Macroeconomic stability in a free banking system

David VanHoose

Atlantic Economic Journal, 1997, vol. 25, issue 4, 343 pages

Abstract: This paper uses a simple general equilibrium banking model to examine how permitting banks to issue notes might affect macroeconomic stability. Adding banknotes to the menu of available liabilities alters the interest sensitivities of bank security and deposit choices. This changes the slope of the economy's LM schedule and the magnitude of its displacement in the face of financial market disturbances. However, the theoretical directions of these changes that free banking would induce are ambiguous. While empirical evidence permits some speculation that free banking actually could reduce stability in the face of expenditure (IS) shocks, the key point of this paper is that any theoretical case favoring free banking cannot rest on an argument that free banking unambiguously would stabilize equilibrium nominal income. Copyright International Atlantic Economic Society 1997

Date: 1997
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DOI: 10.1007/BF02298344

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