In the comment thread of this post, Steve Horwtiz writes (in response to another commenter - not my initial post):
"There was no central bank in the 1890s, but that doesn't indict "free markets" because the US money supply process was still very much affected by the federal regulations of the National Banking System that made it difficult for national banks to respond to increased in the demand for money, especially those associated with harvest season or sectoral problems (e.g. the railroads in 1893). The panics of 1893 and 1907 were classic examples of government intervention (and in the name of financing the Civil War no less) gone bad."
I don't want to endorse his history because I'm no expert on the history of this period, and I don't want to "indict free markets" because of course I am a free market economist. But if we take this to be a reference to free banking, I do want to raise a question about institutional robustness. Since we only seem to be able to point to scattered, fleeting references to free banking, can you blame us non-free-bankers for raising concerns about how robust such a system would be? It's a bit like Communists who are never happy with the totalitarian systems that always seem to result from any attempt at making Communism a reality. There are lots of reasons to criticize Communism, but one quite natural criticism is that the only Communist society they've ever really been happy with survived for a grand total of two months.
I don't think - and have never claimed - central banking is perfect, but I think it works well enough to do the institutional job that we want it to do. We know central bankers learn from their mistakes and adapt the institution over time (just look at the history of the Fed). And we know these institutions are actually stable - we're coming up on the 100 year anniversary of the Fed, and the Bank of England has been going strong for centuries.
Steve is right in this comment - the 1890s were not a free banking era as free bankers understand the term. It's hard to find such an era, actually.
Those of us who care about institutional robustness and the actual functioning of our theoretical ideas in the real world should care about that, I think.
Wednesday, January 25, 2012
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The period of economic history dominated by the Federal Reserve (1913-present) has not been any more stable than the period preceding it, as has been aptly demonstrated by economists such as Christina Romer. So, we do not know that the Federal Reserve has been "stable enough." If we wanted to frame it a negative way we could say that the period dominated by the Federal Reserve has been just as unstable as the period before it -- a free banker could say that the Federal Reserve did not correct the flaws of the previous monetary system.
ReplyDeleteIn any case, I would say that the theory of free banking is just as robust -- on the surface -- as any other theory that has never really been practices empirically (or, in reality, in other words). Other theories that fall under this category, I think, are stimulus -- the Second World War aside, since this is highly debatable -- and radical monetary stimulus (say, Krugman's theory for escaping the liquidity trap with heavy inflation). The robustness of the system has to be judged on the basis of the robustness of the theory.
Fwiw, Selgin's The Theory of Free Banking is very easy to read, and is the single most important contribution to the literature of free banking, I think, to date.
The period of economic history dominated by the Federal Reserve (1913-present) has not been any more stable than the period preceding it
Delete(1) In the case of the US, that is because of 1914-1933. It is correct that a central bank in the absence of proper financial regulation and countercyclical fiscal policy will not necessarily lead to better economic stability.
1945-1973, however, shows much better stability compared to 1914-1933. Even the neoliberal era shows better stability. The same is true of numerous other countries.
(2) Romer's data for the 19th century has been challenged by Balke and Gordon, and it is absurd to believe that we have authoritativem final data on 19th century GNP. The 19th century annual estimates sometimes conceal small recessions of 2 quarters or recessions spanning 2 year periods.
If you really want to accept Romer's data, then 1920-1921 was only a mild recession too, in real output terms.
David Glasner wrote an interesting post on central banking (vs central planning) not too long ago, which included the following passage on free banking:
ReplyDeleteI did indeed write a book nearly 25 years ago in which I advocated free banking. The truth is that I still believe that most of what I wrote in my book was correct, but I would admit to having greater doubts than I did then about the practicality of adopting a free-banking system. The main source of my doubts is that I don’t think that we have yet come up with a model for dealing with insolvent or even illiquid banks. I suggested in my book that money market mutual funds provided a workable model for free banking, but the experience of September and October 2008 in which a run on money market mutual funds that had invested heavily in the commercial paper backed by mortgage backed securities issued by Lehman Brothers and others was a key part of the financial panic suggests to me that we need a more fundamental redesign of monetary institutions than I had imagined if we are to shift to a monetary system without a lender of last resort. I understand all the arguments about the distorted incentives that regulation and other interventions created, promoting risk taking by too-big-to-fail financial institutions, but I don’t know if there is any way of showing that a system of free banking would not entail a higher level of systemic risk than our current system.
I'm pretty intrigued by the idea of free banking... At the very least, I don't count myself knowledgeable enough to dismiss the idea. However, I get the uneasy feeling that the majority of armchair proponents of FB are oblivious to the possibility of systematic risks as described above.
1. Institutional stability. We have had a central banking system for 100 years. You don't want institutions that have no real robustness to them - that degenerate into something unacceptable. We've had what most advocates of central banking would consider a not perfect - but acceptable - central banking system for a century. And far from degenerating, it's been able to learn from its mistakes and adapt to changing circumstances. From an institutionalist perspective, this is a very good thing.
ReplyDelete2. The Romer (and we can add Selgin/White/Lastrapes - forthcoming) evidence is important but we must keep in mind that it's a pre-post picture. That has serious limitations as a method of institutional evaluation. If I had 48 hours in a day I'd put serious time into redoing the Selgin/Lastrapes/White analysis as a difference-in-differences with Great Britain over the same time period. I have no idea what the result would be, but that's more along the lines of what we want.
