Crazy About the Fed

by Don Boudreaux on November 28, 2011

in Competition, Complexity & Emergence, Man of System, Monetary Policy, Myths and Fallacies

Here’s a letter to the New York Times:

Bill Keller reports that Glenn Hubbard – Columbia University economist and advisor to Mitt Romney’s campaign – proclaims that “Nobody who is taken seriously as an economist is going to say ‘cancel the Fed’”; such a notion, says Prof. Hubbard, is “just crazy” (“The Politics of Economics in the Age of Shouting,” Nov. 28).

To propose the abolition of central banking is indeed crazy today – just as, say, proposing the abolition of slavery was crazy in 1812, or proposing the abolition of military conscription was crazy in 1952.  The dominance of the unexamined premises of too many Right-thinking Serious people in the past suffocated practical efforts to fundamentally reform the way labor was supplied to plantation owners and, later, to the military.  Similar unexamined premises today suffocate practical efforts to fundamentally reform the way money is supplied to the economy.

As Prof. Hubbard surely knows, though, the case for central banking is hardly settled; it continues to be debated by serious scholars.  Prof. Hubbard also surely knows that the case for replacing central banking with a more decentralized, privatized, and competitive arrangement is real and rests on significant theoretical and historical research published in premier outlets and conducted by economists with impeccable scientific credentials – economists such as Kevin Dowd, Steve Horwitz, Benjamin Klein, Kurt Schuler, George Selgin, Richard Timberlake, Gordon Tullock, Lawrence H. White, Leland Yeager, as well as by the late F.A. Hayek and Vera Smith.

Sincerely,
Donald J. Boudreaux

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{ 118 comments }

geoih November 28, 2011 at 11:38 am

But without a central bank, how will the state continue to make something out of nothing?

Chris Bowyer November 28, 2011 at 1:20 pm

The key is to watch the Fed’s hands.

GAAPrulesIFRSdrools November 28, 2011 at 11:44 am

Nobody who wants to be taken seriously as an economist is going to Columbia -such a notion, says GAAPrules, is “just crazy”.

I liked Willard better when it was the title of a movie about a guy and his army of gnawing and chewing rats, rather than the name of a presidential candidate and his army of gnawing and chewing technocrats.

brotio November 28, 2011 at 6:50 pm

“Ben the two of us need look no more”…

:D

Ryan Vann November 28, 2011 at 11:53 am

This guy is a notorious insider; no surprise he’d be against the abolition of an institution he was under the employ of.

Seth November 28, 2011 at 11:57 am

Exactly. If they abolished it, he’d never get the chance to run it.

indianajim November 28, 2011 at 2:21 pm

I think you hit the nail on the head: Remember his video when Bernanke got in instead of him

http://mahalanobis.twoday.net/stories/1905672/

Methinks1776 November 28, 2011 at 2:30 pm

I love that video! Thanks for posting it for us to enjoy again. The lead singer reminds me of a nerdy version of the lead singer of Spandau Ballet.

indianajim November 28, 2011 at 2:44 pm

The lead singer IS Glenn Hubbard.

Ryan Vann November 28, 2011 at 2:37 pm

Classic

SaulOhio November 28, 2011 at 11:53 am

So on the subject of central banking, “the science is settled”?

Ryan Vann November 28, 2011 at 12:10 pm

Don’t be a denier; the science is IN!

Jon Murphy November 28, 2011 at 11:55 am

They say that, for every idea, there are 20 people who will reject it for no other reason than “That sounds crazy.” The trick is to find the 21st person who says “That’s just crazy enough to work!”

tw November 28, 2011 at 12:15 pm

I liked Glenn Hubbard much better when he played 2nd base for the Atlanta Braves…

Jon Murphy November 28, 2011 at 12:25 pm

Heh I like that.

Don Boudreaux November 28, 2011 at 1:10 pm

Yep. To this day when I hear the name “Glenn Hubbard” that squat, Yosemite-Sam-looking second baseman comes first to my mind!

Yosemite Sam November 28, 2011 at 1:46 pm

Bang, bang, Pow Pow. Listen up boy, I ain’t no ‘Lanta Brave.

brotio November 28, 2011 at 7:10 pm

I hate the Braves, but here goes, anyway:

ANY OF YOU LILY-LIVERED, REEBLEFLARKIN RASTIFRYKERS CARE TO SLAP LEATHER WITH ME? WELL IF’N YOU DO, MAYBE YOU BETTER KNOW WHO I AM!!!! I’M THE ROOTIN-EST, TOOTIN-EST, SHOOTIN-EST, MEANEST SECOND BASEMAN NORTH, SOUTH, EAST, AaaND WEST OF THE PECOS!!!!!!!!!!!!!!

