It's time to trash the "store of value" function of money

When we first learn about money and banking in high school or university, we are all taught that money has three functions: medium of exchange, unit of account, and store of value. Maybe it’s time for educators to throw out this triumvirate. It’s not very accurate. 

We need a simple and teachable device to take the triumvirate’s place. I propose the money Venn diagram.

Before I explain the money Venn diagram, let’s revisit the textbook triumvirate.

When something is a medium of exchange, what is meant is that it is generally acceptable in trade. You can use it to buy stuff at the grocery store, or purchase stocks on the stock market, or get things online. 

The quality of being a medium of exchange is really more of a gradient than a matter of either/or. Banknotes, for instance, are good at brick and mortar shops, but useless online. Your debit card works great at shops, but forget trying to buy shares with it. But both are sufficiently widely accepted to qualify as a medium of exchange.

Because cryptocurrencies like Bitcoin and Litecoin aren’t widely accepted, they don’t make it across the line to qualify as a medium of exchange. Neither do Walmart or Target gift cards. Cigarettes don’t qualify either, but that wasn’t the case in 1950 when Milton Friedman used them to buy gas:

Milton Friedman describes the time he used cigarettes as money. (I get this from his book "Money Mischief".) pic.twitter.com/1NSjY9vZNX

— John Paul Koning (@jp_koning) November 6, 2020

The unit of account function of money refers to the fact that our economic conversations and calculations are couched in terms of a given monetary unit, whether that be the $, ¥, or £. In Canada and the US, prices are expressed in grocery aisles with dollars, our salaries use dollar units, and our debts are denominated in dollars. We don’t express prices in terms of government bonds, or Microsoft shares, or cigarettes or bitcoins. These things don’t function as a unit of account.

Thirdly, when money acts as a store of value we mean that it preserves value over time and space. Whereas the first two functions are quite useful, the store of value isn’t. Every asset functions as a store of value: houses, diamonds, banknotes, deposits, bitcoins, LSD tabs, lentils, cars, spices. And so it is meaningless to cast store of value as a unique function of money. Monetary economists such as Nick Rowe and George Selgin have proposed, and I concur, that we just chuck store of value from the definition of money.

But we are still left with two useful definitions for money, unit of account and medium of exchange. Which gets us to the money circle.

Note that the two circles in the diagram, medium of exchange and unit of account, don’t perfectly overlap. About 99% of the time the things we use as media of exchange are also the things we use as a unit of account. So the contents of our wallets or our bank accounts, dollar banknotes and dollar deposits are functionally equivalent to the $ units displayed in signs in grocery aisles.

But for the remaining 1% of the time, the unit of account and medium of exchange are separated. The idea of a separation is tough to get one’s head around. Luckily we’ve got a nice example. In Chile the prices of many things, particularly real estate, are expressed in terms of the Unidad de Fomento. But no Unidad de Fomento notes or coins circulate in Chile. It is a purely abstract unit of account.

Apartments for sale in Chile, priced in Unidad de Fomento

If a Chilean wants to buy an apartment that is priced at 840 Unidad de Fomento, she must use a separate medium of exchange, the Chilean peso, to make the payment. The peso is issued by Chile’s central bank, the Banco Central de Chile, in both paper and account form.

How many pesos must she pay? Every day the Banco Central de Chile publishes the exchange rate between the Unidad de Fomento and the peso. Right now one Unidad de Fomento is equal to 28,969 pesos. If an apartment were priced at 840 Unidad de Fomento, a Chilean would have to hand over 24 million Chilean pesos today.

Why has Chile separated its unit of account from its medium of exchange? I have discussed the issue at length. But the short answer is that it was a trick the government used to help cope with high inflation in the 1960s. Chilean inflation has been well under control for decades now. The practice of using the Unidad de Fomento as a unit-of-account has continued nonetheless.

