scholarly journals The Uneasy Case for Fractional- Reserve Free Banking

2021 ◽  
pp. 143-196
Author(s):  
Ludwig van den Hauwe
Keyword(s):  
Business Cycle ◽  
Institutional Analysis ◽  
Banking System ◽  
Invisible Hand ◽  
Free Banking ◽  
Monetary Reform ◽  
Fractional Reserve ◽  
Palabras Clave ◽  
Banking Business ◽  
The Business Cycle

Since a few decades several sub-disciplines within economics have witnessed a reorientation towards institutional analysis. This development has in particular also affected the fields of macroeconomics and monetary theory where it has led to several proposals for far-reaching financial and monetary reform. One of the more successful of these proposals advocates a fractional-reserve free banking system, that is, a system with no central bank, but with permission for the banks to operate with a fractional reserve. This article exposes several conceptual flaws in this proposal. In particular several claims of the fractional-reserve free bankers with respect to the purported working characteristics of this system are criticized from the perspective of economic theory. In particular, the claim that a fractional-reserve free banking system would lead to the disappearance of the business cycle is recognized as false. Furthermore an invisible-hand analysis is performed, reinforcing the conclusion that fractional-reserve free banking is incompatible with the ethical and juridical principles underlying a free society. Key words: monetary and banking regimes, comparative institutional analysis, fractional-reserve free banking, business cycle, invisible hand. Clasificación JEL: B53, E32, E42, E5, G18, H11, K39, P3, P34 Resumen: Desde hace algunas décadas varias subdisciplinas de la economía se ven reorientadas hacia el análisis institucional. Este desarrollo ha afectado más específicamente también a los campos de la macroeconomía y la teoría monetaria donde ha llevado a varias propuestas de reformas financieras y monetarias de gran alcance. Una de las propuestas más exitosas aboga por una banca libre con reserva fraccionaria, o sea un sistema sin banco central en el cual, sin embargo, los bancos puedan operar con una reserva fraccionaria. Este artículo comenta varios defectos conceptuales de dicha propuesta. Más específicamente, varias alegaciones de los banqueros de la banca libre con reserva fraccionaria relativas a las supuestas características operativas de este sistema se critican partiendo de la teoría económica. Más en particular, se denuncia como errónea la alegación de que una banca libre con reserva fraccionaria llevaría a la desaparición del ciclo económico. Además, se realiza un análisis de mano invisible lo cual refuerza la conclusión que la banca libre con reserva fraccionaria es incompatible con los principios éticos y jurídicos propios de una sociedad libre. Palabras clave: banca libre con reserva fraccionaria, ciclo económico, mano invisible.

scholarly journals Free banking, the real-balance effect, and Walras’ Law

2021 ◽  
pp. 241-258
Author(s):  
Ludwig van den Hauwe
Keyword(s):  
Key Words ◽  
Banking System ◽  
Jel Classification ◽  
Free Banking ◽  
Real Balance ◽  
The Real ◽  
Fractional Reserve ◽  
Monetary Systems ◽  
Palabras Clave ◽  
Erroneous Interpretation

The author of this article draws special attention to two particular claims of the free bankers concerning the supposed working characteristics of a fractional-reserve free banking system which may strike the reader as questionable. The first of these relates to the alleged absence of a real-balance effect under free banking. The second relates to the free bankers’ reference to Walras’ Law as providing a rationale for the free banking system’s «offsetting» actions when confronted with changes in the public’s demand to hold bank liabilities. This rationale is defective since it is based on an erroneous interpretation of Walras’ Law. The author’s conclusion does not imply that it is not at all possible, from a rational viewpoint, to make a plausible case for this variant of free banking, only that the argument should be freed from certain questionable tenets. Key words: Free banking, monetary systems, real-balance effects, Walras’ Law. JEL Classification: E0; E32; E42; E5; E51; E52. Resumen: El autor de esta nota llama la atención sobre dos alegaciones particulares relativas a las supuestas características operativas de una banca libre con reserva fraccionaria que podrían resultar cuestionables al lector. La primera se refiere a la supuesta ausencia de efectos de saldo real en la banca libre. El segundo guarda relación con la referencia de los teóricos de la banca libre con reserva fraccionaria a la Ley de Walras que constituiría la base lógica de las acciones «de compensación» de la banca libre al enfrentarse a cambios en la demanda de medios fiduciarios por parte del público. Esta base lógica es defectuosa puesto que parte de una interpretación errónea de la Ley de Walras. La conclusión del autor no implica que no sea posible en absoluto, desde un punto de vista racional, elaborar una argumentación plausible para esta variante de la banca libre, sino que la argumentación debe estar libre de determinados argumentos cuestionables. Palabras clave: Banca libre, sistemas monetarios, efectos de saldo real, Ley de Walras. Clasificación JEL: E0; E32; E42; E5; E51; E52.

