Demurrage (currency) - Theory

Theory

While demurrage is a natural feature of private commodity money, it has at various times been deliberately incorporated into currency systems as a disincentive against the hoarding of money, as well as to achieve other perceived benefits. In particular, with regard to long-term investment financing, it has the effect of changing the dynamics of net present value (NPV) calculations. All else being equal, a currency system with demurrage places an increased emphasis on the value of long-term returns on an investment. As such it may create an incentive to invest in initiatives which offer more in the way of longer-term returns.

Like inflation, demurrage reduces the present value of holding a unit of currency, similar to the effect of a negative interest rate on all currency in circulation. Both inflation and demurrage reduce the purchasing power of money held over time, but demurrage does so through fixed, regular fees while inflation does so through expansion of the money supply through the actions of a central monetary authority distributing the new issue of currency, through endogenous money creation (such as fractional reserve banking), and through charging of interest, which compared to demurrage fees is less certain in the magnitude of its effect, involves an uncertain time lag in the development of its effect, and is not necessarily uniform in its costs and benefits across the holders of the currency. The uncertainties in turn make the determination of net present value of an investment in the currency more uncertain, and thus rational action with respect to future expectations becomes more difficult under inflation than under demurrage, which can undermine the ability of economic actors to take inflation's incentives into account in their actions versus demurrage. The non-uniformity of the distribution of costs and benefits in inflation across the economy meanwhile undermines an aggregate analysis of its effects.

Gresham's law that "bad money drives out good" suggests that demurrage fees would help a currency achieve more rapid circulation than competing forms of currency. This led some such as German-Argentine economist Silvio Gesell to propose demurrage as a means of increasing both the velocity of money and overall economic activity. On the other hand, influential British economist John Maynard Keynes contended that Gesell's proposed demurrage fees could be evaded by the use of more liquid competing forms of money and that therefore inflation is a preferable method to achieve economic stimulation.