This one of your original thoughts? Never seen the like around here.
This is the traditional Austrian/Free banking position (excluding the Rothbardian’s). You will find this position expressed in the works of Wicksell, Hayek, early Mises, and others. There is no such of thing as bad deflation in the Rothbardian framework.
Very interesting.
So it means printing more money?
And you see a flaw in Rothbard’s reasoning?
The modern fractional reserve free-banking school is a rather recent development of no more then 20-30 years. It is basically a resurgence of the old banking school but with more sophisticated arguments. “Traditional” is a rather curious characterization of this school.
The banks will create fiduciary media and satiate the demand for money as money.
Oh yes. Rothbard’s position is extremely simplistic.
Austrian monetary theory was highly influenced by a series of debates between two English schools (Banking School and Currency School). Knut Wicksell, the father of Austrian monetary theory (and monetary equilibrium theory), leaned more towards the banking school which believed that the banking system has a natural/organic adjustment mechanism (elastic money supply) which reacts to changes in the demand for money. Wicksell also understood, unlike the currency school, that banks deposits were money, and can be inflationary. But Wicksell rejected the belief (held by the banking school) that banks cannot cause inflation, or that changes in output, interest rate, and prices changed the money supply (purely endogenous view of money). He introduced his “indirect transition mechanism” where alterations in the money supply affect the interest rate, which, in turn, can change prices (if the market rate deviates either above or below the natural rate, a concept put forth by Austrian economist Eugene von Bohm-Bawerk).
But in Wicksell’s revolutionary book, Interest and Prices (1896), he created a ‘theoretical construct’ where the entire banking system was consolidated into one bank. Mises, in The Theory of Money and Credit, showed that this isn’t really a theoretical construct at all, but was in fact the actual banking condition of the day (banking cartels controlled by central banks, namely the Bank of England). Furthermore, Mises exposed the fact that this organic automatic adjustment mechanism only works if there is actually competition within the banking system; banking cartels are oblivious to changes in the demand for money.
A single bank carrying on its business in competition with numerous others is not in a position to enter upon an independent discount policy… Thus the banks may be seen to pay a certain amount of regard to the periodical fluctuations in the demand for money. They increase and decrease their circulation pari passu with the variations in the demand for money, so far as the lack of a uniform procedure makes it impossible for them to follow and independent interest policy. But in doing so, they help to stabilize the objective exchange value of money. To this extent, therefore, the theory of the elasticity of the circulation of fiduciary media is correct; it has rightly apprehended one of the phenomena of the market, even if it has also completely misapprehended its cause (pp. 347). Theory of Money and Credit
The money supply, then, is indeed elastic. But if the banking system lacks competition, then the elasticity only refers to the fact that it can be expanded ad infinitum, artificially suppressing the market rate below the natural rate, and stimulating the demand for money (contrary to the beliefs held by the banking school). But, on the other hand, if the banking system is allowed to compete, then the money supply is elastic in the sense that it reacts to the demand for money, and has a stabilizing effect. So Mises takes basically an exogenous view of business cycles, where central banks and banking cartels are to blame.
Hayek takes the Wicksell/Mises framework and merely elucidates the fact that there can be a divergence in the market and natural rates of interest without monetary interventionism. The banking system, according to Hayek, could suppress the market rate below the natural rate by not reacting to the changed market conditions fast enough. So if the natural rate rises, the banking system may fail to elevate the market rate when they should have.
Thus the Austrian monetary position is basically a balance between the theories of the Banking school and Currency school with their own insights. Hayek does mention 100% reserves in Monetary Nationalism and International Stability, but calls it theoretically untenable. Free banking/monetary equilibrium positions are very different from the positions put forth by the Banking school (not too sure about the modern day free bankers).
Here’s a question for you, and I mean it in good spirit.
In all practical terms, banks can only respond to a rise in the demand for fiduciary media, and not money in general.
So suppose that the demand for fiduciary media increases, while the proportion in which economic agents wish to consume and invest remains unchanged. The social rate of interest has not altered. Under such hypothetical conditions, economic agents must reduce their monetary demand for consumer goods, and sell bonds and other financial assets, until they can accumulate the greater volume of bank deposits they wish to hold. Remember, social time preference has not altered.
According to your conclusions, the banking system would respond to this rise in the demand for fiduciary media by expanding their issuance by a quantity equal to that of the new demand.
Do you begin to see a problem here? Banks do not transfer the fiduciary media they create to their final users (all those who who’s demand for fiduciary media has increased), but instead, the deposits are lent to entrepreneurs who spend it on investments goods. Do you realize what has happened here? Do you see that there will still be a distortion of the productive structure as the quantity of loans issued is not aligned with the new social time preference?
It seems that you are ignoring the microeconomic effects of what you are suggesting. The modern free banking school, which you say you are not familiar with, is making this same error.
I am also curious. It seems to me that rises and falls in nominal expenditure would be the best indicator of monetary disequilibrium, but even with the Federal Reserve’s expansion of the money supply, nominal expenditure remained well below its previous trajectory. That fact would seem to suggest that the Federal Reserve should have created more money. Steve, why do you conclude that it was too much?
Posted by: Lee Kelly | March 02, 2010 at 02:11 PM
This has nothing to do with my position. I think this is a question for the modern free-banking school who frequently talk about stabilizing “MV.” I don’t care about income-expenditure models, and I would allow for deflation. This is not about ‘price stabilization.’ Furthermore, I don’t want to speculate about the current demand for money, since it cannot be known without actual markets.
Just making sure that you understand his position.