scholarly journals The business cycle: a definition

2021 ◽  
pp. 205-262
Author(s):  
Tuur Demeester
Keyword(s):  
Business Cycle ◽  
Jel Classification ◽  
Austrian School ◽  
Methodological Framework ◽  
The Core ◽  
Palabras Clave ◽  
The Business Cycle ◽  
Necessary And Sufficient ◽  
Counter Argument

The goal of this article is to properly define the economic phenomenon of the business cycle. The text is rooted in the tradition of the Austrian School of Economics, and the methodological framework builds on concepts developed by Aristotle and Thomas Aquinas. This leads to the development of a few new methodological concepts, such as a re-interpretation of «inflation» and «deflation», and the re-introduction of «imaginary goods» as an important social phenomenon. The core observation of the article is that the business cycle is in fact a subclass of another kind of cycle, the «fraud cycle». Our conclusion is that in order to produce a business cycle, the occurrence of institutional fraud in the sphere of money and banking are both necessary and sufficient. The counter-argument that honest banking can also produce business cycles is refuted in Appendix I. We believe this article is significant in two ways: 1) it provides an unambiguous recipe for the long term extermination of the business cycle; and 2) it helps expand the scope of the Austrian School beyond economics into fields of law and morality. Key words: Business Cycle, Fraud Cycle, Austrian School, money and banking. JEL Classification: B53, B49, D01, K13. Resumen: El objetivo de este artículo es definir apropiadamente el fenómeno económico del ciclo económico. El resto está enraizado en la tradición de la Escuela Austriaca de Economía, y el marco metodológico parte de los conceptos desarrollados por Aristóteles y Tomás de Aquino. Esto conduce al desarrollo de algunos conceptos metodológicos nuevos, tales como la reinterpretación de la «inflación» y la «deflación», y la reintroducción de los «bienes imaginarios» como un fenómeno social importante. La observación central de este artículo es que el ciclo económico es de hecho una subclase de otro tipo de ciclo, el «ciclo del fraude». Nuestra conclusión es que para producir un ciclo económico, la existencia de un fraude institucional en la esfera del dinero y la banca es una condición necesaria y suficiente. El Apéndice I refuta el contra-argumento de que una banca honesta también puede producir ciclos económicos. Creemos que este artículo es significativo por dos motivos: 1) ofrece una receta clara para la eliminación del ciclo económico; y 2) ayuda a expandir el ámbito de la Escuela Austriaca más allá del campo de la Economía hacia los campos del Derecho y la Moralidad. Palabras clave: Ciclo económico, ciclo del fraude, Escuela Austriaca, dinero y banca. Clasificación JEL: B53, B49, D01, K13.

scholarly journals Unanswered quibbles: George Selgin still gets it wrong with fractional reserve free banking

2021 ◽  
Author(s):  
Philipp Bagus ◽  
David Howden
Keyword(s):  
Banking System ◽  
Real Income ◽  
Jel Classification ◽  
Free Banking ◽  
Fractional Reserve Banking ◽  
Credit Expansion ◽  
Investment Projects ◽  
Fractional Reserve ◽  
Monetary Equilibrium ◽  
El Sistema

