The Experience of Free Banking.
As Dowd and Schuler recognize, scope for contrast between free and central banking is multidimensional. Their discussion suggests that there are at least four freedoms. The first two are freedoms in a literal sense: freedom of entry into the business of banking and freedom of each entrant to issue its own banknotes. The second two derive from the absence of centralized crisis management--as in government-sponsored lender of last resort--and the absence of macroeconomic stabilization policy. Dealing rigorously with the combined effects of the two instances of "freedom of" together with the two instances of "freedom from" would require theoretical support from several fields of study--both separately and interactively--including macroeconomics, finance, money, and industrial organization. For instance, the fundamentals of monetary theory come into play when the competitive process involving multiple issuers of banknotes imposes an effective constraint on note issue. At some point on the way to full-fledged free banking, the competitive forces themselves become the binding constraint, and the link between the money supply and the underlying quantity of commodity money, e.g., gold, loses much of the significance it once had. Whether the money supply is limited by competition or by commodity money in particular episodes is not always clear in the accounts of the different countries' banking experiences. And connecting this issue in monetary theory with issues relating to market structure, risk management, and macroeconomic stability would require more theory than is now extant. In trying
to discern the meaning of the many twists and turns of banking history, the reader is constantly reminded of how many issues in free banking's research agenda have yet to be explored.
In lieu of a widely accepted theory of free banking and implied standards by which to judge the actual performance of the banking industry in conditions of laissez faire, Schuler and others adopt conventional standards by which to judge alternative banking regimes. How well does the banking industry foster economic growth, intermediate efficiently between lenders and borrowers, maintain stability of prices or exchange rates, avoid problems of fraud and counterfeiting, prevent the overissue of credit, and discourage bank runs and panics? When graded on a curve, free banking wins out over central banking on all counts. Episodes involving some hybrid set of banking institutions confront the researcher--and reader--with judgment calls as to whether the bad performance of the banking industry is attributable to too much or too little freedom. Judgments by the contributors to this volume are made in the light of the economist's general understanding of the merits of individual as compared to central direction of economic activity.
Some readers might get the idea that any goal central banks set for themselves (price-level stability or an accelerated rate of economic growth) can be better achieved as an unintended consequence of the separate actions of profit-maximizing free bankers. The episodic history provides ample evidence in favor of free banking, one suspects, largely because with central banking political incentives cut against economic goals. Inflation that serves political purposes and the consequent degradation of economic performance can easily be beat by a de-politicized banking industry. The Theory of Free Banking as set out by George Selgin |1~ together with the basics of growth theory makes it clear that free banking is not a means to the ends of central banking. Market forces in a regime of competitive note issue, for instance, allow for changes in the money supply in the face of changes in money demand, but those same market forces hold the line on money in the face of changes in real economic output. The contrast between policy goals and market performance can be made with the help of MV = PQ: while the goal of central banking may be to hold P constant despite changes in V and Q, the consequence of free banking is to hold MV constant while changes in Q are offset by changes in P. Further, in a free-banking regime the economy's real rate of economic growth, the rate of change of Q, is sustainable but not necessarily the highest possible. Laissez faire allows the economy to grow at its natural rate--which corresponds to the choices of market participants as between present and future consumption, given the intertemporal terms of trade as dictated by resource constraints and technological considerations.
In one sense, the adoption in the present volume of conventional standards--rather than standards more consistent with free-banking theory--strengthens the book's central message. Free banking fares well even when the standard of judgment stacks the cards against it. At the same time, the ultimate inappropriateness of judging free-banking performance against central-banking standards constitutes the book's major weakness and hints at the breath and depth of the research agenda that still awaits free-banking scholars.
Roger W. Garrison Auburn University
1. Selgin, George A. The Theory of Free Banking: Money Supply under Competitive Note Issue. Totowa, New Jersey: Rowman and Littlefield, 1988.
2. White, Lawrence H. Free Banking in Britain: Theory, Experience and Debate, 1800-1845. Cambridge: Cambridge University Press, 1984.
|Printer friendly Cite/link Email Feedback|
|Author:||Garrison, Roger W.|
|Publication:||Southern Economic Journal|
|Article Type:||Book Review|
|Date:||Jan 1, 1994|
|Previous Article:||Recent Developments in Game Theory.|
|Next Article:||Topics in the Economics of Aging.|