Money, Banks and Finance in Economic Thought

The Reissue of the banking controversy in the modern Austrian School

Martinez Ignacio, Universidad de Sevilla
Garcia Flores Victor, UNIVERSIDAD DE SEVILLA
Palma Martos Luis, UNIVERSIDAD DE SEVILLA

In recent years we have witnessed a bitter debate within the Austrian School of Economics between those who defend a banking system with a 100% deposits coverage and those who advocate for a free banking system. This situation is reminiscent of the one lived in England in the first half of the 19th century between the Currency School and the Banking School. In this reedition of the debate we can identify the defenders of a strong banking regulation, embodied in the followers of authors as Rothbard or Huerta de Soto, as well as the defenders of a free banking system assembled as the “New Banking School”. The scientific production from both sides has been fruitful but nevertheless the debate gravitates mostly in legal and philosophical terms more than in a political economy framework, what risk the outcome of this debate for the progress of the discipline to explain the boom-bust business cycle induced by the banking system. The risk is largely due, as it happened in the debate that preceded the promulgation of the Peel’s Bank Act in 1844, to the essential problems of identification and dynamic process in banks’ performance. Therefore, and to offer an answer to this controversy, we consider the following questions: how do the intertemporal coordination mechanisms behave under the different frameworks proposed? and, Are both analysis mutually exclusive? Given that both positions are based on a model of intertemporal imbalance of production, we can affirm that their behavior is analogous in tendency, although it differs in its diffusion process. In response to the second question, through the analysis of how the fractional reserve and maturity mismatches impact the interest rates, we show that the difference between these practices is a matter of degree and not of category, meaning that the fractional reserve system represents the most extreme case of the intertemporal mismatch between saving and investment.

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Keywords: Fractional reserve banking, credit expansion, bank reform, maturity mismatching, business cycle.

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