Central Banks as Sources of Financial Instability

George Selgin has published an excellent piece in The Independent Review (volume 14, number 4, Spring 2010) entitled "Central Banks as Sources of Financial Instability". Selgin is a senior fellow at the Cato Institute, professor of economics at the University of Georgia, and the author of the Independent Institute book Good Money: Birmingham Button Makers, the Royal Mint, and the Beginnings of Modern Coinage, 1775–1821.

Selgin states:

"The present financial crisis has set in bold relief the Jekyll and Hyde nature of contemporary central banks. It has made apparent both our utter dependence on such banks as instruments for assuring the continuous flow of credit in the aftermath of a financial bust and the same institutions’ capacity to fuel the financial booms that make severe busts possible in the first place."

"Yet theoretical treatments of central banking place almost exclusive emphasis on its stabilizing capacity—that is, on central banks’ role in managing the growth of national monetary aggregates and in supplying last-resort loans to troubled financial (and sometimes nonfinancial) firms in times of financial distress."

"I propose to challenge this conventional treatment of central banking by arguing that central banks are fundamentally destabilizing—that financial systems are more unstable with them than they would be without them. To make this argument, I must delve into the history of central banking and explain both why governments favored the establishment of destabilizing institutions in the first place and why there is the modern tendency to regard central banks as sources of financial stability. I hope to show that the modern view of central banks as sources of monetary stability is in essence a historical myth."