The Free-Banking vs. Central-Banking Debate

Ah, what a lovely way to start the day. A glorious morning, cool and fresh. A meeting of aged soccer players on a lush and muddy turf. No broken bones. No pulled hamstrings. I even scored a goal. Oh, the joy.

And now back home to read over my fan mail. You know…I had no idea that Americans were so passionate. I think that
American-style passion frightens us little Canadians. I suspect that this is what makes Canada so dull. And it’s probably the reason I left too. Welcome to the jungle, Mr. Andolfatto.

As many of you can imagine, I’ve been the recipient of hundreds of rather nasty emails lately. I don’t know any other way to describe it except as “awesome.” Oh, I don’t especially like being called names and being insulted, but it’s no big deal (academics need pretty thick skins to survive). The awesome part is how people are so eager to express their views. It is, I think, a part of what makes America great.

Now for a little story–some background, I guess. Long ago, a remarkable debate took place about the optimal way to organize an economy’s money and banking system. The proponents of free-banking eventually lost out to those who favored some form of central bank regime. The nature of these debates are nicely summarized by Vera Smith in her book, The Rationale of Central Banking.

Then for a long time, it seemed that very few people were interested in this debate anymore. Oh, a few academics would talk about it here and there. But if one was interested in practical monetary policy issues, well, one simply had to take the existence of a central bank as given.

That attitude always struck me as wrong-headed. As a young academic, I was interested in the theoretical foundations for monetary exchange. And I became fascinated in the experiments with money and banking regimes that were tried in the past. I made a point of teaching this to my students. And, in particular, I emphasized the free-banking alternative.

And now I find myself employed at a central bank (I still retain affiliation with my university). Well, I’m at a regional branch of a central bank (there are 12 regional Feds). And because of my present employment, many people evidently believe that I am a hard-nosed central bank type whose sole purpose is to defend the institution and its policies. As if an academic could or would want to ignore 20 years of scholarly research on the subject just like that. No, that’s now how it works–and it’s not the reason I was hired by the St. Louis Fed (if it was, I would not have come).

I love the research division here in St. Louis. My colleagues are great and the intellectual atmosphere is vibrant. The debates we have among ourselves often get lively. And yes, we sometimes talk about the merits of gold standards, free-banking, etc. I have even invited George Selgin, an ardent and articulate proponent of free-banking, to visit us in St. Louis and give us a lecture on the topic (which he has agreed to do some time in the future).

As an academic who has devoted a considerable amount of time on the subject, I cannot say that I presently fall strongly on either side of the debate. I can see merits (and defects) in both points of view. And I think it is great that Ron Paul has brought the subject back into the spotlight. As an academic interested in the subject, it is no less than thrilling. I think I can speak for most of us economists working at the St. Louis Fed in saying that we welcome a healthy debate. (And do not make the mistake of thinking that all Fed economists necessarily fall on one side of the issue).

To make a solid case one way or the other, it is important to keep the facts straight. (Yes, I realize that I am setting myself up for more abuse but please, spare yourself the trouble.) Moreover, it is also important, I think, not to present data in a misleading light. Now, I do not think everything Ron Paul says is wrong. In fact, as I said in my original post, I appreciate the libertarian philosophy. But if one wants to promote libertarianism based on sound intellectual foundations, it does the cause no good to make and promote misguided statements about money, prices, and the role of central banks. History is replete with bad government policies well before the existence of central banks. In my view, it is wrong to convey the impression that something close to economic nirvana will dawn in the absence of a central bank.

In my original post, I wanted to attack one particular idea promoted by Ron Paul. (I did not mean to attack the man personally, and I regret adjective I used to describe what I thought of his idea). I want to be clear that the post was not meant to critique all or even most of the Congressman’s ideas–nor was the post meant to serve as a defense for the Fed.

It is my belief that Ron Paul promotes a misleading argument concerning the fact that our price-level today is much higher today than it was 100 years ago. His argument implicitly suggests that nominal wages today would be roughly where they are at even in the absence of currency debasement. This is, in my view, just plain wrong.

But for people who believe it (and evidently there are many out there that do), it provokes rage against the Fed. It is as if the Fed has stolen virtually all of their wages and that real material living standards today would be much higher if only the price-level had remained at its 1913 level. This proposition is grossly at odds with the evidence, which shows roughly 2% annual real growth in per capita income and roughly stable income and expenditure shares. There is, of course, considerable discussion about growing income inequality. But almost every paper I read about this phenomenon seems to point either to skill-biased technological change or competition from emerging economies. I’m not sure what Fed policy has to do to with those forces.

I am no defender of inflation. But the US inflation rate has been low and stable for decades now. Seigniorage revenue is small potatoes relative to the appropriations made by Congress via direct taxation. Ending the Fed will do little, in my view, to diminish the level of those appropriations. Tackling that issue will take serious tax reform–a reform that would have to take place whether or not a Fed was in existence.

Now, there may be other reasons for abolishing the institution, but if so, then why not emphasize those? As I said in my original post, there are many legitimate arguments one could level at the Fed as an institution or in the way it conducts its policy. But it does no service to the libertarian cause to attack the Fed with misleading arguments (that are mixed in with other more legitimate ones). It does no good because opponents to the libertarian cause can latch on to the lame arguments and use them to discredit the more worthy ones.

The Fed was established by an act of Congress in 1913. The Fed is operating under the rules established by Congress. If you have a problem with these rules, then I encourage you to lobby your Congressional representatives to change them. Blaming the Fed for following the law as established by Congress  (and other guidelines, such as the dual mandate) seems like a rather strange way to go. But hey–power to the people.