George Selgin - Bank Deregulation and Monetary Order
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BANK DEREGULATION AND MONETARY ORDER George Selgin London and New York CONTENTS List of illustrations ix Acknowledgements INTRODUCTION 1 x
1 HOW WOULD THE INVISIBLE HAND HANDLE MONEY? (with Lawrence H. White) 15 2 THE EVOLUTION OF A FREE BANKING SYSTEM (with Lawrence H. White) 57 3 THE RATIONALIZATION OF CENTRAL BANKS 77
4 THE STABILITY AND EFFICIENCY OF MONEY SUPPLY UNDER FREE BANKING 97 5 COMMERCIAL BANKS AS PURE INTERMEDIARIES Between old and new views 119 6 FREE BANKING AND MONETARY CONTROL 129
7 MONETARY EQUILIBRIUM AND THE PRODUCTIVITY NORM OF PRICE-LEVEL POLICY 142 8 THE PRODUCTIVITY NORM VERSUS ZERO INFLATION IN THE HISTORY OF ECONOMIC THOUGHT 163 -vii9 ARE BANKING CRISES FREE-MARKET PHENOMENA?
10 LEGAL RESTRICTIONS, FINANCIAL WEAKENING, AND THE LENDER OF LAST RESORT 207 11 IN DEFENSE OF BANK SUSPENSION 236 12 BANK-LENDING MANIAS IN THEORY AND HISTORY Index 278 256
-viiiINTRODUCTION Remarkably, this consensus of opinion has been reached with little help from economic theory: the instability of unregulated banking is often simply taken for granted, or is demonstrated through causal references to economic history, with little care taken to distinguish market-based sources of instability from ones connected in crucial ways to government interference. In view of this, one is entitled to ask whether an explicit inquiry into the nature and operations of a free banking and payments system, making consistent appeal to predictable consequences of selfinterested behavior, supports prevailing views. This means asking: (1) What sorts of institutions would an entirely unregulated banking and payments system involve? (2) How would nominal magnitudes, including the price level and money stock, behave in such a system? and (3) How vulnerable would such a system be to crises? Until the mid-1970s, scarcely any attempt had been made to answer such questions. Instead, critics of bank regulation (of which there has never been a shortage) settled for a piecemeal approach, revealing the practical shortcomings (and, on occasion, the unsavory origins) of existing regulatory arrangements, but never questioning the claim that some kind of regulation is necessary. That misguided government interference itself might be the main source of observed monetary and banking difficulties was not seriously considered. The claim that financial markets and banking in particular are inherently unstable was not open to doubt. -1During the last two decades, all this has changed. Economists, aroused by Hayeks (1976) pioneering essay on Choice in Currency, began systematic inquiries into the nature and implications of free banking. The basic intent of this research, including books by Lawrence White (1984), David Glasner (1989), Kevin Dowd (1989,
1992, 1993), Tyler Cowen and Randy Kroszner (1994), Steve Horwitz (1992), Larry Sechrest (1993), and myself (1988), was to reconsider governments role in monetary and payments systems, by first imagining how these systems might develop in the absence of government interference. Although different assumptions led each investigator to some alternative vision of monetary laissez-faire, all were led to reject the inherent-instability hypothesis, concluding that problems of existing monetary arrangements were due to government (that is, regulatory and central bank) failures rather than market failure. The essays reprinted here (with minor revisions) are, with two exceptions, articles written by me since the publication of my Theory of Free Banking. They are presented here in three parts, corresponding to the three questions posed above. The essays in Part I consider the institutional implications of monetary laissez-faire. Chapter 1, How would the invisible hand handle money, written with Lawrence H. White, sets the stage by reviewing recent research on the implications of monetary deregulation. White and I identify three distinct schools of thought on this subject. The modern free banking school, to which White and I belong, insists that an entirely deregulated and privatized payments system of the future would involve many of the same basic institutional featuresincluding a single outside base money cum unit of accountfound in past, relatively unregulated banking systems. 1 The competing fiat monies school, to which Hayek belonged, imagines a world of plural, private fiat monies. Finally, the New Monetary Economists believe that deregulation would pave the way to a purely inside monetary system, lacking base money altogether. White and I argue that, of these alternative views of monetary laissez-faire, only the modern free banking view involves institutional arrangements that are both viable and predictable outcomes of individuals self-interested behavior. Chapter 2, The evolution of a free banking system, also written with White, offers a further defense of the modern free banking view in the form of a conjectural history of a typical free banking system. The point of such a conjectural history is to show precisely how the unregulated actions of individual agents give rise to monetary institutions as envisioned in the free banking literature. Although this paper predates my earlier book, and was in fact the prototype for a chapter in that book, I include it here because it is crucial for understanding the institutional assumptions relied upon in my more recent papers. One can, of course, define free banking in a strictly negative senseas a system where bankers are held to the usual laws of contract but where intermediation is not otherwise legally restricted -2-