You can see why it’s rare for these two functions to be separated. It’s awkward to do conversions every time one wants to pay for something. For the sake of ease, we tend to evolve towards systems where the medium of exchange and unit of account are united. But these exceptions are still important enough that we need a Venn diagram.

To sum up, money isn’t best thought of as a medium of exchange, unit of account, and store of value. Let’s just think of it as just a medium of exchange and a unit of account. For the most part these circles overlap, and the two functions are united. But this isn’t always the case. 

[My article was originally published at AIER's Sound Money Project in 2020 under the title A Simpler and More Accurate Way to Teach Money to Students]

The Haitian dollar

Haiti is home to a strange monetary phenomenon. Shopkeepers and merchants set prices in the Haitian dollar, but there is no actual thing as the Haitian dollar.

I've written before about an exotic type of unit-of-account known as an abstract unit of account. A nation's unit of account is the symbol used by its citizens and businesses to advertise and record prices. Here in Canada we use the $ while in a country like Japan people use the ¥. The national unit of account almost always corresponds to the national medium-of-exchange. In both Canada and Japan, the $ and the ¥ amounts advertised in shop aisles are embodied by physical dollar and yen banknotes and coins.

Abstract units of account, on the other hand, don't correspond to anything that exists. In the UK, for instance, race horse auctions are priced in guineas, a gold coin that hasn't been minted in over two centuries. The guinea is a ghost money, an accounting unit that according to John Munro is "calculated according to the precious metal content of some famous, once highly favoured coin of the past than no longer circulates."

There are some strange units of account out there. In the UK, race horse auctions are priced in guineas, a coin that hasn't been minted in over 200 years. Source: https://t.co/cGujWAmlO8 One guinea = Sterling £1.05 pic.twitter.com/vMv927yooU

— JP Koning (@jp_koning) January 29, 2019

Other examples of abstract units of account include include Chile's Unidad de Fomento, or UF, (which I wrote about here) and Angolan macutes (see here).

Like the guinea, the Haitian dollar is an abstract unit of account. I should warn you that I've never been to Haiti--all of this comes from what I've read in tourist guides, newspapers, Haitian blogs, and an academic paper on the topic from Federico Neiburg. But from what I understand, it is quite common for prices in Haiti to be set in a unit referred to as the 'Haitian dollar.' However, there is no corresponding Haitian dollar banknotes or coins. The U.S. dollar and the Haitian gourde, a currency managed by Haiti's central bank, circulate in Haiti and are used to consummate all payments. But the Haitian gourde is not the same as the Haitian dollar.

How does this work in practice? Say that a restaurant is selling sandwiches for fifteen Haitian dollars. Paying with Haitian dollars is impossible--they don't exist--so some other route must be taken to complete the deal. Haitians have spontaneously adopted a rule of thumb that the Haitian dollar is equal to five Haitian gourdes. So to pay for the sandwich, it will be necessary to hand over 75 gourdes (H$15 x 5$H/HG).

Here is a sign showing both Haitian dollar and Haitian gourde (HTG) prices. Source: Pawol Mwen blog

A certain degree of mental gymnastics is thus required of Haitians, since sticker prices must always be multiplied by five (to arrive at the gourde amount) and banknotes held in a wallet divided by five (to arrive at the Haitian dollar amount). For foreigners, this can be confusing, but for Haitians the motley of U.S. dollars, gourdes, and the Haitian dollar unit of account has become second nature. Says Nieburg:

"The adjective Haitian (aysien), as in dolà aysien, is only used when one of the participants in a transaction is foreign. Among Haitians, when people say dolà they always mean dolà aysien."

Nieburg provides some more colour by describing the monetary demographics of Port-au-Prince, Haiti's capital:

"...in the urban islands of foreigners scattered across various regions of the city, the US dollar predominates as a unit of account and means of payment in sectors such as the housing market, as well as in restaurants, hotels, night clubs, and supermarkets (which used to double as currency exchange bureaus) that cater for upper-class Haitians and the legion of ex-pats, relief workers, and consultants. As we move down the social scale, the US dollar begins to be used as a means of payment for transactions calculated in Haitian dollars. Lower down—where the majority of transactions are to be found—people calculate in Haitian dollars and pay in gourdes."