In this article we reply to George Selgin’s counterarguments to our article «Fractional Reserve Free Banking: Some Quibbles». Selgin regards holding cash as saving while we focus on the real savings necessary to maintain investment projects. Real savings are unconsumed real income. Variations in real savings are not necessarily equal to variations in cash holdings. We show that a coordinated credit expansion in a fractional reserve free banking (FRFB) system is possible and that precautionary reserves consequently do not pose a necessary limit. We discuss various instances in which a FRFB system may expand credit without a prior increase in real savings. These facets all demonstrate why a fractional reserve banking system —even a free banking one— is inherently unstable, and incentivized to impose a stabilizing central bank. We find that at the root of our disagreements with Selgin lies a different approach to monetary theory. Selgin subscribes to the aggregative equation of exchange, which impedes him from seeing the microeconomic problems that the stabilization of «MV» by a FRFB system causes. Key words: Free banking, fractional reserve, monetary equilibrium, credit expansion, economic cycle. JEL Classification: B53, E32, E42, E5, G18, H11, K39, P3, P34. Resumen: En este artículo respondemos a George Selgin, que a su vez respondió a nuestro artículo «Fractional Reserve Free Banking: Some Quibbles». Selgin considera que los saldos de tesorería son ahorros, mientras nosotros nos fijamos en los ahorros reales necesarios para mantener proyectos de inversion. Ahorros reales son ingresos reales no consumidos. Variaciones en los ahorros reales no necesariamente coinciden con las variaciones en los saldos de tesoreria. Mostramos que una expansión crediticia coordinada es posible en un sistema bancario de reserva fraccionaria (FRFB) y que las reservas prudenciales no constituyen necesariamente un limite a la expansión co - ordinada. Discutimos varios escenarios en los que el sistema FRFB puede expandir los créditos sin un aumento previo en los ahorros reales. Todas estas facetas muestran que un sistema bancario de reservas fraccionarias —incluso uno de banca libre— es inherentemente inestable y produce incentivos para imponer un banco central estabilizador. Mostramos que el origen de nuestras diferencias con Selgin está en un enfoque diferente a la teoría monetaria. Selgin es partidario de la ecuación de intercambio que es muy agregada y que le impide ver los problemas microeconomicas que la estabilización de «MV» por parte del sistema FRFB produce. Palabras clave: Banca libre, reserva fraccionaria, equilibrio monetario, expansión crediticia, ciclo económico. Clasificación JEL: B53, E32, E42, E5, G18, H11, K39, P3, P34.

scholarly journals Money, Banking, and Financial Markets

2019 ◽  
Vol 87 (5) ◽  
pp. 2049-2086 ◽  
Author(s):  
David Andolfatto ◽  
Aleksander Berentsen ◽  
Fernando M Martin
Keyword(s):  
Central Bank ◽  
Financial Markets ◽  
Dynamic Model ◽  
Banking System ◽  
Free Banking ◽  
Lender Of Last Resort ◽  
Fractional Reserve ◽  
Deposit Contracts ◽  
Liquidity Insurance ◽  
Meaningful Role

Abstract The fact that money, banking, and financial markets interact in important ways seems self-evident. The theoretical nature of this interaction, however, has not been fully explored. To this end, we integrate the Diamond (1997, Journal of Political Economy105, 928–956) model of banking and financial markets with the Lagos and Wright (2005, Journal of Political Economy113, 463–484) dynamic model of monetary exchange—a union that bears a framework in which fractional reserve banks emerge in equilibrium, where bank assets are funded with liabilities made demandable in government money, where the terms of bank deposit contracts are affected by the liquidity insurance available in financial markets, where banks are subject to runs, and where a central bank has a meaningful role to play, both in terms of inflation policy and as a lender of last resort. Among other things, the model provides a rationale for nominal deposit contracts combined with a central bank lender-of-last-resort facility to promote efficient liquidity insurance and a panic-free banking system.

scholarly journals Are the New Basel III Capital Buffers Countercyclical? Exploring the Option of a Rule-Based Countercyclical Buffer

2018 ◽  
pp. 1-6
Author(s):  
Filippo Occhino
Keyword(s):  
Business Cycle ◽  
Banking System ◽  
Capital Requirements ◽  
Economic Fluctuations ◽  
Capital Regulation ◽  
Basel Iii ◽  
Rule Based ◽  
The Business Cycle ◽  
Over Time

Countercyclical capital regulation can reduce the procyclicality of the banking system and dampen aggregate economic fluctuations. I describe two new capital buffers introduced in Basel III and discuss why their countercyclical effects may be small. If over time regulators want to increase the degree of countercyclicality of capital regulation, they might consider adopting a rule-based countercyclical buffer, that is, a buffer that is automatically lowered during recessions according to a rule. I present a conservative example of such a rule and its effects on capital requirements over the business cycle.

scholarly journals TRI-CYCLES ANALYSIS ON BANK PERFORMANCE: PANEL VAR APPROACH

2017 ◽  
Vol 19 (4) ◽  
pp. 403-442 ◽  
Author(s):  
Denny Irawan ◽  
Febrio Kacaribu
Keyword(s):  
Business Cycle ◽  
Financial Risk ◽  
Balance Sheet ◽  
Banking System ◽  
Bank Performance ◽  
Panel Var ◽  
Vector Autoregressive ◽  
Dynamic Relationship ◽  
Credit Cycle ◽  
The Business Cycle

The previous financial crisis has revealed the importance of risk in the financial and business cycle within the economy. This paper examines relationship among three cycles in the economy, namely (i) business cycle macro risk, (ii) credit cycle and (iii) risk cycle, and their impacts toward individual bank performance. We examine the responses of individual bank credit cycle and risk cycle toward a shock in business cycle macro risk and its consequence to the bank performance. We use Indonesian data for period of 2005q1 to 2014q4. We use unbalanced panel data of individual banks’ balance sheet with Panel Vector Autoregressive approach based on GMM style estimation by implementing PVAR package developed by Abrigo and Love (2015). The result shows dynamic relationship between business cycle macro risk and financial risk cycles. The study also observes prominent role of risk cycles in driving bank performance. We also show the existence of financial accelerator phenomenon in Indonesian banking system, in which financial cycles precede the business cycle macro risk.

scholarly journals PROCYCLICALITY AND BANK LENDING BEHAVIOR IN INDONESIA: THE CASE OF DUAL BANKING SYSTEM

2018 ◽  
Vol 4 (1) ◽  
pp. 23-38 ◽  
Author(s):  
Muhammad Rizky Prima Sakti ◽  
Mohamed Zulkhibri
Keyword(s):  
Business Cycle ◽  
Banking System ◽  
Bank Lending ◽  
Medium Size ◽  
Islamic Banks ◽  
Lending Channel ◽  
The Business Cycle ◽  
Financing Behavior ◽  
Conventional Banks ◽  
Lending Behavior

It is widely suggested in the literature that procyclicality of bank lending behavior may lead to financial instability. This study examines bank-lending channel over the business cycle for Indonesian dual banking system by ascertaining to what extent Islamic banks have a role in the credit smoothing. In this context, we utilize Indonesian dual banking system unbalanced panel data for the period 2001-2015. By employing two-step dynamic GMM estimators, the study shows that the bank lending behaviour are procyclical. However, when we categorize the lending behaviour into conventional and Islamic banks, the cyclicality of bank lending affects only for conventional banks. As for the Islamic banks, the business cycle does not affect their financing decision. Specifically, large Islamic banks are more counter-cyclical in their financing behavior than small and medium size Islamic banks. Robustness tests using different measures of loans and model specifications confirm the results that Islamic bank is more stable and less procyclical in the case of Indonesia banking system.

scholarly journals Credit expansion, the prisoner’s dilemma and free banking as mechanism design

2021 ◽  
pp. 133-174
Author(s):  
Ludwig M.P. van den Hauwe
Keyword(s):  
Mechanism Design ◽  
Prisoner's Dilemma ◽  
Banking Sector ◽  
A Priori ◽  
Banking System ◽  
Prisoner’S Dilemma ◽  
Implicit Assumption ◽  
Free Banking ◽  
Fractional Reserve ◽  
Game Theoretic

