Do We Really Need a Central Bank?

On December 2, 2009, Professor Steven Horwitz gave the following speech at The Future of Freedom Foundation’s “Economic Liberty Lecture Series.” The speech "Do We Really Need a Central Bank?" can viewed above in its entirety. It was part of a student lecture series sponsored by the GMU Economics Society, the Future Freedom Foundation, and the Atlas Sound Money Project.

Steven Horwitz is the Charles A. Dana Professor of Economics at St. Lawrence University in Canton, NY. He is the author of two books, Microfoundations and Macroeconomics: An Austrian Perspective (Routledge, 2000) and Monetary Evolution, Free Banking, and Economic Order (Westview, 1992), and he has written extensively on Austrian economics, Hayekian political economy, monetary theory and history, and the economics and social theory of gender and the family. His work has been published in professional journals such as History of Political Economy, Southern Economic Journal, and The Cambridge Journal of Economics . He has also done public policy research for the Mercatus Center, Heartland Institute, Citizens for a Sound Economy, and the Cato Institute. His current project is a book tentatively titled Classical Liberalism and the Evolution of the Modern Family. Horwitz currently serves as the book review editor of The Review of Austrian Economics and as an academic advisor for the Heartland Institute and a contributing editor to Critical Review and Journal des Economistes et des Etudes Humaines. A member of the Mont Pelerin Society, he completed his MA and PhD in economics at George Mason University and received his A.B. in economics and philosophy from The University of Michigan.

From the Atlas Sound Money Project:

"Professor Horwitz joked that the question he set out to answer over the course of the lecture could simply be answered, “No.” But, for the sake of doubters, and to advance the cause of free-banking, Horwitz went on to explain the history of the central bank, the role it has played in our financial history, and the reasons why there are viable alternatives to the Federal Reserve system as we know it. Contrary to claims of the critics of free-banking, the United States has never really given the free-market a chance when it comes to banking. Since the earliest years, banks in the United States have been subject to regulation, first from the states, and later from the national government. The history of these regulations, and the evolution from primarily state-charted banks to the system we know today, is a gold mine for political economists. The centralization of banking in the United States is highly correlated with war, as politicians inevitably discover that the most politically expedient method of funding their budget is to print currency for themselves. A monopoly on money guarantees that in the short term, Congress can run whatever budget it desires without worrying unduly about costs. And so the Federal Reserve system came into existence as politicians required easy money during the Civil War, World War I, and the Great Depression. It is an unsavory history, tied to the centralization of power rather than the good of the financial system. Still, it is only in recent years that criticism of central banking has become mainstream, and its supporters still seem to outnumber its detractors."

"And yet, Horwitz argued, the Fed is unable to do just the things its supports claim it can do. Those who argue for the necessity of the central bank say that banking would be far too chaotic without a governing body, some government agency to watch the financial system and provide counter-cyclical force to erratic economy. However, throughout its history, the efforts of the Federal Reserve have been detrimental to the economy. Because of knowledge problems, time lags, and issues of incentives, the central bank is often unable to act, or worse, act in ways that increase the bubbles and worsen the recessions. And out of these crises, the Fed seems always to come out the other end with more power over the financial system. We have seen even in this latest crises unprecedented powers granted to, or taken by, the Fed. By singling out specific corporations to receive credit and aid, the Fed has taken on the role of caretaker for those institutions who they believe pose systematic risk to the industry at large. The criteria for deciding which institutions are ‘too big to fail’ is vague and arbitrary, and as a result the central bank has never had more political and financial clout."

"But despite the obvious failings of the central bank in the past, and the clear dangers it poses to the free market in the future, the current system still finds support in the media and the government. The current administration continues to call for more regulations of the financial industry and more powers granted to the central bank. Professor Horwitz explained to his audience that it will be no easy task to change the way banking works here in the United States. Not only is the free-banking movement still considered by many to be a fringe movement more suitable for “nutjobs” than informed citizens, but the interests and incentives of those most involved still point toward more centralization than less. The only way to get our arguments out to the general public is to continue to provide reasonable and factual arguments for why the Fed has been a force for ill rather than good in the past and, most importantly, to define and defend workable alternatives. The free-banking movement, Horwitz argued, is not really all that radical. The advent of paperless money and the extensive use of financial instruments like debit cards approximates how the system would operate with free-banking. Allowing individual banks to issue commodity backed currency would allow the market to dictate money supply, and would strictly limit the power of the federal government. The knowledge problems and perverse incentives of the central bank would be almost entirely eliminated in a free-banking system and would in turn provide greater, not less, stability. With this alternative, and all of the objections to the system as we find it today, Horwitz concluded, no, we do not really need a central bank."