Ask the Expert: William Niskanen

 Jacqueline Infante from Lehman College at the City University of New York asks:

 "When money is printed by the government, does it have any backing or is it a fiat currency?"

William A. Niskanen, chairman emeritus and a distinguished senior economist at the Cato Institute, answers:

Money printed by the U.S. government has no backing and, as such, it is a fiat currency. Whether an increase in the supply of money is inflationary, however, depends on the demand for money. At present, there has been a very large increase in the demand for money because of the uncertainty about the value of other assets. So a very large increase in the supply of money is temporarily appropriate and necessary to avoid a general deflation.

At such time as people regain confidence in the value of other assets, probably next year, the Federal Reserve will face a difficult choice: If it does not reduce the supply of money, we face a substantial increase in the inflation rate. On he other hand, a rapid increase in short-tem interest rates would be necessary to reduce the supply of money.

This type of problem is a consequence of changes in the "velocity" of money, the inverse of the demand for money, not of the fact that the U.S. dollar (like most other contemporary currencies) is a fiat currency. Moving to a gold standard or some other asset-backed currency would limit the supply of dollars and prevent a response to a rapid increase in the demand for dollars caused by increased uncertainty about the value of other assets.