Do we need a central bank?
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A trillion here, 500 billion there – it seems no amount is too much when the authorities want to fix a perforated economy. Keeping an economy on life support through extensive intervention has been the typical reaction to a crisis since elements of Keynesianism were applied for the first time during the Great Depression. Yet such Keynesian initiatives cannot be enacted without “big bank and big government” (Minsky); in other words, a reactive central bank and interventionist government.
I will use the Federal Reserve as a case in point as it is a relatively new institution. Interestingly, the US survived until 1913 without a central bank and enjoyed robust growth. Since then the Fed has essentially failed in its objectives of ensuring monetary and financial stability. Interest rates have fluctuated between zero and 21 per cent, prices have continued to rise, and financial crises have been frequent.
Vigorous booms in the US are generally characterised by an artificial expansion of credit followed by a proportionately vigorous bust (the more unremarkable recessions of yesteryear, although more frequent, tended to be shallower). Recessions or depressions that have corresponded to central bank manipulations have produced substantial shifts in the economic sub-structure – we have seen multiple sectors of the economy suffer in the current crisis. In the past, business cycles were just that. Their cyclical configuration led to redundant institutions being liquidated and growth continuing again. Since the Great Depression, however, this kind of cycle has in effect been prohibited though big government and big bank initiatives. But when a boom and bust has happened, it has had much deeper effects on the whole economy.
As the Federal Reserve has tried to prevent recessions, economic growth on average has slowed. While there may be many reasons for this, the assumption that central banks bring both stability and growth is questionable. Indeed, it could be argued that the attempted suppression of the business cycle has been a source of weakness to the US economy.
Growth and innovation can occur without the impetus of artificial credit. It is saving and production, not debt and consumption, that drive economic development. The recent boom was based on the illusion that property appreciation and consumption, rather than production and savings, are the path to growth and prosperity.
21 thoughts on “Do we need a central bank?”
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This is very insightful.
Andre, your analysis feels a little out of date. From the opening line – ‘A trillion here, 500 billion there’ you appear to be referring to a government that is not talking about cutting billions from its budget, including 20% being scythed away from welfare spending.
Furthermore, examples such as the panic of 1907 when compared with the relative calm of the past 20 years, show that today’s more mature central banking system is vastly superior to that which contributed to the great depression.
Also, you ignore that there were two previous attempts at central banking in the US prior to the Federal Reserve (1st and 2nd banks of the US), which mysteriously coincide with your ‘robust growth’.
That being said, Andre, you appear to be calling for the abolishment of the central bank. Since the absence of central banks tends to mean government control of the money supply; without clear indication of an alternative this blog can only be seen as a call for the return of this highly pernicious interventionism. This kind of socialistic system provides more power for truculent governments and creates the conditions for Zimbabwe style hyper-inflation and dictatorial stalinism. This is an unsettling idea.
A more sensible plan would be to recind the central banks monopoly of money and allow other banks to produce their own currency backed by whatever asset they chose.
You forgot to mention that before the Federal Reserve there were as well larger booms and bust than during; however, that is likely due to the poorer access to information in that time. What central banks have created is malinvestment.
“It is saving and production, not debt and consumption, that drive economic development.”
True as far as it goes, but production has to have a counterpart in consumption for it to be profitable, and without debt you can’t produce at all.
Adam Lyons proposes that private banks to produce their own currency backed by whatever asset they chose. That’s beside the point, as the whole point of money is the commonality of its use within a community. It makes no sense to have more than one, and as soon as the public authority declares it to be receivable in payment of taxes, it locks that money into a privileged monopoly.
Michael Petek – your comments are unintentionally ironic!! The whole point of the article is that central bank (or government) money allows the unwarranted use of Keynesianism and state interventionism. That is, of course, exactly the same point you’ve just made!!
I think perhaps what the article meant was that government debt and consumption does not drive true economic growth. Moreover, you clearly can produce without debt. You merely may use debt to facilitate growth for a period. In the longer-term, however, it is only by saving and investment that real economic growth can occur.
John Bell – I don’t think the article was anything to do with fiscal policy like cutting welfare spending (but that would be nice). I think the reference was to the amount of fiat money central banks print – e.g. Quantative Easing.
The past 20 years were not a period of ‘relative calm’ but instead a period of malinvestment promoted by central banking and government policy. Essentially, a re-run of the Great Depression which displayed a similar set of causal factors. Moreover, that governments have interfered with money and economies before the twentieth century is a good indication why previous periods of boom (malinvestment) and bust have occured previously.
John, although the Panic of 1907 was undoubtedly severe it was short-lived, lasting thirteen months in all after which consistent and sturdy growth reemerged. Indeed, the average annual rate of growth before the formation of the Federal Reserve System often reached double digits.
The ongoing economic malaise we are experiencing today is a product of our economic system whereby recessions are continually deferred and monetary mechanisms are used to paper over the cracks of our unbalanced and flawed economy.