Where does the practice of using the Haitian dollar come from? I wasn't aware of this, but during WWI the U.S. invaded Haiti, occupying it till 1934. There was a strong German mercantile presence in Haiti and apparently the U.S. authorities feared that Germany might take over.

By 1918 the government's gourdes had become "so worn and torn" that a shortage of banknotes arose. As part of a 1919 U.S.-initiated monetary reform, all previous issues of gourdes were to be replaced by a new issue by the Banque Nationale de la Republique d'Haiti, which by then was owned and controlled by New York-based City Bank (and would eventually become Citigroup). The BNRH was granted a monopoly on banknote issuance, which meant that the Haitian government could no longer print its own currency.

The new banknotes were to be convertible into U.S. dollars at a rate of five gourdes to the dollar, a promise that the BNRH printed on the face of each bill, as the images below illustrate.

1919 one gourde note (source)

 

"This bill issued by the National Bank of the Republic of Haiti, under its concession contract and conforming with the agreement of May 2, 1919, is payable to the holder in legal money of the United States at the rate of five gourdes to the dollar upon presentation to the bank's office in Port-au-Prince or, after a delay, at its provincial branches."

Even after the U.S. occupation ended and City Bank sold the BNRH back to the Haitian government, the promise to redeem gourdes with U.S. dollars continued. This peg stretched right through the rule of "Papa Doc" Duvalier until the gourde was finally untethered from the dollar in the late 1980s.

So several generations of Haitians had become used to a five-to-one ratio between U.S. dollars and gourdes. Dividing a price by five in order to get the U.S. dollar price may have become such a standard piece of mental arithmetic that the practice continued into the 1990s and 21st century, even after the calculation's answer no longer corresponded to the correct U.S. dollar amount. The Haitian dollar may simply have been a placeholder that was invented in order to provide continuity for the age-old custom of dividing by five.

Since it was unpegged, the Haitian gourde has fallen consistently against the U.S. dollar, possibly contributing to the tradition of using the Haitian dollar unit. Quoting prices in Haitian dollars could be a non-violent way for Haitians to show their dissatisfaction with their government's finances. Or perhaps it is a marketing trick that Haitian merchants use to make their wares seem less cheap, sort of like how shopkeepers here in Canada often set prices at $4.99 instead of $5.00.   

According to Nieburg, the government has even tried to ban the practice of pricing in Haitian dollars. Intellectuals who support the measure have condemned the abstract unit as just "another sign of the country’s backwardness." But the attempt failed. Units of account are just a part of language. And language is very difficult to control.

The Haitian dollar is probably the best (and simplest) modern example I've ever run into of an abstract unit of account. For monetary enthusiasts like myself, it provides a great illustration of the many different functions packaged into the thing we call "money." These functions needn't be unified into one object or instrument. They can be split up, so that the instruments that we pass from hand to hand (or from phone to phone), the so-called medium-of-exchange, no longer correspond to the symbol used for pricing, the unit-of-account.

Nobel Prize winning economist Robert Shiller has written enthusiastically about so-called monetary separation. William Stanley Jevons's tabular standard, which was never implemented but has been considered by some to be the ideal monetary system, relies on a split between the medium-of-exchange and unit-of-account. Rather than being backwards, the sort of Haitian dollar standard that we see in modern Haiti could one day become the guiding principle of the monetary systems of the future.

Dictionary money

Nick Rowe points out that if a central bank wants to control the economy's price level, it needn't issue any actual money—it can just edit the dictionary every morning, announcing the meaning of the word "dollar" or "yen" or "pound" to the public.

