Tuesday, September 03, 2013

Four Ways to Answer Economics Questions


I recently came across a saying about the four ways of answering questions according to the PaƱha Sutta.
  1. There are questions that should be answered categorically [straightforwardly yes, no, this, that].
  2. There are questions that should be answered with an analytical answer, defining or redefining the terms. 
  3. There are questions that should be answered with a counter-question. 
  4. There are questions that should be put aside.
A lot of the questions that economists get asked a lot can be answered in all four ways. I thought it would be fun to play a little "Economics Q&4A." I'll provide a few examples. If you wish, chime in with your own Q&4As in the comments.

Q: Is economics a science?
  1. Yes.
  2. This depends on exactly how you define science and what you consider to be the bounds and scope of economics. For the most part, economists cannot do controlled laboratory experiments. You can see lots of people's opinions on this question here, and you can read Mark Thoma and Paul Krugman here.
  3. Does this really matter? If it were not a science, should we stop trying to do it?
  4. **goes back to work**
Q: Is all this quantitative easing going to cause an inflation problem?
  1. No.
  2. You are probably asking about the Federal Reserve's unconventional monetary policies. For an explanation of why they haven't (and probably won't) cause problematically high inflation, see these posts.
  3. What do you mean by inflation problem? Isn't it possible that a bit more inflation would be a good thing? Do you see any signs of an inflation problem? Don't we have bigger problems than inflation?
  4. **sighs**
Q: If households have to tighten their belts, shouldn't the government?
  1. No.
  2. By belt-tightening, I presume you mean reducing the deficit of the federal government. You might have heard President Obama say, in 2010, "Small businesses and families are tightening their belts. Their government should too." But households are different than the government. You can read some bloggers' reactions here and here.
  3. Is the government a household?
  4. **slumps**
Q: How should I invest my money?
  1. Wisely.
  2. This depends on your situation and your financial goals. I don't know of any guaranteed get-rich-quick investment schemes. You should probably try to diversify, and not keep all your money under your mattress or in gold. I'm also not an investment adviser, just a young academic economist with no experience, so I'm horribly underqualified to help you with this.
  3. How much money do you have? And what are your investment goals? And why are you asking an economics grad student?
  4. **shrugs wildly**
Q: Should we go back on the gold standard?
  1. No.
  2. Here is an excerpt from Barry Eichengreen's answer
"Envisioning a statute requiring the Federal Reserve to redeem its notes for fixed amounts of specie is easy, but deciding what that fixed amount should be is hard. Set the price too high and there will be large amounts of gold-backed currency chasing limited supplies of goods and services. The new gold standard will then become an engine of precisely the inflation that its proponents abhor. But set the price too low, and the result will be deflation, which is not exactly a healthy state for an economy...The distributional effects of deflation are no happier than those of inflation.... The populist revolt of the 1880s was stoked by farmers with fixed mortgages who labored under growing debt burdens and financial distress as a result of falling crop prices. Nor is deflation likely to support robust economic growth, as any close observer of the Japanese economy will tell you.... 
And even if we are lucky enough to get it right at the outset, consider what happens subsequently. As the economy grows, the price level will have to fall. The same amount of gold-backed currency has to support a growing volume of transactions, something it can do only if the prices are lower, unless the supply of new gold by the mining industry magically rises at the same rate as the output of other goods and services. If not, prices go down, and real interest rates become higher. Investment becomes more expensive, rendering job creation more difficult all over again. Under a true gold standard, moreover, the Fed would have little ability to act as a lender of last resort to the banking and financial system...Its proponents paint the gold standard as a guarantee of financial stability; in practice, it would be precisely the opposite." 
3. What have you learned from history?
4. **cowers**

Q: When is Noah coming back?
  1. In about 3 months.
  2. If you mean coming back to the blog, that will be in about 3 months. However, he has never left Twitter. If you mean coming back to the United States, I think that already happened. 
  3. What, don't you like us?
  4. **checks watch**
Your turn!

