Working Papers

More on Pop Austrianism and the Business Cycle

A key element of the pop Austrian critique of contemporary monetary policy is that the inherent unevenness of the process by which newly created base money and inflation work their way through an economy creates a structure of production that a free market economy would not otherwise support (the Ludwig von Mises Institute has plenty of examples of this sort of claim).  In the Austrian view, growth in broad money, credit aggregates and even asset prices is built on a house of cards: fiat money leveraged through fractional reserve banking.  Even those Austrians who accept fractional reserve banking consequently see almost any central bank policy action as inherently destabilising. 

A major problem with this view is that there is no necessary connection between interest rate targeting by central banks and the money base (although in practice they are usually closely linked by the operating procedures currently favoured by monetary authorities).  In principle at least, we could have a market-determined money supply and even non-centralised clearing of overnight inter-bank lending and yet still have a central bank successfully targeting an official short term interest rate through its willingness to buy and sell relevant instruments at given prices.  Unless we define free banking as the complete absence of a central bank, there is no reason why the two institutions could not co-exist.

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posted on 22 February 2005 by skirchner in Economics

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