Free Banking and the Structure of Production: a Contrast of Competing Banking Systems

THE PURPOSE OF THIS NOTE is to apply an argument developed in Hülsmann (2009) to a claim used in advocacy of fractional reserve banking (FRB) under a system of free banking (that is, a system of banks lacking any formal, central control [as characterizes the state-monopolized central banking systems of the modern Western world]). Hülsmann considers the effects on the structure of production of changes in the demand for money, under two contrasting monetary systems: a commodity money system, and a fiat money system. He establishes (contrary to prior Austrian work on the subject) that under a commodity system, changes in the demand for money do have a permanent effect (in the sense of equilibrium or end state) on the structure of production (and in particular on the pure rate of interest [PRI]). In contrast, under a fiat system such changes in demand do not have such a lasting effect on the structure of production (and hence the PRI). He goes on to argue that this impact on the structure of production is in fact a beneficial aspect of a commodity money system in contrast to fiat money systems.