Free banking, central banking and financial regulation

These subjects have been my main interest for most of my career. My work here covers the following themes: 

 

  The history of free banking: the experience of the (relatively) free banking systems of the past. Examples are my essays on free banking in Australia (“Free banking in Australia”), the ante-bellum US (“US banking in the ‘free banking’ period”) and my edited volume The Experience of Free Banking (1992), which brings together a collection of case studies of historical free banking experiences.

 

  The history and development of central banking: See “The evolution of central banking in England, 1821-1890”, “Did central banks evolve naturally?”, “Competitive banking, bankers’ clubs, and bank regulation”.

 

  Deposit insurance: I have written on various aspects of deposit insurance (see under ‘deposit insurance’ heading below) but my main focus of interest has been the Diamond-Dybvig model which is widely cited as providing a theoretical rationale for deposit insurance (Diamond, D.W., and Dybvig, P.H. (1983) "Bank runs, deposit insurance, and jiquidity". Journal of Political Economy 91: 401–19.). Their analysis is, I believe, fundamentally flawed because deposit insurance is not feasible in the confines of their economic model; moreover, their fails to provide any insights into banking as such, because the ‘financial institutions’ in their model are not banks but mutual funds of a sort that have, at best, a very minor role in the financial system. These institutions are unable to provide any capital buffer to reassure depositors so they don’t feel any need to run. (My analysis of Diamond-Dybvig and what is wrong with it can be found in “Models of banking instability: a partial review of the literature” and “Re-examining the case for government deposit insurance”.) The solution to this latter problem is for financial institutions to reassure depositors by offering a capital buffer, and it is the existence of this buffer than makes these institutions true banks in the proper sense of the term. This suggests that we can outline an alternative to the DD model in which we get proper banks whose capital adequacy credibly reassures depositors without deposit insurance, and such a model can be found in “Bank capital adequacy vs deposit insurance”).

 

  Still on the subject of deposit insurance, I would go on to suggest that the impact of deposit insurance on bank competition is much more subtle and damaging than is usually appreciated - in a good system, the incentives should be such as to reward a conservative bank against an irresponsible cowboy bank, and the main damage done by deposit insurance arises because it rewards the cowboy bank and penalises the conservative bank.  This means, in time, that deposit insurance makes all banks cowboys ... and the recent financial crisis has hardly disproved that. For more on this, see “The case for financial laissez-faire”.) 

 

*Capital adequacy regulation: The last two decades or so have seen the growth of a huge apparatus of international capital adequacy regulation. This is, I believe, of virtually no use at all (and again, the recent crisis would seem to confirm this claim). I have a number of articles criticising various aspects of capital adequacy regulation (see under ‘capital adequacy regulation’ below). However, one thing that strikes me is the shallowness of the arguments put forward by its supporters - these usually boil down to paternalistic arguments of one sort or another or to patently obvious hand-waving. An exception is the work of David Miles (D. Miles, “Optimal regulation of deposit taking financial intermediaries,” European Economic Review, 39, pp. 1365-1384, 1995.), which seeks to show why capital adequacy regulation is required from first principles, i.e., from a market failure argument. Basically, Miles argues that there is an information asymmetry problem that can only be overcome by intervention in the form of capital adequacy regulation. However, Miles’s argument is inconsistent. Within the confines of his model, either the technology exists for a party outside the bank to assess the quality of the banks’ assets, or it does not. If such a technology exists, then it can presumably be used to convey information about bank asset quality to the depositors, and in that case the information asymmetry between the bank and its depositors disappears and there is no need for capital adequacy regulation. And if such a technology does not exist, then it is not possible for the financial regulator or central bank to make use of it itself, and in that case the capital adequacy regulation is not feasible. The ‘market failure’ therefore disappears - in effect, Miles was implicitly assuming that the government had access to superior technology than the private sector. See “Does asymmetric information justify bank capital adequacy regulation?

 

Books

Money and the Market: Essays on Free Banking.  London and New York: Routledge, November 2000. 226 pp. Hardback.