To a modern ear trained on a steady diet of central bank verbiage about interest rates, QE, and open market operations, the idea of conducting monetary policy by simply editing the meaning of a word seems odd. But I've got news for you: starting from Caesar's time and extending into the 1700s, the sort of dictionary money that Nick describes has been the dominant form of money in the West.

How has this system worked? People have historically advertised prices for wares using a word, or unit of account, the LSD unit being the most prevalent. In the case of Britain this meant pound/shilling/pence while in France it was livre/sous/denier, both of which come from the Latin librae/solidi/denarii. The monarch was responsible for declaring what these words meant. More specifically, the king or queen would post a sign in some central area saying something to the effect that a pound, or £, was worth, say, ten testoons, a type of silver coin. This definition was subject to change. The next day, for instance, an edict might be issued saying that a £ was now only worth nine testoons. Or, put differently, the £ now contained less silver. Just like that, prices had to rise 10% to account for the alteration made to the dictionary meaning of the word "pound."

Dictionary systems came to an end when the symbol for money was finally fused directly with the instrument itself. Remember, coins never used to have denominations, or units of account, on their face. Rather, they usually only had the monarch's head inscribed on them, maybe the name of the mint, and a few words about how awesome the monarch was. This lack of numbering was convenient. Since coins had no association with the unit of account, the quantity of coins (and thus silver) in the unit of account (i.e. the definition of the word) could be seamlessly changed by royal proclamation.

In the 1700s monarchs began to adopt the practice of inscribing the actual unit of account directly on the coin's face, i.e. coins began to be etched with 5¢ or £0.5.* Once this happened it became awkward to change the definition of the unit of account by editing the dictionary. Having permanently stamped the meaning of the word "dollar" or "pound" on millions of widely-circulating bits of stamped silver, changing that meaning by simply posting a sign on a popular street corner no longer did the trick. Every coin would have to be recalled and re-minted too!

Having long since put the definition of the word "dollar" or "yen" onto the actual instruments they issue, modern monetary authorities now have to do something to the instruments themselves if they want to conduct monetary policy. Maybe they issue a few more units of money or buy them back in order to alter their purchasing power. Maybe they jiggle the interest rate that those tokens throw off. Or they might raise or lower a currency's peg. Some sort of tangible action (or threat thereof) must be taken to change the economy-wide price level. Word updates won't do.

About the only place in the world that has dictionary money is Chile which, buffeted by high inflation, adopted a parallel unit of account called the Unidad de Fomento (UF) in the 1960s. (For more on the UF, see my old post here). Today, Chileans can choose to set prices in UF or in the Chilean peso. The latter is a conventional money, the word "peso" being defined as the 1 peso banknote issued by the nation's central bank. Unlike the peso, the UF lacks an underlying UF banknote. Rather, the Chilean government defines the word "Unidad de Fomento" to mean the number of Chilean pesos required to buy a fixed Chilean consumption basket. This definition changes every day and is posted here.

I think this is a pretty neat idea. As long as Chileans denominate their salary and other contracts using UFs rather than pesos, they are guaranteed to earn a steady stream of consumption, even if the Chilean peso hyperinflates.

These days inflation isn't really such a big deal, at least not in developed nations—central bankers seem to have mastered how to keep the purchasing power of the medium of exchange from getting out of hand. So adopting something like the UF might seem redundant. A dictionary money system is also unattractive because it imposes a calculational burden on citizens. People must be constantly doing conversions between an item's sticker price and whatever happens to be the medium of exchange necessary to complete the transaction. So if a book were to be priced at $5, you'd have to consult a government website to determine how many bitcoins, or dollar bills, or silver coins would be necessary to constitute a five dollar payment. The advantage of our current system is that because the word and the medium are unified, we don't have to do these conversions. A five dollar bill always suffices to cover a $5 sticker price. Simple.

On the other hand, dictionary money may have a role to play in our relatively recent deflationary age. Beginning with Japan back in the late 1990s, central bankers all over the world have been incapable of preventing deflation, or falling prices. Are their tools inadequate? Do they refuse to use these tools to their full extent? Do they not understand how to use them? With dictionary money, a central banker can't blame his or her tools for a miss, since all it takes to alter the price level is an update to the definition. A child could do it.