48 comments:

  1. Q. Should Summers be the next Fed chairman?

    1- No.
    2- Depending on the weights you give to past actions, declarations and which personality traits you consider important in a chairman, you can come up with whatever answer suits your prior. The only undeniable fact is that Summers is a horrible human being.
    3- What do you want out of the Fed Chairman? Does the Fed Chairman even matter? Is this not about systems rather than personalities?
    4- Gallic shrug.

    http://theredbanker.blogspot.com/2013/08/federal-reserve-yellen-versus-summers.html

    ReplyDelete
  2. Q. Are we going to experience another slump?

    1- Quite possibly.
    2- With mere talk of 'tapering' sending some markets into tailspin, it is a fair question but the macro situation in the US doesn't look that dire - what with GDP growth being revised upward and unemployment keeping on reducing, albeit at a painfully slow rate. OTOH, without wage growth, it's hard to fathom where the spending spur will come from and thus it's hard to fathom why businesses would invest... Thus, it's hard to see the economy improving beyond the on-going, tepid, sub-optimal equilibrium we've had since the last recession officially ended.
    3- How do you define 'slump'? Are markets your measurement of economic well-being? Are we even out of the recession yet?
    4- Gallic shrug.

    http://theredbanker.blogspot.com/2013/03/were-stuck-more-of-same-solution.html

    ReplyDelete
    Replies
    1. Nathanael4:54 AM

      Brilliant.

      Delete
  3. "Is the government a household?"

    No, but neither is a business or charitable organization. You seem to think that the economic laws that apply to households and businesses, don't apply to the government. Why? Is it because the federal government can just print more money when it needs to? Have you seen what happened to the government of Detroit, Michigan? Do you know why this happened? It happened because Detroit didn't think the rules of running a household applied to them because they were a government, and therefore exempt from economic law just like all the other gods of the universe. They have since realized that isn't the case. Their kingdom is in shambles and has been left to the dogs. Did you know that the U.S. government is actually in worse shape financially than Detroit? Granted, they can delay the day of reckoning much longer due to the power of the printing press, but delay does not mean escape. The reckoning will come one day. Before that day, other large cities, will also go bankrupt, unless the Feds decide to bail them out.

    Endless debt accumulation is a pipe dream; a utopian fantasy.

    "Just think how great it would be if we could have this great society in which the government provides help for all those who need or want," they say. "Even the poor can live a lower middle class lifestyle. How will we pay for it? We'll just accumulate debt into the hundreds of quadrillions if we must. Debt is not an issue when you can print money, and government is not subjected to economic rules that affect such menial institutions as common households. Our rulers have devised ways to avoid all of that 'financial responsibility' nonsense. We spend money on whatever we want, when we want it, and a lot of that money is spent on helping those less fortunate. We are your benefactors. Do not doubt that. We do not need to reduce the trillion dollar annual deficit, nor do we need to ever pay down our debt. We do into debt to pay debt. That is indeed how we roll and will continue to roll forever and ever. It cannot end in disaster because this is America, the greatest nation that has ever existed in the history of the world, and this is not a household."

    ReplyDelete
    Replies
    1. You seem to think that the economic laws that apply to households and businesses, don't apply to the government. Why?

      Because the government is a natural monopoly in certain markets.

      Have you seen what happened to the government of Detroit, Michigan? Do you know why this happened? It happened because Detroit didn't think the rules of running a household applied to them because they were a government, and therefore exempt from economic law just like all the other gods of the universe.

      A city govt. is different from a federal govt., since it's much more likely to borrow externally.

      The key thing to think about is that when you borrow externally, you owe someone else money, but when you borrow internally, you only owe yourself money.

      A family is not going to go bankrupt from a brother borrowing money from his sister.

      Delete
    2. Certainly the laws that apply to households don't apply to government. Households face a time horizon--debt must typically be paid before retirement since earning power declines with age. Government doesn't have the kind of lifecycle issues that dominate the financial decisions of households. Businesses are more similar to government since they don't face lifecycle constraints.

      But both households and businesses are different from government in that firms and households must sell a product to earn money, while government has earning power that depends much less on the whims of consumers. There are limits to how much a government can tax before dramatically shrinking the economy's output, of course, but we seem nowhere near those limits.

      This is not to say that chronic deficit spending is a good policy; I just think the household comparisons are absurd.

      Delete
    3. So then, is the strategy of the federal government to secretly default on the debt owned by the Federal Reserve Bank? The Fed buys U.S. bonds so that the federal government can continue to spend, and when those bonds mature the federal government simply doesn't pay the Federal Reserve what they are owed.