Despite the distinctive character of the Austrian approach to «microfoundations for macroeconomics», the literature on free banking contains a number of arguments which make use of game-theoretic concepts and models such as the well-known Prisoner’s Dilemma model. While there can be no general a priori presumption against the possible usefulness of game-theoretic concepts for Austrian theorizing, in the context of the debate on free banking such concepts and models have been used with varying degrees of perspicacity. One example which is elaborated in the paper is concerned with the interaction configuration between independent banks in a fractional-reserve free banking system, which has sometimes been modeled as a One-Shot Prisoner’s Dilemma game. This conceptualization does not provide a sufficient argument for the in-concert overexpansion thesis, nor for the thesis that fractional-reserve free banking will tend to lead to the establishment of a central bank. The author drops the implicit assumption that there exists a one-to-one correspondence between the outcome matrix and the utility matrix. When it is acknowledged that banks in a fractional-reserve free banking system need not necessarily adopt a «myopic», self-regarding perspective but may recognize the long-run harmony of interests between the banking sector and society at large, a different conceptualization and a different matrix representation emerge. Key words: Economic Mechanism Design; Business Cycle Theory; Prisoner’s Dilemma; Free Banking. JEL codes: D01, E31, E32, E42, E52, E58, E66, G18, K39. Resumen: A pesar del carácter distintivo del enfoque austríaco de las «microfundaciones para la macroeconomía», la literatura sobre la banca libre contiene algunos argumentos que recurren a los conceptos y modelos de la teoría de juegos tales como el conocido modelo Dilema del Prisionero. A pesar de que no puede existir una presunción a priori sobre la posible utilidad de conceptos de la teoría de juegos para las teorías austríacas, en el contexto del debate sobre la banca libre tales conceptos y modelos han sido manejados con distintos grados de perspicacia. Un ejemplo elaborado en el documento comenta la configuración de interacción entre los bancos independientes en un sistema de banca libre con reserva fraccionaria, que a veces ha sido modelado como un juego de Dilema del Prisionero One-Shot. Esta conceptualización no ofrece suficientes argumentos para la tesis de la sobreexpansión in-concert, ni para la tesis de que un sistema de banca libre con reserva fraccionaria tendería a la creación de un banco central. El autor abandona la asunción implícita de que existe una correspondencia de uno a uno entre la matriz de resultado y la matriz de utilidad. Al reconocerse que los bancos en un sistema de banca libre con reserva fraccionaria no deben adoptar necesariamente una perspectiva «miope» y egoísta, pero pueden reconocer la armonía de intereses a largo plazo entre el sector bancario y la sociedad en general, surgen una conceptualización y representación de la matriz distintas. Palabras clave: Diseño de mecanismo económico; Teoría del ciclo económico; Dilema del Prisionero; Banca libre. Códigos JEL: D01, E31, E32, E42, E52, E58, E66, G18, K39.

scholarly journals Beyond Keynes and the Classics. Outline of the Goods Side/Money Side Model of the Business Cycle and Macroeconomic Configurations

2021 ◽  
pp. 111-135
Author(s):  
Antony P. Mueller
Keyword(s):  
Economic Growth ◽  
Business Cycle ◽  
Aggregate Demand ◽  
Jel Classification ◽  
Macroeconomic Model ◽  
Macroeconomic Analysis ◽  
Palabras Clave ◽  
Demand Models ◽  
The Business Cycle ◽  
Basic Features

This paper presents the goods side/money side (GSMS) model as a novel way of macroeconomic analysis. The GSMS model goes beyond Keynesianism as it makes a sharp distinction between the goods side and the money side and thus avoids the indistinctness between real nominal values that come with spending in aggregate demand models. The GSMS model transcends classical macroeconomics in its traditional and modern versions as it reinstates money as an active factor in the economy. Different from monetarism, the key monetary concept of the GSMS model is «macroeconomic liquidity», which includes velocity of circulation. The present paper presents the basic features of the model and shows its use by analyzing macroeconomic configurations, the business cycle, and economic growth. The paper includes an appendix with an evaluation of macroeconomic configurations in the light of the GSMS model. Key words: GSMS Macroeconomic Model, Monetary Policy, Economic Growth, Austrian Theory of the Business Cycle (ATB). JEL Classification: A23, E32, E52. Resumen: Este trabajo presenta el modelo lado del mercado de bienes/lado del mercado de dinero (GSMS) como una nueva forma de análisis macro-económico. El modelo GSMS va más allá del keynesianismo, ya que hace una clara distinción entre el lado de los bienes y el lado del dinero y, por tanto, evita la ausencia de diferenciación entre los valores nominales y reales que vienen con el gasto en los modelos de demanda agregada. El modelo GSMS trasciende la macroeconomía clásica en sus versiones tradicional y moderna, ya que restituye al dinero un rol activo en la economía. A diferen-cia del monetarismo, el concepto monetario clave del modelo GSMS es la «liquidez macroeconómica», que incluye la velocidad de circulación. El pre-sente artículo presenta las características básicas del modelo y muestra su uso mediante el análisis de configuraciones macroeconómicas, el ciclo eco-nómico y el crecimiento económico. El documento incluye un apéndice con una evaluación de configuraciones macroeconómicas a la luz del modelo GSMS. Palabras clave: Modelo Macroeconómico GSMS, Política Monetaria, Cre - cimiento Económico, Teoría Austriaca del Ciclo Económico. Clasificación JEL: A23, E32, E52.