Money and the Nation State: The Financial Revolution, Government and the World Monetary System. (Edited by K. Dowd and R. H. Timberlake, Jr., with a Foreword by Merton H. Miller.) Published by Transaction Publishers (New Brunswick, NJ) under the auspices of the Independent Institute (Oakland, CA), 1998. 453 pp. Hardback and paperback.

Competition and Finance: A New Interpretation of Financial and Monetary Economics.  Basingstoke: Macmillan Press; and New York: St. Martin’s Press, 1996, 572 pp. Hardback and paperback.

[A Chinese language edition of Competition and Finance was published by China Renmin University Press in 2005.]

Laissez-Faire Banking.  London: Routledge, 380 pp. Hardback edition, 1993. Paperback edition, 1996. 

Money and the Market: Essays on Free Banking.  London and New York: Routledge, November 2000. 226 pp. Hardback.

The State and the Monetary System.  Oxford: Philip Allan Publishers; and New York: St. Martin’s Press. 1989. 212 pp. Hardback and paperback.

Private Money: The Path to Monetary Stability.  Hobart Paper No. 112, Institute of Economic Affairs, London, 1988, 71 pp. Second edition, 1996.

[An revised Italian version was published by the Istituto Bruno Leoni in October 2009 under the title Abolire le Banche Centrali with a preface by Franco Spinelli.]

The Experience of Free Banking. London: Routledge. 1992, 275 pp.  Hardback. Reprinted April 1996.

Articles on Free Banking

Free Banking.” Pp. 173-190 in A. W. Mullineux and V. Murinde (eds.) Handbook of International Banking. Cheltenham: Edward Elgar. 2003.

Are Free Markets the Cause of Financial Instability?Critical Review, Vol. 14, No. 1, 2000, pp. 57-67.

“A Free Retail Investment Market?” (K. Dowd and J. M. Hinchliffe) Economic Affairs, Vol. 19, No. 2, June 1999, pp. 45-47.

“Free Banking: More Relevant than Ever.” The Financial Regulator, Vol. 3, No. 1, June 1998, pp. 41-43.

The Invisible Hand and the Evolution of the Monetary System.”  In J. Smithin (ed.) What is Money? London, Routledge, 1999, pp. 139-156.

“Should the Bank of England be Abolished?Review of Policy Issues, Vol. 2, No. 1, Winter 1996, pp. 3-14.

The Case for Financial Laissez-Faire.Economic Journal, Vol. 106, No. 436, May 1996, pp. 679-687.  [Reprinted as chapter 15 in M. J. B. Hall (ed.) The Regulation and Supervision of Banks, Volume 1: The Case for and Against Banking Regulation. Cheltenham: Edward Elgar, 2001.]

“Money and Banking: the American Experience.” Pp. 1-29 (Chapter 1) in George Edward Durell Foundation, Money and Banking: The American Experience. Fairfax, VA: George Mason University Press, 1995.

“Free Banking.” Pp. 408-413 in P. Boettke (ed.) The Elgar Companion to Austrian Economics, Aldershot: Edward Elgar, December 1994.

“Free Banking.”  New Economy: Journal of Associative Economics, November-December 1993, pp. 4-6.

“The Monetary Economics of Henry Meulen.”  Journal of Money, Credit, and Banking, Vol. 24, May 1992, pp. 173-183.

Models of banking instability: a partial review of the literature.” Journal of Economic Surveys, Vol. 6, No. 2, 1992, pp. 107-132. [Subsequently reprinted in Financial Intermediaries, edited by M. K. Lewis, Cheltenham: Edward Elgar, February 1995.]

Free banking in Australia.” Pp. 48-78 in K. Dowd (ed.), The Experience of Free Banking, Routledge, London, Spring 1992.

"US Banking in the 'Free Banking' Period." Pp. 206-240 in K. Dowd (ed.), The Experience of Free Banking, Routledge, London, Spring 1992.

“A Voluntaryist Path to a Free-Market Money.”  The Voluntaryist, Vol. 63, August 1993, pp. 1, 2-7.

“Is Banking a Natural Monopoly?”  Kyklos, Vol. 45 No. 3, 1992, pp. 379-392. [Subsequently reprinted in Financial Intermediaries. Edited by M. K. Lewis, Cheltenham: Edward Elgar, February 1995.]

Sechrest on Scottish Free Banking.”  Cato Journal, Vol. 10, No. 3, Winter 1991, pp. 821-824.

Option Clauses and Banknote Suspension.”  Cato Journal, Vol. 10, No. 3, Winter 1991, pp. 761-773.

Does Europe Need a Federal Reserve System?”  Cato Journal, Vol. 10, No. 2, Fall 1990 pp. 423-448.

“The Case for Free Banking.” Economic Affairs, Vol. 10, No. 6, August-September 1990.

“Option Clauses and the Stability of a Laisser Faire Monetary System.”  Journal of Financial Services Research, Vol. 1, No. 4, December 1988, pp. 319-333.

Automatic Stabilizing Mechanisms Under Free Banking.Cato Journal, Vol. 7, No. 3, 1988. pp. 643-59.

Articles on central banking

Central Banks: Who Needs Them?Policy Options, 2001, pp. 37-40.

Too Big to Fail? Long-Term Capital Management and the Federal Reserve.” Cato Institute Briefing Paper No. 52. Washington, DC: Cato Institute. September 23rd, 1999.

“Independence – No Way!” (K. Dowd and J. M. Hinchliffe) The Financial Regulator Vol. 3, No. 3 (December 1998), pp. 51-53.

“Should the Bank of England be Abolished?Review of Policy Issues, Vol. 2, No. 1, Winter 1996, pp. 3-14.

“Central Bank Independence and Inflation: An Alternative View.” Review of Policy Issues, Vol. 1, No. 3, Winter 1995, 41-45.

Competitive Banking, Bankers’ Clubs, and Bank Regulation.” Journal of Money, Credit, and Banking, Vol. 26, No. 2, May 1994, pp. 289-308. [Reprinted as chapter 14 in M. J. B. Hall (ed.) The Regulation and Supervision of Banks, Volume 1: The Case for and Against Banking Regulation. Cheltenham: Edward Elgar, 2001.

“The Political Economy of Central Banking.”  Critical Review, Vol. 8, No. 1, 1994, pp. 49-60.

Money and the Market: What Role for Government?”  Cato Journal, Vol. 12, No. 3, Winter 1993, pp. 29-45. Translated into Russian and reprinted in Denyezhnaya Reforma v Postkommunisticheskikh Stranakh (Monetary Reform in Postcommunist Countries) edited by J. Dorn and R. M. Nureyev, Moscow: Catallaxy Press, 1996, pp. 79-103.

The Evolution of Central Banking in England, 1821-1890.”  Pp. 24-28 in F. Capie and G. E. Wood (eds.) Unregulated Banking: Order or Chaos?, London: Macmillan, l991.

“A European Central Bank?” The Durell Journal of Money and Banking, Vol. 2, No. 3, February 1990, pp. 22-31.

Did Central Banks Evolve Naturally?  A Review Essay of Charles Goodhart’s The Evolution of Central Banks.”  Scottish Journal of Political Economy, Vol.37, No. 1, February 1990, pp. 96-104.

“The Case Against a European Central Bank.”  The World Economy, Vol. 12, No. 3, September 1989, pp. 361-372.

“Some Lessons from the Recent Canadian Bank Failures.” In G. G. Kaufman (ed.) Research in Financial Services: Private and Public Policy, Vol. 1. JAI Press, Autumn I989, pp. 113-l28.

Articles on financial regulation

How Should the Financial System be Regulated?” (K. Dowd and M. Hutchinson) Cato Journal, Vol. 34, Number 2 (Spring-Summer 2014), pp. 353-388.