      Delete
    4. "The Federal Reserve will not monetize the debt." Ben Bernanke, Sworn testimony to Congress, June 3, 2009

      Delete
    5. So then, is the strategy of the federal government to secretly default on the debt owned by the Federal Reserve Bank? The Fed buys U.S. bonds so that the federal government can continue to spend, and when those bonds mature the federal government simply doesn't pay the Federal Reserve what they are owed.

      This strategy was suggested by Ron Paul:

      http://noahpinionblog.blogspot.com/2011/07/now-ron-paul-wants-to-debase-currency.html

      But I think it's very dangerous.

      Delete
    6. Or is the strategy for the federal government to pay all of its debts faithfully, but the Federal Reserve simply gives all the money back to the U.S. Treasury once it has been paid by the federal government for the trillions of dollars of debt that it acculmulates? It would be helpful to know the logistics of how you believe this is going to work. The only way internal borrowing works is if those you are lending to essentially forgive your debts without any adverse reaction. In other words they continue to vigorously lend to you even as you are defaulting.

      Delete
    7. Actually, the "internal borrowing" thing is not about the Fed. Forget about the Fed for a moment, and just think about the U.S. Treasury bonds that are owned by U.S. citizens.

      Delete
    8. "A city govt. is different from a federal govt., since it's much more likely to borrow externally."

      Isn't this basically saying that the difference between a city government and the federal government is the federal government has a central bank that will buy an unlimited amount of its debt with currency created at will, whereas a city government does not?

      Delete
    9. I'm don't know how much U.S. debt is owed to U.S. citizens, but I imagine that most of what the government owes to them is in pension plans. Are you suggesting that the government will default on the bonds owned by these plans, or that paying this money out to the citizens of the U.S. will actually put the U.S. on sound financial footing?

      Delete
    10. dropbearz10:36 AM

      who is this wacko?


      sorry, I stopped reading your diatribe because you still don't know the difference between a sovereign gov't and a dependent state, which is still in the same category as a household.

      And btw, the first answer should have been a simple succinct yes or no, not a rant - lol you couldn't even get that one right!.

      better keep up, slow kid.

      Delete
    11. I'm don't know how much U.S. debt is owed to U.S. citizens, but I imagine that most of what the government owes to them is in pension plans.

      Pension plans are mostly local (or state). Not federal.

      Most of that federal debt you see? Trillions and trillions of dollars? It's owed to Americans.

      Delete
    12. We apparently disagree that federal debt is less of a burden because it is owed to Americans. That money still has to be paid, and the federal government will have to continue to borrow money in order to make those debt payments.

      Delete
    13. That money still has to be paid

      When it is paid, it is (mostly) paid to Americans.

      Delete
    14. Because the government is a natural monopoly in certain markets.

      Congress can gather enough information to know the optimal provision of prisons...but they can't gather enough information to know the optimal provision of milk?

      Do you drink milk? Do you ever stop and think how weird it is for adults to drink milk? Does it make it worse or better that it's not even human milk...it's cow milk.

      I drink Silk Milk. I shake it well and buy it often. Why? Because it matches my preferences. How do you know that it matches my preferences? Because I was willing to sacrifice the alternative uses of my money. And now you know more about my preferences than congress does.

      Delete
    15. Do you ever stop and think how weird it is for adults to drink milk?

      I prefer to chase squirrels.

      Delete
    16. The big issue is not even discussed here.
      1. Where does money come from?
      2. If people want to hold more financial assets, doesn't that mean someone else has to hold more financial liabilities.
      3. If everybody is try to improve their net financial asset position at the same time, how can that work?

      And unlike Noah, I think that under certain circumstances, it is perfectly OK for the government to spend more than it earns by "printing money" (OK borrowing from the central bank).

      Delete
    17. Anonymous11:21 AM

      So what do you figure happens when households are increasing their savings rate and the government is reducing deficits at the same time?

      Obviously interest rates plummet because the demand for savings plummets and so rates eventually must become negative for capital markets to clear.

      But because cash always has a 0% nominal interest rate, you may be unable to get real interest rates low enough (if inflation is low) to clear the markets.

      So what happens?

