The world history of free banking

Abstract

The inability of central banks to prevent inflation in recent years has led a growing number of economists to rethink government’s role in issuing money. Milton Friedman and Anna Schwartz, in their article ‘Has government any role in money?’ (1986), answered that it has very little role, while Friedrich A.Hayek has called for the outright abolition of central banking (1978:106-7). They and others who question the desirability of central banking argue that money is best supplied competitively for the same reasons that competition is best for supplying other goods. Several writers have developed new models of competitive money supply (‘free banking’) and compared them with models of money supply under central banking (Vaubel 1984a; White 1984b:1-22; Selgin 1988; Christ 1989; Dowd 1989: chs 1-4). The new models cast doubt on standard justifications for central banking, among them the claims that the production of reserves is or evolves into a natural monopoly, that competitive supply of money creates harmful ‘external effects’ that are absent under central banking, that a lender of last resort is necessary to keep a panic-prone banking system from collapsing, and that central bank policies stabilize output.

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