Jon Murphy November 28, 2011 at 2:24 pm

I think Hubbard is now their 1st base coach.

Daniel Kuehn November 28, 2011 at 12:27 pm

Out of curiosity, how would you respond if someone noted that some of the ideas you’ve mocked over the years “rest on significant theoretical and historical research published in premier outlets and conducted by economists with impeccable scientific credentials“?

Josh S November 28, 2011 at 12:41 pm

I don’t think Don has ever said something like, “Nobody who is taken seriously as an economist is going to say ‘the government should try fiscal stimulus.’” Deriding Scotsmen who wear boxers under their kilts is quite different from saying that no true Scotsman wears boxers under his kilt.

Daniel Kuehn November 28, 2011 at 1:11 pm

He’s used those exact words in certain places (http://www.thefreemanonline.org/columns/the-return-of-keynesianism/), and implied it elsewhere.

Your defensiveness here is obscuring a pretty easy point. Either Don is arguing from authority here and not making a good argument against Hubbard, or he’s making a reasonable (though incomplete) argument against Hubbard here and it’s an argument that he should take into account in other things that he writes.

I opt for the latter, and I’ve never liked people that mock Austrians simply because their ideas sound a little outlandish – but don’t act as if Don hasn’t taken the exact same approach that Hubbard does.

tomharvey November 28, 2011 at 1:48 pm

[apologies for the misplaced duplicate post below]

Well, there is great imprecision in “taken seriously”, but when Don said (in the article you cite) “Economists before Keynes (at least, those who were taken seriously) rejected such ideas.”, he may have been broadly correct. If not, why isn’t it called “[the-name-of-the-guy-before-Keynes-who-WAS-taken-seriously]-ian Economics”?

Josh S November 28, 2011 at 3:26 pm

Those aren’t like examples. When Don points out that Keynes revived mercantilist ideas discarded by virtually all mainstream economists before him, he’s (as much as I can tell) correct. I mean, I don’t know of any economic histories that claims mercantilist ideas had much weight at all between Smith and Keynes. And in the article you link, he doesn’t argue from authority; he summarizes the reasons why mercantilism and consumptionism were discarded in the first place.

By contrast, when Hubbard claims that “no serious economist” gives the idea of abolishing central banks any weight, he is simply not correct. There are plenty of serious economists in serious economics departments at serious universities that write about alternatives to central banking and even alternatives to government-issued money.

Josh S November 28, 2011 at 3:26 pm

Also, note that the article you linked is about how many modern serious economists are rushing back to Keynes…

brotio November 28, 2011 at 7:24 pm

Come on, Daniel,

You constantly complain about the “disingenuous” label that Vidyohs tagged you with, and then you disingenuously link that article in order to insinuate that the pot is calling the kettle black. You’re far too literate to not have understood that link the same way that Josh S interpreted it.

F.A. Hayek from the Great Beyond November 28, 2011 at 1:48 pm

economists with impeccable scientific credentials“?

Since when do economists have scientific credentials?

Greg Webb November 28, 2011 at 1:02 pm

“Glenn Hubbard – Columbia University economist and advisor to Mitt Romney’s campaign – proclaims that “Nobody who is taken seriously as an economist is going to say ‘cancel the Fed’”; such a notion, says Prof. Hubbard, is ,just crazy.’”

Apparently, Professor Hubbard does not know enough about the subject to make a persuasive argument backed up with some objective, verifiable evidence. The burden of proof is on the person advocating for big government to prove that it’s Constitutional and, if so, why its a good idea. Professor Hubbard fails miserably to make his case.

W.E. Heasley November 28, 2011 at 1:18 pm

Greg Webb:

“Hubbard fails miserably to make his case”.

You are correct.

However, upon further review, Hubbard purposefully made no case by employing arguments without arguments.

Stated alternatively, “Nobody who is taken seriously as an economist is going to say ‘cancel the Fed’”; such a notion, says Prof. Hubbard, is “just crazy.” is a purposeful use of a combination of:

(1) the complex complex,

(2) all or nothing,

(3) shifting view point,

(4) general proclamations.

Hubbard merely and purposely answers with debate tactics rather than evidence.

Invisible Backhand November 28, 2011 at 1:40 pm

Yep.

Greg Webb November 28, 2011 at 1:49 pm

That was my point exactly, W. E. Healey. He may be able to make a proper argument, but he chose not to. I hope he decides to make a persuasive argument that the Fed is Constitutional and is a good idea.

Nikolai Luzhin, Eastern Promises November 28, 2011 at 1:31 pm

Webb no “objective, verifiable evidence” exists for anything you have ever written here.

Hubbard didn’t write this piece, so he has no reason to give his evidence.

Where does this wack job stuff like, a “person advocating for big government [has to prove} that it’s Constitutional come from.” No such requirement exists. The law is to the opposite: laws are presumed constitutional.

Jon Murphy November 28, 2011 at 1:37 pm

“[has to prove} that it’s Constitutional come from.” No such requirement exists. The law is to the opposite: laws are presumed constitutional.”

Actually, that’s incorrect. As of the beginning of 2010, all laws must cite what article, section, and line of the Constitution justifies the Federal Government’s legislation.

Also, laws are not presumed constitutional. That’s why we have a court system to decide their constitutionality. Judges can put an injucture or strike down a law, juries can refuse to uphold the law, and enforcers can refuse to enforce the law if they believe it is unconstitutional. In fact, laws are presumed unconstitutional. When a law is challenged in the Federal Court of Appeals, the authors of the law must defend its constitutionality to the Bench, not vice-versa.

Invisible Backhand November 28, 2011 at 1:44 pm

Jon, that’s exactly right. And the “is it Constitutional” requirement is Constitutional as wisely noted by the Supreme Court in its decision in Marbury v Madison in 1803.

Greg Webb November 28, 2011 at 1:46 pm

That is correct, IB. So you are smarter than little Nikki Luzha!

Nikolai Luzhin, Eastern Promises November 28, 2011 at 6:29 pm

Jon

You want to bet your right hand on this false statement? You have no restraints and lie about the most simple of propositions.

You write, “When a law is challenged in the Federal Court of Appeals, the authors of the law must defend its constitutionality to the Bench, not vice-versa.”

This is a lie. Federal statutes are presumed constitutional.

United States v. Carolene Products Co., 304 US 144 – Supreme Court 1938:

“We see no persuasive reason for departing from that ruling here, where the Fifth Amendment is concerned; and since none is suggested, we might rest decision wholly on the presumption of constitutionality.”

Go spend, for you, a life time running Munn v. Illinois, 94 US 113 – Supreme Court 1877 through Google Scholar

Jon Murphy November 28, 2011 at 6:38 pm

*facepalm*

It may help to read the entire opinion as opposed to one sentence in it. The entire opinion goes on to say that a law, “while legislation appears on its face to be within a specific prohibition of the Constitution” is constitutional if supported by another area or amendment of the Constitution. In other words, a law cannot be presumed unconstitutional if another aspect of the Constitution finds it constitutional (and vice versa).

Jon Murphy November 28, 2011 at 6:38 pm

Footnote 4.

Greg Webb November 28, 2011 at 6:40 pm

Swing and a miss!

It’s called Judicial Review.

Marbury v. Madison, 5 U.S. (1 Cranch) 137 (1803) is a landmark case in United States law and in the history of law worldwide. It formed the basis for the exercise of judicial review in the United States under Article III of the Constitution. It was also the first time in Western history a court invalidated a law by declaring it “unconstitutional”, a process called judicial review.[1][2] The landmark decision helped define the “checks and balances” of the American form of government.

The case that you cite is one where the constitutionality of the law is not called into question ( “since none is suggested”) during the original trial.

GiT November 28, 2011 at 11:38 pm

Actually, in a comparative sense laws are presumed constitutional.

Yes, there is judicial review, but judicial review only comes in to effect if a law is challenged within a court case. The judiciary can’t challenge the constitutionality of a law until it comes under their purview.

Laws may now have to cite their basis, but that can’t be challenged until after a law goes into effect.

In some other constitutional systems (like with France’s Constitutional Council), the judiciary reviews legislation prior to that legislation’s execution, and so prior to any suit being brought to the judiciary. That is to say that the law is vetted before it goes into effect.

Greg Webb November 30, 2011 at 12:07 am

*facepalm*

Thanks for the useless, irrelevant dicta. Congress will not approve bills that are thought to be unconstitutional, the Preident will veto a bill he deems unconstitutional, and the courts may rule a law unconstitutional. Groups have been formed to challenge any law deemed unconstitutional. These are all recent developments. Look for this activity to increase as the people’s understanding of the Constitution, and it’s limits on government power, grow.

GiT November 30, 2011 at 11:46 pm

*Facepalm*

If Congress will not approve bills ‘that are thought to be unconstitutional,’ then all laws that congress passes are, by logical consequence, ‘not thought to be unconstitutional,’ which is to say they are ‘thought to be constitutional.’

Similarly, if a President will veto a bill he deems unconstitutional, then bills that become law were not ‘deemed unconstitutional,’ which is to say they were ‘deemed constitutional.’

Both of those are just another way of saying they were presumed to be constitutional.

Now, groups can challenge a bill’s presumed constitutionality all that they are able when it is being considered, but a bill is not a law.