      Bad things. Really bad things. Just think about it.

      To suggest that EVERYONE in the economy- households, businesses, governments- tighten their belts all together is easy but ignores our current circumstances.

      Delete
    18. Nathanael3:41 AM

      Neil, did you even read what you wrote?

      "You seem to think that the economic laws that apply to households and businesses, don't apply to the government."
      Correct.
      " Why? Is it because the federal government can just print more money when it needs to?"
      Correct.
      " Have you seen what happened to the government of Detroit, Michigan? Do you know why this happened?""
      Because the government of Detroit, Michigan cannot, in fact, print money, and did not print money.

      The Federal Government, on the other hand, actually can print money. Although for insane reasons they repeatedly choose not to. (The US Mint coins *some* money, but not enough.) The Federal Government used to print money, back when we had wiser governments -- look up Lincoln's "Greenbacks" (US Notes).

      Delete
  4. Q: Is capitalism evil and immoral?

    1- Yes

    2- Capitalism, in its application since the days of Adam Smith, has led to the systematic exploitation of the worldwide underclass to benefit a ruling elite that uses violence through the state to perpetuate their expansion of power.

    3- Haven't you read Marx?

    4- *punches questioner in the throat*

    ReplyDelete
    Replies
    1. You must be popular at parties...

      Delete
    2. Anonymous11:35 AM

      "2-Capitalism, in its application since the days of Adam Smith, has led to the systematic exploitation of the worldwide underclass to benefit a ruling elite that uses violence through the state to perpetuate their expansion of power."

      I can do this too:

      For decades the deleterious consequences of communist policies promulgated by banal demagogues, ostensibly in the service of the masses, have been deliberately obscured by a sustained series of verbose, sophomoric, pseudo-intellectual assaults on capitalism in the public domain.

      Delete
  5. Anonymous9:57 AM

    Are economists ever wrong?

    1. No.
    2. It's not about being right or wrong, but creating quantitative-sounding support for political arguments.
    3. When your predictions don't pan out, sir, do you not use special pleading?
    4. *makes "on the one hand" gesture followed by the same with the other hand*

    ReplyDelete
  6. Can the average person understand macroeconomics?

    1. No.

    2. It depends in part on how you define "average," "person," "understand" and "macroeconomics." Also "can." Many people of above- average intelligence and education are baffled when they read econospeak, but it is unclear whether macroeconomists themselves understand macroeconomics.

    3. Why should you want to? Do you try to understand, say, physics or chemistry beyond, maybe, a college undergraduate level of knowledge of forces and interactions? Do you like abstruse math? Do you try to understand alchemy? Is macroeconomic theory appreciably different?

    4. **punches questioner in the throat -- always a good response and who gets invited to parties anyway?**

    ReplyDelete
  7. That last one wasn't even an economics question, Carola.

    1. I'm sorry, but you have to phrase your specious argument in the form of a question.
    2. Haven't Dubner and Levitt shown the value of applying economic thinking to situations not normally considered to be economics? From that perspective, isn't "When is Noah coming back?" amenable to a variety of questions about the supply and demand curve of Noah posts? Why I remember this one obscure passage in Adam Smith that has nothing to the subject but I'll happily drone on about...
    3. This is about your dislike of Josiah's post stemming from your reflexive impulse to reduce all Libertarians men to their constituent particles, isn't it John?
    4. **Ponders to self that Noah appears to have gotten tenure and a bunch of graduate students, two of whom are Asian. Wonders if this means that Krugman and/or Kimball will be given A-- grades and just who is going to fix the giant garbage ball.**

    ReplyDelete
  8. Forgot. Post-Structuralist Bonus Round on "When is Noah coming back?"

    5. **Answer unreadable. Summary: First they attempted to misconstrue the question as being about the Biblical patriarch and talked about how the Babylonian version was immortal, then they gabbled on a bit about Hegelian trielectic for a bit, concluding with a detailed analysis of the themes of gender dominance in a passing banner ad as relates to a receipt on their desk.**

    ReplyDelete
  9. Many of us apparently differ that national debts are a smaller problem since it is payable to People in the usa. Those funds continues to have to become compensated, along with the authorities must always get a loan to help make those personal debt installments.
    Runescape 3 Gold
    FFXIV Gil For Sale

    ReplyDelete
    Replies
    1. Spammers are getting increasingly specialized. And desperate.

