17  Smith recognised this too: “though the wages of the workman are commonly paid to him in money, his real revenue, like that of all other men, consists, not in money, but in the money’s worth; not in the metal pieces, but in what can be got for them” Wealth of Nations, I,ii,p295. 4  BIS Review 102/2006  can’t force people to use paper money, although after the French Revolution the Jacobins had a try. They made it a capital offence to use commodities as money! This was a desperate and unsustainable action resulting from the Jacobin policy of debasing their paper money – the Assignat – to make up for a collapse in tax revenues and to finance a war against Prussia. A more sensible solution is to create institutions in which we can have trust. On the front of this Bank of England £ note is written “I promise to pay the bearer on demand the sum of Twenty Pounds”. In essence, the promise is that the “stuff” that you can buy with this note does not change much from one year to the next. In other words, the general purchasing power of the note is broadly stable – we have price stability. Our ability to maintain price stability depends upon an institutional framework which is expected to persist. That depends on all of us acting collectively – the value of a nation’s money is inherently a political choice. Inflation arises when the collective political commitment to maintain price stability weakens.
And we understand the need for social institutions to constrain our actions. Since Smith, economists have underplayed the importance of institutions, although there have been notable exceptions such as Douglas North and Ronald Coase. Over the centuries, theories of a competitive market economy have been refined. From these theories flows the remarkable result that, under certain conditions, the pursuit by each person of their individual self interest leads to a more efficient outcome for society as a whole. That work reached its apogee in the post-war work by Kenneth Arrow and Gerard Debreu. Those economic models are, however, silent about many of the institutions that are fundamental to the results. 12 But without the appropriate institutions we tend to anarchy not prosperity. The challenge facing us is to design and maintain the right set of institutions or  8  Theory of Moral Sentiments, II,ii,3.3,p86. 9  In her 2002 Reith lectures “A Question of Trust”, Onora O’Neill argued that in order to interact with others, both as individuals and institutions, trust plays a crucial role. 10  Wealth of Nations, I,11,2,p26. 11  Rothschild (2001) puts Smith’s writings in the context of the Enlightenment and, while pointing to the complexity of Smith’s views and his caution in expressing them in public, paints an overall picture of a man who is not best described as a split personality. 12  Economists have grappled with the challenge of understanding worlds in which there are not markets for everything.