For instance, a nation like Japan could create dictionary money by removing the word "yen" on bills. It would do so by recalling all outstanding banknotes and replacing them with, say, Japanese pesos. Prices, however, would continue to be set in terms of the yen unit of account. Each morning the Bank of Japan would announce to the world how many Japanese pesos were in a yen. Say it starts with the yen being defined as ten pesos. To create some inflation, it would simply proclaim that the yen now contained just five pesos. Everyone with pesos in their pocket would suddenly be able to buy twice as much yen-denominated products as before. They would race out and spend. Shopkeepers who had previously been selling widgets for 1 yen, and getting ten Japanese pesos as payment, would quickly jack up prices to 2 yen in order to ensure that they still earn ten pesos per widget.

Voila, instant inflation.


* See Ernst Weber's "Pre-industrial Bimetallism: The Index Coin Hypothesis " [link]

Getting rid of the monetary triumvirate

The textbook definition of money is anything that functions simultaneously as a store of value, a medium of exchange, and a medium of account. This is the monetary triumvirate, and we need to get rid of it.

The first problem with this explanation is that all goods and assets function as stores of value, some better than others. Items that can't 'store' value would be be worthless because their lives would be too fleeting to provide any utility. Even an ice cream cone serves as a store of value, at least for a few minutes.

So if everything serves as a store of value, then money must be that peculiar good that functions as both a medium of exchange and a medium of account, right?

Wrong. All valuable things function as media of exchange, or, put differently, they all have a degree of exchangeability. A head of cabbage is a cabbage farmer's medium of exchange, since he uses it exchange with a food distributor, and it also functions as one of the distributor's many media of exchange, since he uses it to exchange with a grocer, and it also functions as one of the grocer's many media of exchange, since the grocer holds an inventory of cabbage in order it to exchange with the public. We can quibble over the general acceptability of any given medium of exchange; a dollar bill is more exchangeable than a cabbage, after all. But a dollar bill, like a cabbage, is not universally acceptable—try buying a house with it, or Microsoft stock.

So if everything serves as a store of value to some degree or other, and everything serves as a medium of exchange to some degree or other, then money must be that peculiar good that functions as a medium of account.

The upshot is that the only binary difference between the various goods and assets in this world is along the medium of account-or-not axis, both the store of value and medium of exchange functions being ranges or spectra, not binary categories. This means that a good is either a medium of account, or it isn't. There's no point in using an umbrella word like "money" anymore, since medium-of-account stands on its own as a useful definition.

A medium of account, if you don't remember, is the good that we use to quote prices. There are only a handful of media of account in the world, with the great majority of things not functioning as media of account. Dollar bills are certainly a medium of account. Credit cards (combined with network fees) also function as a medium of account. There are weird artificial media of account, like whatever is used to define Chile's Unidad de Fomento. Commodities like cloth, or macutes, have served as media of account in West Africa, as have silver pennies in Europe.

So let's retire that tired old triumvirate. The word money is redundant and meaningless; if we really want to divide the world into these and those, the medium-of-account bucket is about all we need. The other two functions, store of value and medium of exchange, are pervasive rather than exclusive (everything has at least a little bit of each), and therefore can't serve as the basis for drawing strict lines between goods.

Ghost Money: Chile's Unidad de Fomento

Santiago skyline

This post continues on the topic of the separation of the medium-of-exchange function of money from the unit-of-account function. My previous post discussed how the medieval monetary order was characterized by both a medley of circulating coins and one universal £/s/d unit of account. This post introduces a modern example of medium-unit divergence: the Chilean peso and Chile's Unidad de Fomento. I'll explain how the Chilean system works and end off by asking some questions about the macroeconomic implications of this separation, specifically what happens at the zero lower bound.