      Delete
    2. Yep. Spam filter missed this one.

      Delete
    3. I guess they're trying to get all the online RPG players who were looking for places to buy standard RPG gold but wind up on blogs about the gold standard by mistake.

      Delete
  10. If things like self satisfaction, having comparable wealth/status to neighbors, low unemployment are important, why do we have round about economics conversations about unrealated things (QE2) instead of just giving people a shovel, and telling half of em to dig and half of em to fill ?
    1) economist don't get high status and wage for simple things
    2) Do you have a log linear utility function for satisfaction ? is it in aggregate statistics time series cross country databases ?
    3) If employment is related to interest rates, what is wrong with talking about QE2 ?
    4)this was a GREAT blog post (seriously) particularly in how it eschewd jargon and words like "nominal", which are cant for specialists

    ReplyDelete
  11. John S7:58 AM

    Carola, I believe you and Eichengreen are both overlooking something major on this question:

    Should we go back on the gold standard?

    The problem with Eichengreen's analysis, both in this article and in his book "Globalizing Capital," is that he doesn't distinguish between a govt managed gold standard and a free banking (i.e. w/o a central bank) system using gold as outside money (e.g. Canada until 1935, and Scotland until 1844). The distinction isn't at all trivial, b/c the gold reserve ratio in govt managed systems was far higher (due to legal restrictions) and much less flexible than those seen in free banking systems (typically 35-40% in the former vs. as low as 2% of total liabilities in the latter).

    For example, in "Globalizing Capital," Eichengreen notes that in 1920 "the Federal Reserve System ran low on gold; the cover ratio fell perilously close to the statutory 40 percent floor. The Fed adopted harsh deflationary policies in order to raise its reserve." (Kindle loc. 729) The need to defend arbitrarily high reserve ratios necessitated these kinds of disruptions to the credit cycle many times in by the Bank of England in the 19th century and the Fed and other central banks in the early 20th century.

    In free banking systems, however, the banks themselves were free to set their own reserve ratios, so that new currency and credit creation could adjust up and down in accordance with the needs of the economy (w/o having to change the definition of the unit of account in terms of gold, as Eichengreen--who should know better--suggested). As Lawrence White points out in his "Theory of Monetary Institutions," reserve ratios in the most historically advanced free banking systems were as low as 2% or less (p. 21). In other words, due to the sophistication of the interbank clearing mechanism, free banking systems achieved maximal efficiency in using gold reserves to support a proportionally greater amount of currency and credit than govt managed systems, thus negating Eichengreen's other claim (made in his book) that world gold production was not sufficient to maintain reserves for the int'l financial system.

    ReplyDelete
    Replies
    1. John S8:14 AM

      So while I agree that no one should want to go back to a govt managed gold standard, the issue of whether the current system would be preferable to a free banking system based on gold (or a rule-based fiat standard, as a transition) is not a clear-cut issue b/c both the Scottish and Canadian free banking systems were finished by political, rather than economic, circumstances (Peel's Act of 1844 for Scotland and creation of the Bank of Canada in 1935--despite the fact that Canada had suffered no bank failures during the height of the Depression).

      http://www.jstor.org/discover/10.2307/2122238?uid=2&uid=4&sid=21102584704681

      You asked, "What have we learned from history?" Scholars of free banking systems have learned that such systems, nearly all of which were based on gold, were remarkably stable and successful, esp. in comparison with the leading central banks of their times (the BoE and the Fed). A summary of the historical research can be found in "The Experience of Free Banking."

      http://menghusblog.files.wordpress.com/2012/02/the-experience-of-free-banking.pdf

      A great description of Canada's free banking system by George Selgin can be seen here: http://www.youtube.com/watch?v=kkpgJ1g-I-8

      Despite not being well known, I think the history of the successful gold-based free banking systems absolutely must be taken into consideration when answering questions about a gold standard, rather than focusing only on the poor performance of govt managed gold standards, as Eichengreen has emphasized in his work.

      Delete
    2. Nathanael3:37 AM

      The problem with free banking is frequent, major, long, recessions, generally triggered by bank runs or other bank collapses.

