Document Type

Working Paper

Publication Date

4-11-2015

College/Unit

Chambers College of Business and Economics

Document Number

15-08

Department/Program/Center

Economics

Abstract

Building on Selgin (1994), we develop a simple model of free banking and study the system’s effects on familiar macroeconomic variables. We show a free banking system does in fact stabilize nominal income in response to aggregate demand shocks. However, in the event of an aggregate supply shock, a free banking system instead stabilizes inflation, engaging in mildly procyclical behavior. We conclude by calling for a broader study of nominal income targeting and free banking in the tradition of ‘monetary constitutionalism’ (Yeager 1962; White et al. 2014) to ascertain whether this result, while almost certainly not the best of all possible worlds, is in fact the best of all probable worlds.

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Economics Commons

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