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The Uneasy Case for Fractional-Reserve Free Banking

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  • van den Hauwe, Ludwig

Abstract

Since a few decades several sub-disciplines within economics have witnessed a reorientation towards institutional analysis. This development has in particular also affected the fields of macroeconomics and monetary theory where it has led to several proposals for far-reaching financial and monetary reform. One of the more successful of these proposals advocates a fractional-reserve free banking system, that is, a system with no central bank, but with permission for the banks to operate with a fractional reserve. This article exposes several conceptual flaws in this proposal. In particular several claims of the fractional-reserve free bankers with respect to the purported working characteristics of this system are criticized from the perspective of economic theory. In particular, the claim that a fractional-reserve free banking system would lead to the disappearance of the business cycle is recognized as false. Furthermore an invisible-hand analysis is performed, reinforcing the conclusion that fractional-reserve free banking is incompatible with the ethical and juridical principles underlying a free society.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 120.

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Date of creation: 05 Oct 2006
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Handle: RePEc:pra:mprapa:120

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Keywords: monetary and banking regimes; comparative institutional analysis; central banking versus free banking controversy; fractional-reserve free banking; Law and Economics of money and banking;

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  1. Robert J. Barro & David B. Gordon, 1983. "A Positive Theory of Monetary Policy in a Natural-Rate Model," NBER Working Papers 0807, National Bureau of Economic Research, Inc.
  2. Robert J. Barro & David B. Gordon, 1984. "Rules, Discretion and Reputation in a Model of Monetary Policy," NBER Working Papers 1079, National Bureau of Economic Research, Inc.
  3. Garrison, Roger W, 1996. " Central Banking, Free Banking, and Financial Crises," The Review of Austrian Economics, Springer, vol. 9(2), pages 109-27.
  4. Selgin, George & White, Lawrence H, 1996. " In Defense of Fiduciary Media--Or, We Are Not Devo(lutionists), We Are Misesians!," The Review of Austrian Economics, Springer, vol. 9(2), pages 83-107.
  5. Selgin, George A, 1994. "On Ensuring the Acceptability of a New Fiat Money," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 26(4), pages 808-26, November.
  6. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  7. Shah, Parth J, 1997. " The Option Clause in Free-Banking Theory and History: A Reappraisal," The Review of Austrian Economics, Springer, vol. 10(2), pages 1-25.
  8. E. F. Shawyer, 1998. "Editorial," Maritime Policy & Management, Taylor and Francis Journals, vol. 25(2), pages 105-105, January.
  9. de Soto, Jesus Huerta, 1995. " A Critical Analysis of Central Banks and Fractional-Reserve Free Banking from the Austrian School Perspective," The Review of Austrian Economics, Springer, vol. 8(2), pages 25-38.
  10. Klein, Benjamin, 1974. "The Competitive Supply of Money," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 6(4), pages 423-53, November.
  11. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
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Cited by:
  1. van den Hauwe, Ludwig, 2006. "Review of Huerta de Soto´s `Money, Bank Credit, and Economic Cycles´," MPRA Paper 49, University Library of Munich, Germany.
  2. van den Hauwe, Ludwig, 2008. "Free Banking, the Real-Balance Effect, and Walras´ Law," MPRA Paper 17294, University Library of Munich, Germany.

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