      This was pretty well documented by the contrasting of "free banking" periods with the "managed banking" periods. It's dramatic how much worse the free banking periods are.

      Delete
    3. John S12:44 AM

      Nathanael, may I ask what countries/periods you are referring to when you state, "It's dramatic how much worse the free banking periods are"? Research has shown that free banking worked very well in Canada, Scotland, and other areas (please see the relevant chapters in "The Experience of Free Banking," linked above). The only major downturn associated with free banking is Australia in the 1890s, but I don't see how a central bank could have prevented an economic slowdown following the sudden withdrawal of British capital following the Barings Crisis of 1890.

      On Scotland specifically, here is Larry White's "Free Banking in Britain":

      http://www.iea.org.uk/sites/default/files/publications/files/upldbook115pdf.pdf

      Delete
    4. John S12:48 AM

      I'm guessing you are referring to the US "free banking" period (from the end of the 2nd Bank of the US to the Civil War). However, nearly all of the problems stemmed from govt restrictions on banking:

      1) prohibitions on branch banking (resulting in over-exposure to local conditions and over-reliance on NY, Chi, and St. Louis banks for access to major money markets);

      2) bond collateral requirements for private banknote issuance (e.g. to issue $100 of notes, a bank first had to buy $110 worth of state bonds). This arbitrarily tied note issuance to the supply/demand for state debt and led to a highly inelastic money supply.

      More here: "The Case for Free Banking: Then and Now"
      http://object.cato.org/sites/cato.org/files/pubs/pdf/pa060.pdf

      I'm not completely opposed to the idea that a central bank might be necessary to implement counter-cyclical policy. But we can't discount the viability of a private money system unless we examine the history and theory of free banking. This is something most economists, including Eichengreen, are unwilling to do. That's unfortunate, b/c we could learn a lot about how money and banking work by thinking about a pure free-market system.

      Delete
    5. Nathanael3:32 PM

      OK, so you rationalize out of existence the US Free Banking period (using bogus rationales). You explicitly ignore the Australian free banking period. You ignore the *ancient Chinese* free banking period (which was full of bubbles and busts).

      You have Canada, Scotland, and really nothing else left. What's notable about Canada? Extremely strict government regulation and startlingly small numbers of banks. Canada never had a "free banking" period.

      What's notable about Scotland? It never really had a free banking period either; it was an economic satellite of England and both were on the Gold Standard.

      In short, you're really not looking at the history. Private money gives you an extremely cyclical economy. That may be OK, but be aware what you're getting into.

      Delete
    6. John S6:53 AM

      Nathanael, thank you for your response. You bring up some very good points to which I will respond as fairly as I can.

      You wrote: you rationalize out of existence the US Free Banking period (using bogus rationales)

      I did not claim that the "free banking era" of US banking history never existed. I merely pointed out that it was a flawed system, and I listed its two main flaws: restrictions on branch banking and the bond backing requirement for notes. Are these points "bogus"? No, they are rather uncontroversial. The most prominent "mainstream" economic historians specializing in North American banking history--Hugh Rockoff, Michael Bordo, Charles Calomiris, and Gary Gorton--are all aware of these restrictions and their harmful effects on US 19th cent. bank system stability. Here's Calomiris and Gorton on branch banking:

      "Canada experienced no panics after the 1830s. Bordo (1985) provides a useful survey of banking and securities market "panics" in six countries from 1870 to 1933. Summarizing the literature, Bordo attributes the U.S. peculiarity in large part to the absence of branch banking."

      http://www.nber.org/chapters/c11484.pdf (p. 116)

      Here's Rockoff: "One restriction that was important in the United States, although not in other countries, was the limitation on the right to establish branches. Although free-banking laws in the United States allowed entrepreneurs to establish a bank with one office within a particular state, branching was often prohibited, and branching across state lines was ruled out because the chartering of banks was state law and states prohibited banks with charters from “foreign” states from establishing branches. As we will see below, there is a strong consensus [emphasis mine] that prohibitions on branch banking caused a great deal of trouble in the United States."

      http://econjwatch.org/articles/do-economists-reach-a-conclusion-on-free-banking-episodes (p. 9 of the downloadable article)

