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Edited by Andrew W. Mullineux and Victor Murinde
Chapter 7: Free Banking
Kevin Dowd* 1 INTRODUCTION A free banking system is a ﬁnancial system with no central bank or other ﬁnancial or monetary regulator, and no government intervention. It therefore allows ﬁnancial institutions to operate freely, subject only to the discipline of market forces and the rules of ‘normal’ commercial and contract law. Free banking is thus equivalent to ﬁnancial laissez-faire. Although the idea is strange to most modern economists, there are in fact many instances of (relatively) free banking in the historical record,1 and there were vigorous controversies about it in a number of countries in the early nineteenth century (see, for example, Smith, 1936, ch. 6; White, 1984, ch. 4). The notion of free banking was then largely forgotten, even among economists favourable to laissez-faire,2 and was only rediscovered in the last quarter of the twentieth century after Friedrich Hayek resurrected the idea in a famous pamphlet in 1976 (Hayek, 1976). Hayek’s proposal attracted considerable attention, and subsequently gave rise to a substantial literature on the topic.3 The argument for free banking is essentially an application of the general argument for free trade: if free trade is generally desirable, as most economists agree, then presumably free trade is also desirable in individual sectors of the economy, including ﬁnancial services, and free trade in ﬁnancial services is free banking. And if free banking is desirable, the whole panoply of government intervention into the ﬁnancial sector – central banks, government-sponsored deposit insurance, and government regulation of the ﬁnancial system – should be...
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