Like most modern currencies, the peso is issued by the nation's central bank; the Banco Central de Chile. Local banks offer peso-denominated chequing and savings accounts. Chileans use these pesos as the nation's medium-of-exchange. They pay their bills with pesos, settle rent with it, and buy food with it.

The differences between Chile's monetary system and those of other nations only emerges when we begin look at the unit in which goods are priced. Most nations have one unit-of-account, but Chile has two. While many Chilean prices are expressed in terms of the peso, or P, a broad range of prices are expressed in an entirely different unit, the Unidad de Fomento, or UF. Real estate, rent, mortgages, car loans, long term gov securities, taxes, pension payments, and alimony are all priced using UF. As examples, this real estate website sets prices in UF terms, and this car rental business levies insurance in UFs. On the other hand, wages, consumer good prices, and stock prices are expressed in peso terms.

So what is the UF? The UF was introduced in 1967 by the Chilean government, though it only came into wide use as a unit-of-account in the 1980s. There are no UF coins or notes circulating in the Chilean economy. Rather, the Unidad de Fomento exists as a purely abstract, or indexed, unit-of-account, totally divorced from any media-of-exchange. Goods and services quoted in terms of the UF can only be purchased with an entirely different medium — pesos.

The UF is defined as the amount of currency units, or pesos, necessary for Chileans to buy a representative basket of consumer goods. The amount of pesos in one UF, or the peso-to-UF exchange rate, is calculated daily, and is published on the Banco Central's website. The daily value is interpolated from the previous month's consumer price index, or the Indice de Precios al Consumidor (IPC). If you go to this website, you can see the current peso-to-UF rate and how it has been adjusted over the last week.

This all sounds quite odd, so let's use an example to get a better idea for how the system functions. When a Chilean seller prices something in UF, they are indicating that they expect to receive a fixed quantity of CPI basket-equivalents as payment. For instance, say that a landlord advertises an apartment in downtown Santiago at a monthly rate of 10 UF. A potential renter, curious about the price, checks the UF-to-peso exchange rate at the central bank's website. He sees that today's rate stands at 23,000. Using a cellphone app (in real life, the rate will probably not be a convenient round number), he multiplies 10 UF x 23,000 P/UF to arrive at the current monthly rate in pesos, or 230,000P (this is about US$450). Deciding that the price is good, the renter signs a lease and starts to pay UF-denominated rent each month in pesos.

Say that the Banco Central adopts an easy money policy and six months later the Chilean peso's purchasing power has fallen by around 10%. Rent is still priced at 10 UF. But now the peso content of the UF has risen —after all, it takes about 10% more pesos to buy the same consumer basket. The computed rate on the central bank's website is now 25,000 P/UF. The monthly amount in pesos that the renter must make out to the landlord now comes out to 250,000P (10UF x 25,000 P/UF), up from 23,000. However, while the rent payment is nominally higher, the payment's UF value is constant. In other words, the transaction represents the exact same quantity of CPI baskets as six months before.

It works the same way when the with a tight money policy. Imagine a 10% peso deflation. The UF sticker price stays constant while the conversion rate to pesos on the central bank's website falls by 10%. Rent is nominally lower in peso terms but in terms of representative consumer baskets it has stayed constant.

The UF/P system is similar in many ways to a partially dollarized economy in which the US dollar has been adopted as the unit in which to price long term contracts while the local currency is used to price current goods and services. What makes Chile different from partially dollarized economies is that the dollar tends to circulate along with the local currency as a medium-of-exchange. Thus there are two different units-of-account corresponding to two different media-of-exchange. Chile's UF, on the other hand, is a purely abstract unit with no corresponding medium of its own.

Irving Fisher was skeptical of medium-unit divergence and declared so in his 1913 paper The Compensated Dollar:

Not only would the multiple standard necessitate much laborious calculation in translating from the medium of exchange into the standard of deferred payments, and back again but, if, as has been suggested, the employment of a multiple standard were at first optional, the result would be that many business men whose prosperity depended on a narrow margin between their expenses and receipts would be injured rather than benefited by having one side of their accounts predominantly in the actual dollar and the other in the ideal unit.