      Delete
    7. John S7:44 AM

      The effects of branch banking on stability can be seen in other historical contexts. Here's an analysis of the Great Depression years:

      "Using data on national banks from the 1920s and 1930s, we show that branch banking increases competition and forces weak banks to exit the banking system. This consolidation strengthens the system as a whole without necessarily strengthening the branch banks themselves. Our empirical results suggest that the effects that branching had on competition were quantitatively more important than geographical diversification for bank stability in the 1920s and 1930s."

      http://www.nber.org/papers/w11291 (from the abstract)

      [Actually, I would question the second conclusion, which downplays the importance of geographical diversification, since interstate banking was largely suppressed until the 1970s and restrictions weren't completely lifted until 1994.]

      Similarly, there is a consensus among scholars that the bond collateral backing requirements for banknote issues were highly problematic for "free" US banks. Here's John Chown (A History of Money From AD 800, p. 189) remarking on the "Free Banking Act of 1838":

      "This was by no means laissez-faire. There were many restrictions. First, there were strict reserve requirements. The bank was required to hold a 100 per cent reserve against its notes in the form of mortgages or state bonds and an additional 12.5 per cent in specie. (The specie requirement was repealed in 1840). These were really quite strict: a bank could not raise funds for commercial lending by issuing notes, although there was undoubtedly a profit from the operation."

      Here is Rockoff again, p. 25, comparing the US and Canadian systems:

      "The flexibility of a system in which notes were issued based on general assets [such as Canada's] provided measurable benefits. Interest rates in Canada did not follow the distinct seasonal pattern, rising in the fall and winter and falling in the spring and summer, which prevailed in the United States. The reason, as Selgin and White (1994a) show, is that in Canada the banks could adapt to the heavy demand for notes during the crop-moving season by issuing more notes relative to deposits.

      In the United States this kind of adjustment was hampered by the bond collateral system, and the seasonal pattern of interest rates prevailed, a constant irritant to farmers who found that interest rates were highest when they ran short of funds. This pattern lasted until the establishment of the Federal Reserve System."

      As is well known, a major stated purpose of the establishment of the Fed was to provide an "elastic currency," precisely to solve the problem of the inelastic currency that had led to panics. But a central bank wasn't the only possible solution--as Canada's experience showed, eliminating restrictions on note issuance was another workable option (emulating the Canadian system was considered, but ultimately rejected in favor of central banking, in the US after the Panic of 1907; "Experience of Free Baning, p. 88).

      Delete
    8. John S8:21 AM

      You explicitly ignore the Australian free banking period.

      I'm honestly puzzled by this charge, b/c I explicitly included reference to Australia as an example of a major downturn coinciding with a free banking system. However, if you still believe me guilty of trying to stack the deck, I apologize. Here's a link to an article which makes the case against free banking w.r.t. Australia:

      "Free banking gone awry: the Australian banking crisis of 1893"
      http://menghusblog.files.wordpress.com/2012/05/free-banking-gone-awry-the-australian-banking-crisis-of-1893-hickson-and-turner.pdf

      While the 1890s downturn was severe, it must also be acknowledged that Australia's free banking system also coincided with many decades of extremely high growth, during which Australia enjoyed the highest per capita GDP levels in the world:
      http://pages.stern.nyu.edu/~dbackus/CA/McLean%20Aussie%20GDP%20ER%2004.pdf (Table 1, p. 332)

      Australia is an interesting case. There are many factors to consider: declining terms of trade (esp. wool); demographics (gold rush population boom in 1850s-1870s contributing to building boom in 1880s); the Baring Crisis and sudden withdrawal of British capital/deposits (UK deposits were more than a quarter of total Aus. deposits on the eve of the crisis); unwillingness of the Aus. provincial govts to restructure debt post-Baring (as Argentina did); and the droughts of the mid-1890s, hampering recovery.

      Far from ignoring it, I'm very interested in the subject and want to learn more about it. I'm also open to the idea that govt action could have softened the monetary effects of the crash (I'm less sanguine that a central bank could have prevented the property boom or anticipated/prevented the sudden capital outflow; plenty of countries with central banks have experienced both problems). The discussion in Rockoff's paper is illuminating, as is this paper by Ian McLean (author of Why Australia Prospered): https://economics.adelaide.edu.au/research/papers/doc/wp2005-19.pdf

      However, I still think it's premature to declare the Australian case as proof positive that free banking (or as Rockoff more accurately puts is, "lightly regulated banking") doesn't work. There have been a couple of pretty bad financial crises under central banking, also.

