Abstract
Throughout their long collaboration Milton Friedman and Anna J. Schwartz consistently argued that fractional reserve banking was “inherently unstable.” This paper traces the evolution of their ideas, the policies that they advocated to reduce the problems created by the inherent instability, and the implications of their views for current attempts to strengthen the banking system. Recent attempts to reform banking have incorporated some of the ideas that they advocated, but in some cases have moved in a different direction.
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Notes
- 1.
Friedman (1950, 477) used the phrase in the course of pointing out that Wesley C. Mitchell rejected the idea that the economic system as a whole was inherently unstable. The term was also mentioned in DePres et al. (1950), a report by a committee of the American Economic Association which included Friedman.
- 2.
My interpretation of Simons is that he expected evasion to arise quickly once 100% reserves were put in place, but he doesn’t discuss explicitly how long this would take.
- 3.
In both of the counterfactual examples the initial stocks of money would have been lower. We can imagine that the economy had adjusted to these lower amounts through lower prices, and that what mattered was the change from 1929 to 1933.
- 4.
Data from www.measuringworth.com.
- 5.
Silber (2007) provides a detailed treatment of the episode and reaches a similar conclusion.
- 6.
George Bailey (Jimmy Stewart) might have considered this option in “It’s a Wonderful Life” rather than using the money Mary (Donna Reed) saved for their honeymoon.
- 7.
Homer Jones was Friedman’s professor at Rutgers University. Jones went on to head the research department of the St. Louis Federal Reserve which became known for its monetarist views.
- 8.
- 9.
The book that accompanied the television series, Friedman and Friedman (1980, 80–82), also gives a starring role to the failure of the Bank of United States.
- 10.
See Nelson (2013) for a broader discussion of the extent to which Friedman’s ideas about monetary and banking policy were implemented after the crisis in 2008.
- 11.
That said, the first version of the bailout bill that Paulson sent to Congress which was 840 words long, would have authorized $700 billion for buying toxic assets, and made the Secretary of the Treasury immune from oversight by the courts or Congress. The text of the proposal read, in part, “Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.” http://www.nytimes.com/2008/09/21/business/21draftcnd.html?_r=1.
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Rockoff, H. (2018). Milton Friedman and Anna J. Schwartz on the Inherent Instability of Fractional Reserve Banking. In: Rockoff, H., Suto, I. (eds) Coping with Financial Crises. Studies in Economic History. Springer, Singapore. https://doi.org/10.1007/978-981-10-6196-7_5
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