Further, if all of these are ‘recent’ developments, then it is simply not the case that the President, Congress, or ‘groups’ always challenged the constitutionality of a bill prior to its enactment into law, and as such it would, logically, be the case that before ‘recently,’ bills were passed into law which were thought to be unconstitutional.

Laws are only ruled constitutional or unconstitutional (as opposed to being ‘thought to be,’ ‘deemed,’ or ‘presumed’ to be so) by the judiciary. The office of legislative council, public opinion, or the opinion of congressional staffers is not sovereign. (Unless, of course, we’re talking about a constitutional amendment.)

You should really try to actually understand what you yourself write before hitting the ‘reply’ button. It would save me the time of having to explain to you what your own words mean.

In any case, my point stands. In some constitutional systems, laws go from the legislature to the judiciary to the executive. In the US they go from the legislature to the executive to, potentially, the judiciary. Being executed before being judicially reviewed evidences the fact that constitutionality is presumed before it is definitively decided upon (even if the burden of proof, once a law is called into question, is on proving that it is constitutional).

Krishnan November 28, 2011 at 1:06 pm

If you listen to the latest podcast (Russ with Simom Johnson) you may indeed conclude that it does make sense to eliminate the Fed – They have, using their unlimited powers rewarded their friends/cronies – not allowed creditors to take the risk but allowed them to get rewarded … there is some terrific discussion about Lehman and Bears Stearns and Citi (what Prince did) and JP Morgan …

What Goldman Sachs did in 1991 to change a few lines in a financial legislation is very telling – They anticipated the day when “investment banks” would be in trouble and so paved the way for them to be able to go feed at the Fed’s trough (i.e. taxpayers).

There is indeed agreement between the Occupy Wall Street people and the Tea Party when it comes to “financial regulation” – those that are “regulated” actually take OVER the regulators and do whatever (almost whatever) they want – and send the bill to taxpayers when they lose.

Nikolai Luzhin, Eastern Promises November 28, 2011 at 1:17 pm

send the bill to taxpayers when they lose

and, if we don’t regulate them properly, the bill will be even bigger

SaulOhio November 28, 2011 at 1:35 pm

If the bill isn’t sent to the taxpayers, how can it get bigger?

If the losers have to pay for it, they will have less to lose next time, and will be more careful.

Double bonus: Smaller bill, and the taxpayers don’t have to pay it.

Nikolai Luzhin, Eastern Promises November 28, 2011 at 6:30 pm

If the losers have to pay for it, they will have less to lose next time, and will be more careful.

And, idiot, what will you pay this time?

Nikolai Luzhin, Eastern Promises November 28, 2011 at 1:20 pm

What Goldman Sachs did in 1991 to change a few lines in a financial legislation is very telling – They anticipated the day when “investment banks” would be in trouble

Dear god, we have someone anticipate the need for effective government.

And, if the legislation had not been passed, how much further damage would have been done to taxpayers, when the music stopped?

Steve Horwitz November 28, 2011 at 1:08 pm

Well Glenn, you’re going to have to tell me who really is the crazy one.

After all, the Journal of Economic Literature, which is one of the AEA’s flagship journals, published an entire literature review by Selgin and White in December of 1994 exploring the question “How Would the Invisible Hand Handle Money?” So does this mean that the leadership of the AEA and the editors of the JEL are crazy too for even entertaining this idea?

Nikolai Luzhin, Eastern Promises November 28, 2011 at 1:18 pm

abolishing the fed makers less sense than taking seat belts out of cars and trucks

Nikolai Luzhin, Western Provinces November 28, 2011 at 1:34 pm

If there were spikes on steering wheels, and cars looked just as unsafe as they really are, would collisions drop? Collision rates? Fatality rates? Unarguably yes.

Q- what is the single greatest fatality risk an average American makes on a daily basis?

A- Changing lanes while traveling between fifty and seventy miles
per hour.

Moral hazard: “I’m safe because I’m a licensed and insured driver in a safe car. They wouldn’t let me do it if it was dangerous. Government power emerges from history and car crashes are history”

Jon Murphy November 28, 2011 at 1:40 pm

“Moral hazard: “I’m safe because I’m a licensed and insured driver in a safe car. They wouldn’t let me do it if it was dangerous.”

That’s not the moral hazard. The moral hazard is “This car is insured, so if I get into an accident, I will not bare the entire financial burden so I don’t have to drive as safe as if I were uninsured.”

http://en.wikipedia.org/wiki/Moral_hazard

F.A. Hayek from the Great Beyond November 28, 2011 at 1:57 pm

he moral hazard is “This car is insured, so if I get into an accident, I will not bare the entire financial burden so I don’t have to drive as safe as if I were uninsured.”

Actually Jon, that’s “morale” hazard. Moral hazard, in risk management is actually INTENTIONAL acts to obtain indemnification, as opposed to reduced vigilance due to insulation from loss.

Of course, most recent literature lumps all behavioral changes under “moral hazard”, perhaps because the line between gross negligence and intentional acts is rather indistinct.

Jon Murphy November 28, 2011 at 2:01 pm

” Moral hazard, in risk management is actually INTENTIONAL acts to obtain indemnification, as opposed to reduced vigilance due to insulation from loss.”

They are one and the same. Moral hazard is “a situation in which a party makes a decision about how much risk to take, while another party bears the costs if things go badly, and the party insulated from risk behaves differently from how it would if it were fully exposed to the risk.”

Nikolai Luzhin, Eastern Promises November 28, 2011 at 6:32 pm

Nikolai Luzhin, Western Provinces

truth hurts, you idiot

what you write has nothing to do with anything

Dan J November 28, 2011 at 10:05 pm

You bring nothing of substance to discussions. I will read Daniel Kuehn’s arguments, as they often have substance and interesting debate. IB and Nik bring zero of interest.

EG November 28, 2011 at 1:37 pm

The point of the article was about the “shouting”.

There’s arguments to be made on all you said there Don, but a lot of those arguments, if not all of them, have 2 central weaknesses: 1) they fail to describe the realistic costs of changing the system and 2) they fail to explain exactly how they control for the weaknesses of the current Fed, any better than some other alternative that keeps the Fed in place (ie, what you get is something that kind of looks like the fed anyway, and has similar inherent weaknesses…and there are other alternatives with equal benefits which don’t necessitate ending the Fed)

Second, we confuse making an academic argument of alternatives to the Fed, and making a POLICY argument to be implemented when XYZ (Ron Paul) becomes President. The two can be worlds apart. To hypothesize how something would work, is different than to want to make it happen…today!

tomharvey November 28, 2011 at 1:44 pm

Well, there is great imprecision in “taken seriously”, but when Don said (in the article you cite) “Economists before Keynes (at least, those who were taken seriously) rejected such ideas.”, he may have been broadly correct. If not, why isn’t it called “[the-name-of-the-guy-before-Keynes-who-WAS-taken-seriously]-ian Economics”?

Sam Grove November 28, 2011 at 2:50 pm

“Nobody who is taken seriously as an economist is going to say ‘cancel the Fed’”

What he is really saying is: “we” should not take seriously anyone proposing to do away with the Fed, that way we do not have to address their arguments or critiques, or, indeed, give any thought to them at all.

Greg Webb November 28, 2011 at 2:55 pm

Excellent analysis, Sam!

Sam Grove November 28, 2011 at 9:55 pm

This is the same dismissal attempted by Daniel and others against libertarian thought.

“They aren’t serious, so we don’t have to examine their ideas or defend our own.”

Pingry November 28, 2011 at 2:59 pm

This is the same George Selgin, by the way, who doesn’t believe in Diamond-Dybvig. I know because I asked him here, at Cafe Hayek, and he said told me so in no uncertain terms.

So, how’s that working out? We just had a major run on the shadow banking sector which quite clearly shows that Diamond-Dybvig banking institutions are prone to runs. Far from pillars of stability, banking institutions with no deposit insurance, no regulation and no lender of last resort are actually prone to instability.

This is a big reason why the economists which Don lists in yet another unpublished LTE are not taken seriously.

I suggest having Douglas Diamond and/or Philip Dybvig on EconTalk to chat about the epic failures free banking.

–Pingry

Jon Murphy November 28, 2011 at 3:04 pm

“Far from pillars of stability, banking institutions with no deposit insurance, no regulation and no lender of last resort are actually prone to instability.”

So are banks that are regulated, have financial insurance, and lenders of last resort (see the most recent crises and the S&L crisis of the 80′s). What’s your point?

The only difference I see here is one costs a shiton of money and is rife with perverse incentives, the other is not.

Pingry November 28, 2011 at 3:13 pm

And you really think that collapsing banks doesn’t cost a “shiton” of money?

Um, hello, we had the Great Depression in which banks collapsed left and right! I’d argue that with 25% unemployment, that was extremely costly to society in every way. And the loss of tax receipts due to a massive contraction is extremely costly.

I’m not arguing that regulations, deposit insurance and a lender of last resort facility are perfect, but I am saying that they are far superior to free banking.

–Pingry

Jon Murphy November 28, 2011 at 3:36 pm

To bail out these banks, we spent nearly $1T. Taxpayer money. That would not have happened otherwise.

Ryan Vann November 28, 2011 at 5:14 pm

1T is just tarp. Total government guarantees and other programs put the number nearer to 16T.