Capital Inadequacies: The Dismal Failure of the Basel System of Bank Capital Regulation.” (K. Dowd, M. Hutchinson, S. Ashby and J. Hinchliffe) Cato Institute Policy Analysis No. 681, July 29, 2011.

The Failure of Capital Adequacy Regulation”. Pp.73-80 in P. Booth (ed) Verdict on the Crash, London: Institute of Economic Affairs, April 2009.

Lessons from the Financial Crisis: A Libertarian Perspective.” Expanded version of the Second Chris R. Tame Memorial Lecture delivered at the National Liberal Club, March 17th 2009. Libertarian Alliance Economic Notes 111.  The presentation is available on the web here. This article was the feature of an article by Bjarni Olafsson in the Icelandic newspaper Morgunbladid Fimmtudagur, April 16th 2009. 

Moral Hazard and the Financial Crisis.Cato Journal, Vol. 29, No. 1, (Winter 2009), pp. 141-166. The video presentation of this paper is on the web here at the 26th annual Cato Monetary Conference, November 19, 2008, Washington DC. [My presentation is that end of this session, but the other presentations are well worth watching.] 

Paternalism Fails Again - the Sorry Story of the Financial Services Act.” (K. Dowd and Jimmy M. Hinchliffe. Pp. 167-182 in K. Dowd, Money and the Market: Essays on Free Banking. London: Routledge, 2000.

“A Free Retail Investment Market?” (K. Dowd and J. M. Hinchliffe) Economic Affairs, Vol. 19, No. 2, June 1999, pp. 45-47.

Competitive Banking, Bankers’ Clubs, and Bank Regulation.” Journal of Money, Credit, and Banking, Vol. 26, No. 2, May 1994, pp. 289-308. [Reprinted as chapter 14 in M. J. B. Hall (ed.) The Regulation and Supervision of Banks, Volume 1: The Case for and Against Banking Regulation. Cheltenham: Edward Elgar, 2001.

Articles on capital adequacy regulation

Capital Inadequacies: The Dismal Failure of the Basel System of Bank Capital Regulation.” (K. Dowd, M. Hutchinson, S. Ashby and J. Hinchliffe) Cato Institute Policy Analysis No. 681, July 29, 2011.

The Failure of Capital Adequacy Regulation”. Pp. 73-80 in P. Booth (ed) Verdict on the Crash, London: Institute of Economic Affairs, April 2009.

It’s Time to Abolish Risk-Based Regulation.Insurance Risk and Capital, December 19, 2008.

Assessing the Pre-Commitment Approach to Bank Capital Regulation.” Journal of Risk Finance, Vol. 3, No. 4 (Summer 2002), pages 35-40.

Bank Capital Adequacy versus Deposit Insurance.”  Journal of Financial Services Research, Vol. 17, No. 1, February 2000, pp. 7-15.

Does Asymmetric Information Justify Bank Capital Adequacy Regulation?”  Cato Journal, Vol. 19, No. 1, Spring-Summer 1999, pp. 39-41.

The Regulation of Bank Capital Adequacy.” Advances in Austrian Economics, Vol. 4, 1997, pp. 95-110.

Articles on deposit insurance

Bank Capital Adequacy versus Deposit Insurance.”  Journal of Financial Services Research, Vol. 17, No. 1, February 2000, pp. 7-15.

“Re-examining the Case for Government Deposit lnsurance: Reply.” Southern Economic Journal, Vol. 62, No. 4, April 1996, p. 1092. 

Re-examining the Case for Government Deposit Insurance.” Southern Economic Journal, Vol. 59, No. 3, January 1993, pp. 363-370.

Deposit Insurance: A Skeptical View.”  Federal Reserve Bank of St. Louis Review, Vol. 75 No. 1, January-February 1993, pp. 14-17.

Models of banking instability: a partial review of the literature.” Journal of Economic Surveys, Vol. 6, No. 2, 1992, pp. 107-132. [Subsequently reprinted in Financial Intermediaries, edited by M. K. Lewis, Cheltenham: Edward Elgar, February 1995.]