Fisher went on to propose his compensated dollar scheme, which was essentially a combined unit-of-account/medium-of-exchange dollar. The real purchasing power of the compensated dollar would stay constant over time, much like the UF/peso combination, but without the necessity of imposing the laborious calculations involved in medium-unit divergence. That Chileans did choose to adopt a somewhat laborious mechanism that involves conversion from/to pesos to/from the ideal UF demonstrates the degree to which they were willing to free themselves of the burdens imposed by the 1970s inflation of the peso. The practice of publishing the UF-to-peso rate on a daily basis—which began in 1977— may have also encouraged UF adoption. Prior to then, the UF had only been calculated monthly.

While the idea of separating the unit from the medium is not a common one, when it does arise it tends to have been inspired by the desire to avoid the deleterious effects of inflation. Widespread use of the UF, as pointed out earlier, came about as a response to 500%+ peso inflation of the 1970s. Robert Shiller, the most vocal modern advocate of unit/medium separation, has also been motivated by concerns over the deleterious effects of inflatio. Shiller believes that because people tend to succumb to money illusion when dealing with inflationary episodes, the adoption of indexed units-of-account may be the most palatable way to reduce the problem.

Just as interesting, however, is the idea of separating the unit-of-account and medium-of-exchange to help cope with deflationary episodes and the zero-lower bound problem

First, let's set up a hypothetical scenario without the UF and a combined peso unit-of-account and medium of exchange. Say the Chilean economy suddenly collapses. Pessimistic Chileans expect to earn a negative return on projects and investments. Peso cash provides a superior return in this environment since it pays 0%—hardly great, but 0% is better than -x%! Peso prices need to fall dramatically in order to restore equilibrium. Put differently, the value of the peso needs to rise to a level at which it is expected to decline at the same rate as all other projects and investments. Yet peso-denominated sticker prices are rigid, preventing the necessary adjustment. What should be a short period of sharp adjustment turns into a long painful period of high unemployment and idle resources.

Now let's assume that all prices are expressed in UF while actual transactions are conducted in pesos. The same shock hits the Chilean economy. Once again the negative yield on projects and investments is overwhelmed by the 0% yield on peso cash. Peso prices need to fall dramatically in order to equilibrate the peso's return with all other yields. As before, sticker prices are rigid.

Here's the difference between our first and second scenarios. In a world with an ideal unit-of-account and no related medium-of-exchange, it really doesn't matter that prices can't adjust. This is because prices are no longer expressed in terms of 0%-yielding peso cash. Rather, they are expressed in terms of UF. Because the UF lacks a physical counterpart, there are no equivalent UF instruments that might also hit the zero-lower bound. The peso's outsized 0% return relative to all other negative yielding assets, which before was the root of the problem, will be quickly equilibrated as the peso-to-UF exchange rate published on the central bank's website jumps higher.

So a shock to an economy in which a combined medium-of-exchange and unit-of-account prevails can quickly become a tragedy. The 0% nature of the former interferes with the stickiness of the latter. But when the medium-of-exchange is divorced from the unit-of-account, the 0% nature of the former will quickly be resolved since stickiness is now in terms of an ideal unit, and not in terms of pesos.

Medium/unit separation, it would seem, could be yet another foolproof way of escaping deflation and the zero-lower bound.

---

References:
1. Robert Shiller, Indexed Units of Account: Theory and Assessment of Historical Experience, 1997. [RePEc]
2. Robert Shiller, Designing Indexed Units of Account, 1998. [RePEc]
3. Robert Hall, Controlling the Price Level, 2002. [RePEc]
4. Stephen Davies, National money of account, with a second national money or local monies as means of payment: a way of finessing the zero interest rate bound, 2004