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The Uneasy Case for Fractional-Reserve Free Banking


  • van den Hauwe, Ludwig


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.

Suggested Citation

  • van den Hauwe, Ludwig, 2006. "The Uneasy Case for Fractional-Reserve Free Banking," MPRA Paper 120, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:120

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    References listed on IDEAS

    1. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August.
    2. 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.
    3. 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 808-826, November.
    4. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
    5. Shah, Parth J, 1997. "The Option Clause in Free-Banking Theory and History: A Reappraisal," The Review of Austrian Economics, Springer;Society for the Development of Austrian Economics, vol. 10(2), pages 1-25.
    6. 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;Society for the Development of Austrian Economics, vol. 8(2), pages 25-38.
    7. Klein, Benjamin, 1974. "The Competitive Supply of Money," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 6(4), pages 423-453, November.
    8. Garrison, Roger W, 1996. "Central Banking, Free Banking, and Financial Crises," The Review of Austrian Economics, Springer;Society for the Development of Austrian Economics, vol. 9(2), pages 109-127.
    9. 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;Society for the Development of Austrian Economics, vol. 9(2), pages 83-107.
    10. Soto Jesus Huerta de, 1994. "Banque Centrale Ou Banque Libre : Le Debat Theorique Sur Les Reserves Fractionnaires," Journal des Economistes et des Etudes Humaines, De Gruyter, vol. 5(2-3), pages 1-14, June.
    11. E. F. Shawyer, 1998. "Editorial," Maritime Policy & Management, Taylor & Francis Journals, vol. 25(2), pages 105-105, January.
    12. 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 473-491, 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 8765, University Library of Munich, Germany.
    3. van den Hauwe, Ludwig, 2007. "Professor Becker on Free Banking: A Comment," MPRA Paper 8251, University Library of Munich, Germany, revised 05 Nov 2007.

    More about this item


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

    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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