Who needs a central bank anyway? Perhaps we should fire Mark Carney and get rid of the Bank of England, says Simon Wilson.
What is “free banking”?
It’s banking that is “free” from the kind of state controls that are now almost universal – a laissez-faire system under which the state treats banks just like any other commercial business and there are no special regulations specifying, for example, the level of reserves they must have and how much they can lend. A key part of such a system would be competitive note issuance by competing free banks, allowing the market – and not a state-controlled central bank – to set both the price of money (interest rates) and determine its supply. Other key features include low legal barriers to entry and no central control of reserves.
Sounds utopian – is it a new idea?
No, it’s as old as banking itself and in some countries was long considered the norm. Arguments in favour of free banking can be found in Adam Smith’s The Wealth of Nations (1776), while in Smith’s homeland, Scotland, just such a system was in place from 1716 until 1845. In England the Free Banking School of economists lobbied the government to copy the Scottish model until 1844, when the Bank Charter Act formalised the terms of the Bank of England’s monopoly on currency issuance. Sweden operated a broadly successful free banking policy from 1830 to 1902. In America, the years 1837-64 are known as the Free Banking Era (though the banks were under more local state controls than the term implies).
Not utopian, then – but archaic?
It’s true that for the past century and more governments throughout the world have assumed an ever-greater role in formulating and implementing “macroeconomic” and “monetary” policies, in the belief that wise “experts” are best placed to manage the money supply, tame the business cycle and promote growth. And those who have championed the idea, such as Ludwig von Mises and Friedrich Hayek, have tended to be dismissed by most economists as libertarian dreamers. Even so, according to its supporters – including the Adam Smith Institute (ASI) think tank, which has just published a paper by economist Anthony Evans reviewing and promoting the case in favour – it’s an idea whose time has come again.
Principally because governments keep making such a hash of things. First, the 1970s and 1980s saw rampant inflation and declining output in many countries, leading previously sceptical economists (such as Milton Friedman) to re-examine the basics of the monetary order. More recently, the 2008 financial and banking crisis and subsequent global recessions and sovereign debt crises have led to urgent and intense debates about the role of central banks, and whether they are doing more harm than good. Advocates of free banking think that a different system could lead to a stabler system and better outcomes, not least of which would be the decline of “moral hazard” – free banks would have to take responsibility for their own risky behaviour rather than rely on taxpayers’ money for bailouts. Instead, the market would force banks to become more prudent, reducing the risk of financial crisis and fostering greater macroeconomic stability.
Is that feasible?
Anthony Evans’ argument in his ASI paper is that free banking would be possible (and desirable) as the culmination of a three-part plan radically to transform the architecture of monetary policy. First, he calls for an overhaul of “open market operations” – ie, the methods of intervening in the markets by which central banks manipulate the short-term interest rate and the supply of base money (see box). Second, he calls for monetary policy that targets a level of nominal gross domestic product (NGDP, ie, the total amount of nominal spending in the economy) rather than just inflation, as at present. Third, in the longer term, the central bank would be stripped of its powers to control monetary policy entirely and private banks be given currency-issuing powers instead.
That sounds pretty radical?
Indeed, the case against free banking is that it would merely be free to be radically unstable. Supporters of the status quo believe central-bank intervention is needed to smooth the ups and downs of the economy. But what the central bank does is all down to the discretion of a highly centralised institution. Investors pore over obscure central-bank entrails for hints of the future direction of monetary policy rather than making decisions based on prices set in a free market. The result is the creation of artificial booms, followed by painful busts. It’s hard to believe a free-market system could be worse.