3. I do need to get and read that I think. This basic income article I'll be writing later this spring is going to need to frame things in a way that's appealing to Austrian monetary disequilibrium folks.
SERIOUSLY?
ReplyDeleteEver heard of Larry White's Free Banking in Britain?
Free bankers have been citing Scotland for decades.
Before you resort to all caps, maybe read a little more closely and note that I never said there was no historical example - just that there are few and they often turned into a system of central banking.
DeleteI am quite aware of free banking in Scotland. That doesn't change the fact that institutional robustness presents a problem for free bankers.
"institutional robustness"
DeleteBy this I assume you mean a centralized mechanism exercising control over the system. Is this correct?
Your grasping here. Is institutional robustness (in the sense you're talking about it) supposed to mean something? Countless dicatorships have been robust, feudalism was robust, and hey, under your definition, slavery was robust. All of these institutions relied on certain power structures....not really getting what your point is.
ReplyDelete"We know central bankers learn from their mistakes and adapt the institution over time (just look at the history of the Fed."
Yeah the 2000's really confirm this assertion.....
Distinguish between robust and enduring. For the former, I take it to simply mean resilience to systemic risk.
DeleteNo, it's not grasping ml. This is a pretty standard thing to discuss.
DeleteI would have thought dictatorships are NOT robust, but feudalism and slavery probably are, I'd agree.
Obviously robustness isn't the only thing to be concerned about - nobody to my knowledge said it was. It's still an important characteristic for any institutional arrangement.
I'm not expert on comparative institutions/institutional analysis but I see the difference as largely what stickman points out. Of course robustness usually implies endurance.
Anyway, ml - wander over to the blog Coordination Problem where Pete Boettke discusses these issues a lot. I'm not grasping at all here - you just seem unfamiliar with the discussion.
Daniel is correct in the sense that the burden of proof is on the shoulders of free bankers given the widespread acceptance of central banking worldwide. I think that means those of us who are defending it have to do three things:
ReplyDelete1. Point to the historical examples of systems that were very close to, if not, free banking and demonstrate their strengths. BTW, there are more than you think Daniel. See, for example: http://tinyurl.com/8yfm94p
2. Offer good arguments and historical evidence for why the increased role played by government in money production, whether in the form of NBS type regulation or true central banks, were the result not of failures of free banking but of rent-seeking by private interests and/or the desire of government actors to have access to revenue through money creation. I'm quite confident that the cases where pretty free systems became central banks fit this pattern.
3. Do what White, Selgin, and Lastrapes have done and demonstrate that generally accepted macro outcomes have been worse under central banking than more free systems. Again, I think a real preponderance of the evidence is on the side of free banking here.
My point, though, is that these are the issues that need to be discussed by all parties, even if the burden of proof is on those of us offering what seems to be a radical alternative. (FWIW, I actually think the burden of proof SHOULD be on the proponents of central banking, but I willingly accept the reality that it is the free bankers who will have to bear it in the world we live in.)
The major example exposing the instability and inferior nature of free banking (or, at least, a system close to it) is Australia in the 1880s and 1890s. See C. R. Hickson and J. D. Turner. 2002. “Free Banking Gone Awry: The Australian Banking Crisis of 1893,” Financial History Review 9: 147–167.
Deletere: "were the result not of failures of free banking but of rent-seeking by private interests and/or the desire of government actors to have access to revenue through money creation. I'm quite confident that the cases where pretty free systems became central banks fit this pattern."
DeleteRight, but if you're vulnerable to rent-seeking in this way it means you're not very robust!!!
Communists often complain that totalitarian-minded rent-seekers spoiled the worker's paradise. We usually don't take this to be a good argument supporting the institutional robustness of Communism!
If you need angels to get a system of free-banking to work, then you're out of luck because men aren't angels.
I'm quite open to Daniel's view here and I've thought of it a lot myself.
DeleteIn many examples of government action it's quite clear that government action X caused result Y. But, in others it's much less clear, free banking may be one of those.
In that case we perhaps must accept the fact that central banking will always exist because central bankers and governments will always be able to blame the failures of banking on commercial banks. And commercial banks will play along with that for their own reasons.
This is, in some ways, similar to the debate about socialism and communism. Those who oppose socialism in it's various forms could be seen as the idealists because they believe that it's possible to create a world without it. I don't believe that. My own view is that "progressivism" in some shape or form is inevitable, because the proletariat will always form the majority of voters and will (in the long run) vote in their own short-term interest. I see the role of people like myself as stripping away the legitimacy of that, as revealing it to be simple class war.
But, I'm not convinced this kind of argument extends to central banks. The question here is, if different political situations could exist where the rent-seeking and so on would be more obvious. This isn't science fiction, today people like yourself are much more aware of rent seeking in normal business than they were in the past. If you look at Elizabethan times in England, for example, rent-seeking ran wild because nobody understood it's consequences.
It seems to me that many free bankers have the disadvantage that they approach the topic of money and banking from a very different paradigm than others. So, for example, I'm not sure that economists such as Horwitz, Selgin, White, etc., would have approached the mutual funds market dilemma from the same angle as did Glasner (who is/was a free banker in a different economics tradition). I don't mean to put words in anybody's mouth, but at least this is the sense I get from whatever knowledge I do have on the different paradigms from which these economists look at the world.
ReplyDelete