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Unformatted text preview: Mere Quibbles: Bagus and Howdens Critique of The Theory of Free Banking George Selgin* April 1, 2011 Revised April 4, 2011 JEL Classifications : E31, E32, E41, E42, and G21. Keywords : Free banking, fractional reserves, Austrian theory of the business cycle. * Department of Economics, the Terry College of Business, University of Georgia, Athens, GA 30602; Selgin@uga.edu . I am grateful to Steve Baker, Toby Baxendale, Nicolas Cachanosky, Bill Lastrapes, Steve Horwitz, and Lawrence H. White for their comments. The usual disclaimer applies. 1 In the introduction to their recent contribution to The Quarterly Journal of Austrian Economics , Philipp Bagus and David Howden (2010, p. 30n1) generously refer to my Theory of Free Banking as a pivotal turning point in the spread of free banking ideas among Austrian economists. The rest of their 25-page article is devoted to criticisms of my books arguments. Although Bagus and Howden refer to them as quibbles, they do not mean it. Instead their criticisms are intended to suggest that the very foundation upon which the case for free banking rests is deeply and irreparably flawed. I propose here to defend my work against Bagus and Howdens criticism, by showing that their assessment rests upon (1) careless readings or interpretations of my particular arguments and (2) a defective grasp of more basic monetary theory, including components of that theory that play a crucial part in the Austrian theory of the business cycle. Monetary Disequilibrium. My 1988 book is subtitled Money Supply under Competitive Note Issue. Its main purpose is to show how the stock of bank-issued money (or money substitutes, in Misess terminology) behaves in a banking system in which paper notes are issued competitively rather than by a single, privileged bank. After an introductory chapter and one devoted to describing the features of a free banking system, by way of an account of such a systems evolution, there follow four chapters describing forces that regulate the stock of bank money in such a system, and showing the circumstances in which that stock is likely to either expand or shrink. Bagus and Howden (ibid, p. 31) offer a competent if very brief summary of the main conclusions of these chapters, observing (among other things) that, according to my argument, a fractional reserve free banking system adjusts the supply of money to changes in its demand, keeping MV constant in the famous equation of exchange, and that this beats relying on changes in moneys purchasing power or the general level of prices ( P in the famous equation) to offset changes in velocity because such changes can take full effect only in the long run, so that relying on them means enduring what may be protracted periods of monetary shortage or surplus....
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- Fall '11