May 10, 2014

Free Banking in History and Theory

  • Lawrence H. White

    Distinguished Senior Fellow, F. A. Hayek Program for Advanced Study in Philosophy, Politics and Economics
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This paper surveys economists’ work on the theory and the history of free banking regimes. Support for free banking - a laissez-faire monetary system without a central bank, typically conceived as operating under a commodity standard - has been much rarer than support for free trade, even among self-identified free-market economists. Yet where something close to a free banking system was given a trial, for example in Scotland and Canada (seven other cases are also reviewed), the consensus among economic historians finds that it functioned better for the typical user of money and banking services than more heavily restricted systems in other countries. The widespread adoption of central banking, despite the success of free banking, can be explained by the latter’s fiscal advantages to national governments. The standard arguments for deposit insurance, and the leading counter-arguments, are also reviewed. Recent work on the importance of credible commitments - in monetary, fiscal, and bank regulatory policies - has the potential to reinvigorate the case for free banking on a commodity standard.