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The Uneasy Case for Fractional-Reserve Free Banking

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van den Hauwe, Ludwig

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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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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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Related research
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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Find related papers by JEL classification:
E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
B53 - Schools of Economic Thought and Methodology - - Current Heterodox Approaches - - - Austrian
K39 - Law and Economics - - Other Substantive Areas of Law - - - Other
G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
P34 - Economic Systems - - Socialist Institutions and Their Transitions - - - Finance
H11 - Public Economics - - Structure and Scope of Government - - - Structure and Scope of Government

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. 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. [Downloadable!] (restricted)
  2. 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. [Downloadable!] (restricted)
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  3. 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.
  4. Garrison, Roger W, 1996. " Central Banking, Free Banking, and Financial Crises," The Review of Austrian Economics, Springer, vol. 9(2), pages 109-27.
  5. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121. [Downloadable!] (restricted)
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  6. 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.
  7. 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. [Downloadable!] (restricted)
  8. 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. [Downloadable!] (restricted)
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  9. Klein, Benjamin, 1974. "The Competitive Supply of Money," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 6(4), pages 423-53, November. [Downloadable!] (restricted)
  10. 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. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  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. [Downloadable!]
  2. van den Hauwe, Ludwig, 2008. "Free Banking, the Real-Balance Effect, and Walras´ Law," MPRA Paper 8765, University Library of Munich, Germany. [Downloadable!]
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