Nikolai Luzhin, Eastern Promises November 28, 2011 at 6:34 pm

Jon

you are a lying idiot

we did not bail out the banks

their shareholders have taken enough of a loss to satisfy any demand for moral hazard.

we bailed ourselves out from the damage we would have sustained, if we did not have banks

Greg Webb November 28, 2011 at 6:43 pm

Swing and another miss!

The US Treasury Department bailed out investment banks, commercial banks, AIG (which indirectly bailed out Goldman Sachs), GM, and Chrysler. Where have you been, Lusha?

Greg Webb November 28, 2011 at 5:53 pm

Pingry, how does a bank insolvency and management by a bankruptcy court cause unemployment?

Nikolai Luzhin, Eastern Promises November 28, 2011 at 9:02 pm

Greg Webb

you are a literal idiot

we bailed out ourselves

if these firms had been allowed to fail we would have all had personal losses that far exceeded what federal funds were (mostly) loaned to these businesses.

we did not bailout the shareholders in such firms, all of whom lost almost all of their investment, so why you keep acting like we did?

Jon Murphy November 28, 2011 at 9:10 pm

Isn’t the argument the OWS people (and yourself) make is that the banks got bailed out and we didn’t? Are you now recanting your testimony? Or are you saying banks and corporations are people, too?

Greg Webb November 28, 2011 at 11:05 pm

Jon, the Luzha is just rambling incoherently again.

vikingvista November 29, 2011 at 10:39 am

Exactly. Bankruptcy is merely a predetermined method of ownership transfer. It there is something inefficient about this method, then it is all the more important to allow it to happen whenever possible, so that future lenders can innovate more efficient procedures. Bailouts to bailout employees or customers or the economy. They bailout the bad decision makers, encouraging them to continue making bad decisions.

Josh S November 28, 2011 at 6:22 pm

Where are you getting this idea that the USA had a free banking system in 1929? The Federal Reserve Act was passed in 1913, not 1933.

Dan J November 28, 2011 at 10:10 pm

I’m not arguing that regulations, deposit insurance and a lender of last resort facility are perfect, but I am saying that they are far superior to free banking-pingry

You could be correct in assuming these ‘safeguards’ are needed when assuming that GOVT will meddle with the market, creating distortions. Also, in assuming that GOVT officials will practice crony capitalism and corruption, then indeed, those ‘safeguards’ are required.

George Selgin November 28, 2011 at 3:48 pm

Even Pingry ought to be able to do better than this: to suggest that I must not take recent financial failures seriously because I fail to “believe in” Diamond and Dybvig’s particular formal treatment of bank runs is perfectly ludicrous. As a matter of fact, it is precisely owing to the fact that “Diamond-Dybvig banking institutions” have nothing in common either with ordinary deposit banks or with the “shadow banks” at the center of the recent crisis that I have little use for their model or its implications. That Pingry imagines otherwise suggests that he’s never actually worked through D-D, which is to say, that he knows as much about their model as he seems to know about free banking.

Those wishing to appreciate the many crucial respects in which “Diamond-Dybvig banking institutions” do not resemble real-world banks are encouraged to read Kevin Dowd’s excellent survey “Models of Banking Instability” and my own paper “In Defense of Bank Suspension”. Just to give you some indications: D-D “banks” (1) have no capital; (2) dispense real goods (and are the only source of such in the economy); (3) are run as quasi-mutuals, with period-2 withdrawers treated not as creditors but as residual claimants. Did I mention that there’s only one “bank” in the model, so that a run (“bad” equilibrium) on the one bank=systemic crisis? And them’s just for starters.

I also marvel at Pingry’s claim that “shadow” banks lacked the support of any LOLR. That’s mistaking the one exception (Lehman) for the rule! But what can one expect from someone who evidently can’t appreciate the difference between Goldman Sachs ca. 2008 and the Royal Bank of Scotland ca. 1820?

SaulOhio November 28, 2011 at 3:49 pm

I’m not sure what it signifies to this discussion to compare Diamond-Dybvig banks to the rest of the economy, when they are just as prone to inflationary pressures from the Fed. A central bank floods the economy with a lot of money and brings down interest rates, ALL institutions that lend money are affected the same way.

SaulOhio November 28, 2011 at 3:52 pm

In fact, it seems to indicate to me that the regulations, including deposit insurance and lender of last resort make no difference, and the banks that have them experience the same bubble mania behavior as the less regulated banks.

Sam Grove November 28, 2011 at 9:40 pm

Is it wise to put all our monetary eggs in one basket (a lender of last resort)?

What happens when that lender goes under?

vikingvista November 29, 2011 at 12:46 am

If ever allowed to, unstable banking models would disappear and stable ones prevail–by definition of “stable” and “unstable”. Instead, regulations relieve the market of its creative destruction function, by protecting them from the consequences of unstable practices.

F.A. Hayek from the Great Beyond November 28, 2011 at 3:53 pm

@Jon Murphy

“They are one and the same.”

