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Would a free banking system stabilize NGDP growth?

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  • Salter, Alexander William
  • Young, Andrew T.

Abstract

Since the 2008 financial crisis, a number of economists have suggested that central banks should follow an NGDP-targeting rule. Other researchers have argued that a free and unregulated banking system stabilizes NGDP growth as an unintended consequence. We explore this argument in a simple model of a free banking system. We find that a free banking system does indeed stabilize NGDP growth in response to aggregate demand shocks. However, we find that in response to aggregate supply shocks it stabilizes the inflation rate. An implication of this is that, unlike an NGDP-targeting central bank, a free banking system would not allow for disinflation or even deflation in response to a positive aggregate supply shock.

Suggested Citation

  • Salter, Alexander William & Young, Andrew T., 2018. "Would a free banking system stabilize NGDP growth?," The Quarterly Review of Economics and Finance, Elsevier, vol. 70(C), pages 21-25.
    • Handle: RePEc:eee:quaeco:v:70:y:2018:i:c:p:21-25
    DOI: 10.1016/j.qref.2018.04.016
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    1. Salter, Alexander William & Young, Andrew T., 2018. "A theory of self-enforcing monetary constitutions with reference to the Suffolk System, 1825–1858," Journal of Economic Behavior & Organization, Elsevier, vol. 156(C), pages 13-22.

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    More about this item

    Keywords

    Free banking; NGDP targeting; Inflation targeting; Monetary policy rules; Macroeconomic stability; Business cycles;
    All these keywords.

    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies

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