but some more positive understanding of the nature of free banking is needed before any conclusions can be reached concerning its practical consequences. Charles Goodhart (1988) rejects the conclusions White and I reach concerning features of a typical free banking system. Noting economies of scale achievable through a centralization of bank reserves, Goodhart argues that reserves will naturally tend to gather in a dominant bankers bank. Central banking itself is thus seen as a natural development. As I note in Chapter 3, The rationalization of central banks, some centralization of reserves is in fact assumed in modern discussions of free banking. However, some earlier proponents of free banking appeared to deny any natural tendency for reserves to become centralized. Walter Bagehot (1873), for one, refers to free banking as an arrangement with every bank keeping its own [cash] reserve (ibid., pp. 331-2). Goodhart is right to argue that this view is incorrect. It does not follow, though, that reserves will naturally accumulate in a bankers bank, like the Bank of England. On the contrary: despite his erroneous view of free banking, Bagehot was on solid ground when he called the Bank of Englands reserve monopoly the gradual consequenceof an accumulation of legal privileges [which] no one would now defend (ibid., p. 100). The possibility overlooked by both Bagehot and Goodhart is that free banks can, and indeed historically did, achieve reserve economies while avoiding possible conflicts of interest by establishing branch networks and by joining non-bank clearinghouses. A number of new case studies of free banking (Dowd 1992), published since Goodharts critique appeared, lend additional support to this modern free banking view. The same case studies do not, on the other hand, support any of the alternative visions of monetary laissez-faire: one finds, for example, no historical instances of freely evolved moneyless payments systems of the sort contemplated by the New Monetary Economists or of systems relying upon broad index-type accounting units of the sort recommended by Dowd (1989, pp. 98-100) and Glasner (1989, pp. 227-49). Voluntarily accepted, privately issued fiat money is likewise unheard of. Instead, simple, single-commodity standards have tended to emerge and to remain in place until their eventual dismantlement by governments; and, although the most sophisticated free banking systems, like Scotlands, were ones in which bank customers rarely converted banknotes into gold or silver, there is no reason to suppose, pace Cowen and Kroszner (1994), that consumers failure to exercise their legal rights heralded a voluntary abandonment of those rights. Indeed, it is more accurate to say that the Scots did not bother to convert banknotes into gold only because they believed banknotes could always be converted in gold.
Part II gathers my papers addressing the implications of free banking for the behavior of nominal macroeconomic magnitudes including the money -3stock, the price level, and nominal income. Unlike the essays in Part III, these generally take for granted public confidence in the banking system, and so address the behavior of free banks during normal (non-crisis) periods. Surprisingly and, I think, wrongly, some critics of free banking seem inclined to treat these normal monetary implications of free banking as a diversion from the real issue of banking crises, as if a systems ability to avoid crises were the only thing that mattered, and as if the likelihood of crises itself were not crucially dependent upon the workaday stability of nominal magnitudes. To at least some extent, I suppose, this attitude reflects the simultaneous abatement of inflation and resurgence of banking crises after 1980 as well as the fashion that arose during the same period (known as the new classical revolution) of downplaying the importance of monetary changes to real activity. Fashions change, of course, and I believe it will not be long before theorists begin to see the behavior of nominal magnitudes during normal times as the fundamental issue for free banking theory. Much depends, of course, on whether theorists in general become convinced, as I am (for reasons given in Part III), that banking crises themselves are mainly due to unwarranted government interference with ma