Jon, they most definitely are not the same. There’s a reason for the distinction. Maybe in an academic setting, the distinction doesn’t matter, but in the world of risk management, it’s very important.

Its pretty easy to understand and prevent payment on losses causes by intentional acts (arson), even to anticipate the conditions that will increase in occurrence.

On the the other hand its much more difficult to anticipate how an insured loses ordinary diligence because while there are clear acts of negligence others are so insidious that the person may not even realize how they are relaxing their behavior and letting down their guard.

Sorry to burst your bubble, but unless you have some insurance background, you don’t understand.

Jon Murphy November 28, 2011 at 4:16 pm

I didn’t know Hayek was an insurance salesman.

But I am afraid I still don’t see the difference between the two. It seems to me one may cause the other: if one lets down his guard against arson (to use your example) because his property is now insured, is that not moral hazard?

Am I missing something?

F.A. Hayek from the Great Beyond November 28, 2011 at 9:51 pm

Yes, you are missing it.

The presence of insurance causes the existence of two separate classes of hazards, moral and morale.

Moral hazard comes into play when the insured INTENTIONALLY torches their own house or claim losses on overvalued nonexistent assets. If you think of insurance as a conditional put, anytime there’s a significant spread between the insured’s value and the strike price-there’s an inducement to creating the condition. It’s invariably a criminal act and for that reason, plus laws against profiting from such a fraud, the controls are after-the-fact although if there’s falling property values, loss managers tend to be more suspicious. Its also why the industry spends so much money to create an awareness that its criminal. Nothing is immune. In the 1930′s unemployed people struggling while FDR screwed around committed suicide to obtain payment for beneficiaries.

With morale hazard, you fail to exercise diligence. Now typically, nobody is not going to make every effort against another’s arson, since you still have your life-which you value- at risk. Usually, morale hazard in the homeowner’s market is very subtle, such as failing to make repairs that would prevent greater loss or buying a shorter and cheaper fence than you might if you were responsible for liability losses. There is no intent to create the loss and these hazards are why your policy has a ton of due diligence requirements.

In property and casualty insurance-the hazards operate differently, and create different liabilities, which is why the distinction is important.

When dealing with losses by financial institutions,the distinction may not be so important, because there’s really no such thing as “criminal malinvestment” and you’d have to be a mind reader to know whether somebody intentionally incurred a loss in pursuit of a profit or merely tolerated them.

Dan J November 28, 2011 at 10:22 pm

Care to cite a source, widely accepted, that backs your differentiated definitions ? I only ask, because I give Thomas Sowell opinions much weight, and while typos are likely in books or columns, he references ‘moral hazards’ often. And, he depicts ‘moral hazards’ as the steps not taken by an individual due to some assumed risk by others.

Dan J November 28, 2011 at 10:23 pm

Example: seat belts and car insurance

Jon Murphy November 28, 2011 at 10:27 pm

I see what you are saying, but you are actually confusing something.

The first situation you describe is adverse selection. The insurance company failed to do due diligence in selecting this insuree.

The second situation is moral hazard.

Frankly, I have no clue where you are getting “morale hazard” from. None of this effects morale and I’ve never heard that term used before this moment.

GAAPrulesIFRSdrools November 28, 2011 at 11:23 pm

Jon: No, I’m not Hayek, I was messing around with a second pseudonym, just to see what its like to be Muirbot or Invincible Ignorance.

Now a little more about me:

Over ten years in the insurance industry, Chartered Life Underwriter, Chartered Financial Consultant, Master Fellow, Life Management Institute. MBA, CPA

Your credentials?

“The first situation you describe is adverse selection. ”

Wrong. Adverse selection is the result of asymmetric knowledge, undiscoverable or excessively costly to determine in underwriting-it’s why there’s different mortality rates for life insurance and annuities-life insurers do their diligence, but you betray/signal your superior knowledge in product selection.

“Frankly, I have no clue where you are getting “morale hazard” from. None of this effects morale and I’ve never heard that term used before this moment.”

I know you don’t. But then again the whole point of reading Hayek is to be reminded of how little you know, especially when you think things outside your knowledge don’t exist. (I’ll bet NN Taleb would roll over laughing,reading that bit you wrote)

Maybe someday, I’ll dig out my old textbooks to give you a quote, but not now. For now, young wannabe, you’ll just have to accept that every once in a while, youthful exuberance will get you into a tussle you aren’t equipped to wage. This is one of those times.

GAAPrulesIFRSdrools November 28, 2011 at 11:33 pm

Oh I can’t just leave you hanging:

Here you go:

http://www.irmi.com/online/insurance-glossary/terms/m/morale-hazard.aspx

Ben F. November 28, 2011 at 4:40 pm

Professor Boudreaux (or any knowledgeable commentators),

Where has the case for central banking been made? I’m doing research for a book and any additional sources would be extremely helpful.