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    9. John S8:46 AM

      You ignore the *ancient Chinese* free banking period

      I know next to nothing about Chinese monetary & banking history, but I'd love to learn. Any book or article recommendations?

      You have Canada, Scotland, and really nothing else left.

      Kurt Schuler has listed about 60 historical cases of free banking ("Experience, p. 40, Table 2.1: Free Banking Episodes). (Also Charles Goodhart--probably the premier central banking expert today--has also pointed out to Larry White the existence of many examples of free banking, according to a footnote in "Free Banking in Britain").

      http://menghusblog.files.wordpress.com/2012/02/the-experience-of-free-banking.pdf

      Of course, none of these was pure laissez-faire banking. However, they all featured competitive, private note issues and had no govt central bank. Rockoff's paper includes a good discussion and checklist of what constitutes free banking (or "lightly regulated banking," as he puts it).

      Sorry for the deluge of comments, Nathanael. I'll comment on the Canadian and Scottish episodes in a day or two.

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    10. John S8:01 AM

      To continue my response:

      You wrote: "What's notable about Scotland? It never really had a free banking period either; it was an economic satellite of England and both were on the Gold Standard.

      Let me address your last point first. Yes, Scotland's free banks issued gold-redeemable currency. But that was the entire point of my original post; the term "Gold Standard" can mean either a govt managed system of monopolized currency issue OR a free system in which each bank issues its own gold-redeemable currency and maintains its own specie reserve.

      In fact, the term "Gold Standard" refers to an even wider range of monetary systems:
      http://www.freebanking.org/2013/08/29/the-necessity-of-distinctions/

      Is it true that Scotland never had a free banking period? A comparison of the two systems shows that the Scottish system was certainly much freer than the English system (citations below will refer to the book page #'s in White's "Free Banking in Britain," not the PDF page #'s).

      1. The Bank of England was the sole currency issuer in London, and due to a Parliamentary Act of 1708, all other banks with more than six partners were prohibited from issuing currency in England or Wales (White, 69; http://www.iea.org.uk/sites/default/files/publications/files/upldbook115pdf.pdf).

      2. B of E notes accounted for one half to two-thirds of all currency in England as a whole as of 1820 (White, 69). From 1826, the BofE began opening branches outside of London, augmenting its share of note issuance. IN 1833, BoE notes became legal tender (i.e. customers could not refuse redemption into BofE notes instead of specie), effectively making them high-powered reserve money for the entire system (White, 35).

      3. In contrast, Scottish banks had complete freedom to issue notes backed by specie. From 1774, all Scottish banks of issue were part of a note-clearing system of mutual par acceptance (White, 28).

      4. Unlike the English system, no single Scottish bank achieved anything close to the dominance that BofE notes held in terms of the % of outstanding notes. In 1845, at the end of the free banking era, no bank had more than 15% of notes outstanding (White, Table 2.2, p. 33).

      5. Scottish banks were free to branch anywhere in the country, including the capital of Edinburgh (White, 30-34). In contrast, due to the six-partner rule, English country banks of issue were small, undercapitalized, and fragile. In 1826, all note-issuing banks were explicitly prohibited from opening offices within a 65 mile radius of London (White, 37).

      Finally, was the Scottish system merely a satellite English system? White addresses this specific issue in pp. 54-62, which you may refer to yourself. At any rate, it should be clear that the BofE did not act as a lender of last resort for the Scottish system. The Scottish free banking era ended in 1845--several decades before the publication of Bagehot's Lombard Street in 1873, a time when the BofE had still not yet explicitly acknowledged its role as LoLR for England, let alone Scotland.

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  12. Nathanael3:35 AM

    Forget the ludicrous idea of backing the currency with shiny metal....

    ....I want a fixed *cocoa bean* standard, such as the Aztecs had. Back the currency with something *valuable*. :-)

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    Replies
    1. John S8:05 AM

      Apologies, Nathanael. I lost a comment on the previous thread. If it doesn't get posted, I'll resubmit it.

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