The Importance of Fiat Money as a Concept

Fiat money is typically backed by the good faith of the government maintaining or backing the money supply, importantly faith that it will accept the fiat currency in payment of taxes. Hence, the credibility of the government's policy would, in theory, impact the decisions of consumers and producers in a market economy. Under this assumption, economic actors might make decisions they would otherwise not make for fear that the currency or money that they hold will change in value radically. Managing this risk could produce economic distortions: when people convert money to other forms, increasing the demand for goods to be hoarded. Economic actors might also shelter income in other, more stable currencies, or charge higher interest rates.

Fiat money is also closely tied to government borrowing for expenditures that do not have a clear social return, or which may have negative expectations, such as wars of conquest. Governments could pay for wars using fiat money, rather than in hard currency or specie, on the belief that the returns of war will be sufficient to pay promised notes, and that during wartime shortage and austerity, goods are not available in any case. This has seldom proven to be the case in the absence of strong inflationary controls. Instead, the usual cycle is for the value of fiat notes to trade at a significant discount to portable and stable forms of exchange, specifically those that will be tender regardless of the winning side in the conflict. A variation on this was the use of fiat occupation currency to place the burden on other areas.
Some political economists argue that there is no such thing as fiat money, that governments can create fiat currency, but that the amount of money is determined by the valuation of the market place, and that attempts to create fiat currency beyond the demand for money generate inflation. In the words of Keynes, “Money doesn’t matter,” meaning that control of the money supply beyond limited boundaries will be adjusted for in the marketplace.