This paper argues that economic fluctuations before the Peel’s Bank Act were caused by extrinsic random events relating to possible suspension of convertibility of the Bank of England. We show that there are economies in which (i) sunspot equilibria exist in the absence of the legal restrictions espoused by the quantity theory; (ii) the restrictions can be used to eliminate those equilibria; (iii) the proposals of the real-bills doctrine improve the outcomes of the quantity theory restrictions as well as free banking; and (iv) the welfare improvement of the real-bills regime can be accomplished only with the legal restrictions imposed.
