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Banking Panics and the Origin of Central Banking

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  • Gary Gorton
  • Lixin Huang

Abstract

Gorton and Huang (2001) argue that private coalitions of banks can act as central banks, issuing private money and providing deposit insurance during times of panic. This lender-of-last-resort role depends upon banking panics occurring threat of liquidation makes the private bank coalition incentive compatible, inducing banks to monitor each other. But, despite the evolution of private bank coalitions, government central banks and government deposit insurance schemes historically replaced the private bank coalitions. In this paper we ask why this transition from private arrangements to public arrangements occurred. We survey the historical and international evidence on panics, suggesting that Gorton and Huang (2001) are consistent with the evidence. Then, we extend Gorton and Huang (2001) to show the welfare improvement brought about by a government central bank replacing private bank coalitions as lender-of-last-resort. In particular, panics, while necessary for private coalitions to function, are costly because they disrupt the use of bank deposits as a medium of exchange. With government deposit insurance, panics do not occur, but the government must monitor banks. Such monitoring by the government is not as effective as private bank coalitions. We provide conditions under which the government can avoid the costs associated with panics by implementing deposit insurance and thereby raise social welfare.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9137.

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Date of creation: Sep 2002
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Publication status: published as Altig, David and Bruce Smith (eds.) Evolution and Procedures in Central Banking. Cambridge University Press, 2003.
Handle: RePEc:nbr:nberwo:9137

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  1. Charles W. Calomiris, 1989. "Deposit insurance: lessons from the record," Economic Perspectives, Federal Reserve Bank of Chicago, issue May, pages 10-30.
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Cited by:
  1. Piffaretti, Nadia F., 2008. "Reshaping the International Monetary Architecture and Addressing Global Imbalances: Lessons from the Keynes Plan," MPRA Paper 12165, University Library of Munich, Germany.
  2. Ager, Philipp & Spargoli, Fabrizio, 2013. "Bank Deregulation, Competition and Economic Growth: The US Free Banking Experience," MPRA Paper 49269, University Library of Munich, Germany.
  3. Philipp Ager & Fabrizio Spargoli, 2013. "Bank Deregulation, Competition and Economic Growth: The US Free Banking Experience," Tinbergen Institute Discussion Papers 13-210/IV/DSF69, Tinbergen Institute.
  4. Gary Gorton & Lixin Huang, 2002. "Bank Panics and the Endogeneity of Central Banking," NBER Working Papers 9102, National Bureau of Economic Research, Inc.
  5. Jon Danielsson & Jean-Pierre Zigrand, 2006. "Equilibrium asset pricing with systemic risk," LSE Research Online Documents on Economics 24515, London School of Economics and Political Science, LSE Library.
  6. Hasan, Zubair, 2011. "Money creation and control from Islamic perspective," MPRA Paper 39796, University Library of Munich, Germany, revised 21 Dec 2011.
  7. Stephen Millard, 2007. "The foundations of money, payments and central banking: A review essay," Money Macro and Finance (MMF) Research Group Conference 2006 106, Money Macro and Finance Research Group.
  8. Piffaretti, Nadia F., 2009. "Reshaping the international monetary architecture : lessons from Keynes'plan," Policy Research Working Paper Series 5034, The World Bank.
  9. Philipp Bagus & David Howden, 2012. "Still unanswered quibbles with fractional reserve free banking," The Review of Austrian Economics, Springer, vol. 25(2), pages 159-171, June.
  10. repec:pra:mprapa:39795 is not listed on IDEAS
  11. Tallman, Ellis W. & Moen, Jon R., 2012. "Liquidity creation without a central bank: Clearing house loan certificates in the banking panic of 1907," Journal of Financial Stability, Elsevier, vol. 8(4), pages 277-291.
  12. Margarita Samartin & Gerald Dwyer, 2004. "Why do Banks Promise to Pay Par on Demand?," 2004 Meeting Papers 180c, Society for Economic Dynamics.
  13. Viral V. Acharya & Denis Gromb & Tanju Yorulmazer, 2012. "Imperfect Competition in the Interbank Market for Liquidity as a Rationale for Central Banking," American Economic Journal: Macroeconomics, American Economic Association, vol. 4(2), pages 184-217, April.
  14. Itai Agur, 2009. "What Institutional Structure for the Lender of Last Resort?," DNB Working Papers 200, Netherlands Central Bank, Research Department.
  15. Yorulmazer, Tanju, 2003. "Herd Behavior, Bank Runs and Information Disclosure," MPRA Paper 9513, University Library of Munich, Germany.

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