Free banking: the limits of mathematical models

Theoretical economic worlds are so nice. Only equations and equilibria, and no need to bother about empirical evidences or simply historical facts: you design your nice imaginary world and you reach conclusions from it. Conclusions that have the potential to influence policymaking or economic teaching.

Equation Fed PaperA new paper produced by a Philly Fed economist illustrates exactly that (see one of its nice systems of equations above). The paper is titled On the inherent instability of private money. Here is the abstract (my emphasis):

A primary concern in monetary economics is whether a purely private monetary regime is consistent with macroeconomic stability. I show that a competitive regime is inherently unstable due to the properties of endogenously determined limits on private money creation. Precisely, there is a continuum of equilibria characterized by a self-fulfilling collapse of the value of private money and a persistent decline in the demand for money. I associate these equilibrium allocations with self-fulfilling banking crises. It is possible to formulate a fiscal intervention that results in the global determinacy of equilibrium, with the property that the value of private money remains stable. Thus, the goal of monetary stability necessarily requires some form of government intervention.

That’s it. He just validated the existence of central banking. No need to go any further, the mathematics just demonstrated it: private currencies are unstable and we need government intervention for the better good.

What’s interesting though is that this paper does not contain a single reference to the now relatively large free banking literature of the likes of White, Selgin, Horwitz, Dowd, Salter, Sechrest, Cachanosky… Which, you’d admit, is curious for a paper discussing precisely that topic. Perhaps this would have helped him avoid the embarrassment of discovering that historical reality was, well, the exact opposite of the conclusions his equations reached. That in fact, private currency-based systems had been more stable than monopoly issuance-based ones (see here for the track record, but everywhere on this blog for other evidences, as well as numerous papers and books such as Selgin’s The Theory of Free Banking: Money Supply under Competitive Note Issue).

Coincidentally, George Selgin published a new post a couple of days ago criticising the current state of monetary economics which, in his opinion, rely too much on abstract maths and not enough on historical evidence. Ben Southwood also mentioned this paper, along with the fact that even ‘far from perfect’ free banking systems (i.e. the 19th century US experience) outperformed central banking ones. He also asks a very good question:

My real issue is why this evidence isn’t breaking through? Why are so many smart, knowledgeable people opposed to free banking? Why is the ruling tendency now towards practically outlawing bank/debt finance altogether in favour of steps toward equity financing everything? I don’t have a good answer.

This is also something that worries me. Why does a paper on free banking not reference (let alone discuss) a single free banking paper or book? Why is this literature avoided? Is it inconvenient? Unless ignorance is the culprit, despite the fact that quite a few articles show up after a quick Google search for the terms ‘free banking’ or ‘competitive private note issuance’. What’s wrong with the mainstream academic world?

Advertisements

Tags:

3 responses to “Free banking: the limits of mathematical models”

  1. Doug Carroll says :

    Isn’t it obvious. The majority of the economics profession has a vested interest in activist/discretionary government intervention into the real economy and financial markets. Job security and the nodding approval of the likeminded Progressive economists who seem to dominate the public discourse whether from government, wall street or academia are the primary motivations. They don’t believe in the wisdom of the (unwashed) crowed. They believe their own wisdom to be superior to that of the collective information generated by markets and self directed behavior of individual consumers and business firms. Truly Dismal Scientists!

  2. F. William Ballou says :

    Essential to any model of anything are fundamental assumptions of the model maker. Progressive economists, enamored by egalitarian objectives and realizing “true equality” is not the product of a free market, a free market in banking being one of those products, instinctively turn to “government” mandates. Many years ago (1969) at the AGM of the Mont Pelerin Society, I offered in response to a contribution by George Stigler a short paper, The Use of Mathematical Models in Forecasting. No one has to my knowledge in all these years shown my conclusions to have been out of touch with reality: first, Models are not Reality; second, it is impossible for central planners to allocate resources without creating distortions, bubbles and other disasters. I still wonder why mathematical geniuses use their skills for writing arcane equations that cannot be certified. I lean toward the idea that they are hiding behind their equations because complexity, while hiding method, serves as a shield against criticism. Models cannot be certified by repeatable experiment. No model is complex enough to predict the choices of millions of actors exercising free will. The more complex the model the less likely does it produce predictable outcomes. Further, concentration of power in a central authority guarantees that mistakes will harm all those decision makers whom the central planner plans to control. Those who do not trust the “chaos” of free markets will eventually face the chaos of central control gone out of control.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

Marginal REVOLUTION

Small Steps Toward A Much Better World

Dizzynomics

Finding patterns in finance, econ and technology -- probably where there are none

Alt-M

When financial markets spontaneously emerge through voluntary human action

Pumpkin Person

The psychology of horror

Uneasy Money

Commentary on monetary policy in the spirit of R. G. Hawtrey

Spontaneous Finance

When financial markets spontaneously emerge through voluntary human action

ViennaCapitalist

Volatility Is The Energy That Drives Returns

The Insecurity Analyst

When financial markets spontaneously emerge through voluntary human action

Sober Look

When financial markets spontaneously emerge through voluntary human action

Social Democracy for the 21st Century: A Realist Alternative to the Modern Left

When financial markets spontaneously emerge through voluntary human action

EcPoFi - Economics, Politics, Finance

When financial markets spontaneously emerge through voluntary human action

Coppola Comment

When financial markets spontaneously emerge through voluntary human action

Lend Academy

Teaching the World About Peer to Peer Lending

Credit Writedowns

Finance, Economics and Markets

Mises Institute

When financial markets spontaneously emerge through voluntary human action

Paul Krugman

When financial markets spontaneously emerge through voluntary human action

Free exchange

When financial markets spontaneously emerge through voluntary human action

Moneyness

When financial markets spontaneously emerge through voluntary human action

Cafe HayekCafe Hayek - where orders emerge - Article Feed

When financial markets spontaneously emerge through voluntary human action

%d bloggers like this: