreements denominated in the new currency, using "old" currencies as collateral (though in the long-run, other assets could come to fulfil this role). Although using repurchase agreements rather than unsecured loans removes much of the risk, it may still be desirable to construct a simple reputation system, so that the repo rate for high reputation parties is truly a risk-free rate.
I'm not sure I fully understand this, but it seems fairly complex. In the situation you're imagining, when the interest rate being paid on the currency is set/changed, the code running on the network is just hooked up to this decentralized exchange and uses the prices there to set the new rate in a 100% automated way?
Is this complexity really worth avoiding a ~2-3% expected annual deflation?
with a crypto-currency one has a second instrument, namely the release of new coins via the "proof-of-work" mechanism. With this one could ensure that the nominal interest rate remained at least (say) 4%, which is approximately the long run real interest rate,
Is the idea that the stability would come from less people wanting to hold the currency for speculation/investment, because they would know there would be expected 4% inflation?
Btw, my idea for solving the price stability problem is to simply have the government or some trusted private institution publish a price index, which could be NGDP-targeted. All prices, wages, and contracts could refer to units of this index (maybe the government would give favorable tax treatment to businesses which do this). So even though the underlying value of Bitcoin might be fluctuating wildly, people can get stability of they want it. Banks can offer checking accounts denominated in this new unit, giving less risk to the consumer in exchange for keeping the bulk of the value gained from the expected deflation.