scholarly journals How to create a banking & monetary system for the 21st century: the Huerta de Soto and Chicago plans reworked

2021 ◽  
pp. 13-66
Author(s):  
Alok Basu
Keyword(s):  
Monetary Policy ◽  
Business Cycle ◽  
Economic Activity ◽  
Present System ◽  
Fractional Reserve Banking ◽  
Monetary System ◽  
Fractional Reserve ◽  
Credit Creation ◽  
The Business Cycle ◽  
Reserve Banking

Every economics textbook will tell you that banking is at its core a process of intermediation designed to facilitate the transfer of savings into investment. In some respects fractional reserve banking does this much too well. It is a system which takes deposits and lends them out. The problem is that this process is built on – for want of a better word – deceit. Borrowers are offered secure term contracts, while depositors are promised their money back whenever they want it. This deceit only works because most depositors are happy to keep their money in the banking system most of the time. Supporters of fractional reserve banking would say – so what. The fact that the system exploits this trait of depositors – to keep their money in banks rather than under their mattresses – is surely a good thing. Without such a system, lending would not happen to anywhere near the same degree, credit creation would be severely impeded and economic activity adversely affected. The problem with this system is that it has a tendency to max out on credit creation in the good times, but chronically undersupply credit in the bad times – thus greatly accentuating the natural ups and downs of the business cycle. And over a course of time, it results in an accumulation of debt in society that is not economically very healthy. Recent events underline these concerns. Any proposed reform of the banking and monetary system needs to be able to illustrate that such a system will be capable of delivering the «right amount» of credit in good times and bad – so as not to impede economic activity in downturns, but also not to act as an accelerator for the good times. We can refer to this as the «optimal» quantity of credit over the course of the business cycle. In this paper, I assess two models. One is a derivative of the so-called «Chicago Plan», and set out in the IMF Working Paper by Michael Kumhof and Jaromir Benes titled The Chicago Plan Revisited published in August 2012. The other is an equity-based proposal which I call the «Huerta de Soto Plan», and derived from proposals set out by Professor Jesus Huerta de Soto in his book Money, Bank Credit and Economic Cycles, published as far back as 1998. The Kumhof/Benes proposal puts monetary policy at the heart of the credit creation process in a way that is far more effective than under the current system. Governments end up achieving far greater control of the levers of monetary power than under today’s fractional reserve system. By contrast, the Huerta de Soto Plan opts for a free-market based approach to money resulting in a free and genuinely open market for credit that is driven entirely by the forces of competition and where governments and central banks have no role to play in monetary policy. This paper spells out the mechanics underlying both plans, and assesses their relative merits. Neither plan is perfect. Both propose extremely radical reform of the modern monetary system, and they can result in – I believe – some potentially very inflationary and damaging behavioral effects in the process of the transition from the present system to what is proposed. The Kumhof/Benes proposal is far and away the weaker of the two – not only would it be economically and politically unworkable – the behavioral consequences would be harder to control. By contrast, the Huerta de Soto Plan – although more radical in many respects – would also be more palatable, albeit it would need certain tweaks, and the adverse behavioral impacts arising from the implementation of this plan would be somewhat easier to offset. Key words: Huerta de Soto, Kumhof/Benes, Chicago Plan, Fractional Reser-ve, Mutuals, Quantitative Easing. JEL Classification: B31, B53, E42, E52.

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