The systematisation and persistence of the Federal Reserve’s lender of last resort mandate, accompanied with the FDIC, has arguably institutionalised moral hazard in the US.Continued..
Continued…Central banks not only have the ability to invoke economic crises by creating an environment of moral hazard, they also prolong the recovery process.
A recession clears up all the malinvestment that occurred during the expansion of credit. Projects and debts become liquidated and the economy goes through a necessary correction.
Importantly, all of the Fed’s mandates have failed. Unemployment is high, the dollar is worth a fraction of what it used to be worth and interest rates correspond to political pressures rather that the nation’s savings pool.
Adam, you make a valid if slightly hyperbolic point. By no means do I advocate affording a government entity control of the money supply. Allowing private banks to issue their own currency -backed by a basket of tangible assets- is certainly an option. Although perhaps a more all-encompassing solution would be to return to a commodity standard. But that’s another discussion altogether.
Perceptive, incisive and well written.
Produce without debt? In that case, why don’t we try running a barter economy? How far do you you think businesses would get if they had to pay wages today against revenue not due for another two months?
To quote myself:
“Moreover, you clearly can produce without debt. You merely may use debt to facilitate growth for a period (which is exactly what you are suggesting!). In the longer-term, however, it is only by saving and investment that real economic growth can occur.”
Businesses running a short-term debt is not the same as governments running national debts that are then financed by central bank-induced inflation. Which was, after all, the point of the article.
Whig – the fact that Andre did not mention cuts was my point – he loses relevance by opening with a reference to fiscal stimulus at a time when none within government are considering such action.
Whether the past 20 years were a period of relative calm is subjective I agree, however it is clear that GDP growth in the US has smoothed over this time – an important factor in my claim.
Andre – the era with no central bank in the US boasted deflation of 35% over 6 years, and inflation of 32% over another 5 as the price of gold/silver fluctuated, as well the failure of around half the country’s banks. Just imagine what the growth rate would have been with decent monetary policy!
@Michael Petek – I would be interested to know how the current practice in business payments developed. In many non-business-to-business transactions, payment in advance is the norm.
John Bell – surely his point is that those “fiscal stimuli” which have occurred are part-funded by central banks? As he states: ‘Yet such Keynesian initiatives cannot be enacted without “big bank and big government”’
Is the ’smoothing’ of GDP growth a good thing, particularly when it seems that this GDP growth ’smoothing’ means lower growth? I’d suggest that the growth rate with ‘decent (!) monetary policy’ in the in the USA c19 would have been far, far lower than it actually was because government intervention would have promoted the misallocation of scarce resources and thus reduced the growth rate. That’s what happening now, anyway.
When you remove the monopoly over currency, each issuing bank will become a “central bank” for its own currency, its own branches and any other banks that it permits to hold deposits or lend its currency.
Competition will go a long way to curb the excesses, but the overall functionality will still remain in my opinion, albeit without the power of monopoly.
Whig – No. That is not his point, since fiscal stimuli are generally funded by fiscal policy, and monetary ’stimuli’ are (through the actions of a central bank) introduced through monetary policy.
I am however glad that you now agree that the last 20 years have seen a smoothing of the growth rate, but whether this is good or bad is of course highly debatable. Personally, I am not adverse to reasonable fluctuations in GDP, as I am young, with few responsibilities, well equipped to station myself wherever the economy demands my services. However, I was simply making the point that to say that central banking has not improved since the conception of the Fed is absurd.
John Bell I did in no sense agree with you, I merely questioned your assumption. It might well be that there has been no smoothing as a result of central banking – there has certainly been less real growth, however.
Central banking may or may not have ‘improved’ but it is its very existence (as a monopolist of money – not its other roles) which is being questioned.
Your separation of monetary and fiscal stimuli is artificial. The one funds the other through inflation, as he and I are pointing out.
Tim Carpenter. “When you remove the monopoly over currency, each issuing bank will become a “central bank” for its own currency, its own branches and any other banks that it permits to hold deposits or lend its currency.
Competition will go a long way to curb the excesses, but the overall functionality will still remain in my opinion, albeit without the power of monopoly.”
Yep. Central Banks perform a function of covering deposit withdrawal limitations. The action of controlling aggregate demand is a function but can be done in other manners.
Perhaps the question should be should the ‘Central Bank’ whether national or private control aggregate demand?
A very good presentation by Mr Phijuntjitr—the follow-up commentary is instructive, too! Central banks is one of my current study subjects; other readers may be interested in Murray Rothbard’s The Case Against the Fed, and the positive stance taken by Tim Congdon in Central Banking in a Free Society.
I also suggest this article and video by Steven Kates, who looks at down cycles not caused by central banks, i.e. the overproduction of particular items or lack of consumer demand for what is on offer.