Jon Murphy November 28, 2011 at 4:49 pm

Do you mean economic justification for a central banking system or the expansion of the role of the central bank in the recent crisis?

Jon Murphy November 28, 2011 at 4:59 pm

If you are looking for something on the origins of the central bank in the US, as well as economic justification of it’s role during the crisis, I’d suggest Frederic Mishkin’s rather excellent textbook “The Economics of Money, Banking, & Financial Markets, specifically Chapter 12.

George Selgin November 28, 2011 at 10:17 pm

Mishkin’s book has its merits–but a satisfactory explanation of the Fed’s origins isn’t one of them. For that have a look, for starters, at Elmus Wicker’s various books (all of which are very informative if nonetheless “pro” Fed) and at the relevant chapters in Vera Smith’s Rationale of central Banking.

GAAPrulesIFRSdrools November 28, 2011 at 11:27 pm

Dr Selgin:

Sounds like a good topic for another Econtalk (hint, hint)

Nikolai Luzhin, Eastern Promises November 28, 2011 at 6:37 pm

what for Newt or Cain to sell next year

I love the new description of Cain, Newt, Bachman, et al. Using the Sarah Palin business model to sell books and t-shirts to conservatives

GAAPrulesIFRSdrools November 28, 2011 at 11:28 pm

Nobody beats the ChiaObama

Adam Smith November 29, 2011 at 11:05 am

OH YEAH!

Lawrence H. White November 28, 2011 at 9:33 pm

The arguments made pro and con, at the time central banks were established, are well summarized in Vera Smith’s The Rationale of Central Banking. For a more recent argument pro, see Charles Goodhart, The Evolution of Central Banks.

Ben F. November 28, 2011 at 9:56 pm

Thanks a lot, Professor White. One thing I’ve been doing is going through the archives of the major English-language economics journals looking for any and all articles about central banking. Is that likely to be an effective strategy, or should I stick to books like the ones you mentioned?

Lawrence H. White November 29, 2011 at 4:11 pm

Your strategy might find some arguments not discussed by Smith, especially around the dates of the founding of central banks (Fed 1913, Bank of Canada 1935, etc.). It seems unlikely to yield much once central banking came to be taken for granted.

Ben F. November 28, 2011 at 8:37 pm

I’m looking for intellectual arguments from economists, philosophers, etc. for the desirability of a central bank. The problem is, it’s an old and powerful institution, so a lot of thinkers supported it because that’s just how things were. Adam Smith, for example, merely asserts its desirability. It’s easier to find arguments against the central bank because arguments against the central bank actually had to be made.

Politicians made arguments on both sides, but I’m looking for something meatier than what is essentially a sales pitch.

Jon Murphy November 28, 2011 at 8:48 pm

I know you said no politicians, but there is Ron Paul’s End the Fed, which does have some sound economic reasoning behind it.

There is FA Hayek’s “A Free-Market Monetary System” (free e-book here: http://mises.org/books/monetarysystem.pdf).

The Mises Institute has lots of free publications on this topic by both living and dead, well-known and respected economists (www.mises.org).

Ludwig von Mises’ short essay A Critique of Interventionism, while not directly addressing this issue, provides background and may be worth your time.

Milton Friedman’s Capitalism and Freedom, specifically Chapter III, is a good source. While not strictly anti-central bank, it provides an alternative from the current system.

Those are just a couple off the top of my head for anti-central bank arguments.

Jon Murphy November 28, 2011 at 8:51 pm

Just a word of warning, Hayek is good, but his language can be cumbersome at times. It’s not something you can skim.

Ben F. November 28, 2011 at 9:02 pm

Thanks, Jon. Other organizations could learn a lot from the Mises Institute’s approach to accessibility of material.

Jon Murphy November 28, 2011 at 9:07 pm

I agree. But they also have a lot of pay-per-view material, too. But they are a publisher as well as an institute, so it’s the advantage of owning the material.

I hope that helps. One of their economists, Robert P. Murphy (no relation), have some good talks on the subject, too.

Nikolai Luzhin, Eastern Promises November 28, 2011 at 9:03 pm

Ben F.

some truths are self evident

Ben F. November 28, 2011 at 9:05 pm

So Adam Smith thought, which is a shame, because I would have liked an argument from him. He’s normally so empirical.

Lawrence H. White November 28, 2011 at 9:35 pm

Adam Smith did not endorse central banking. There wasn’t any in his day to endorse. He did call the Bank of England “a great engine of the state,” but I don’t read that as an endorsement. He argued in favor of Scotland’s (free) banking system, which had no central bank.

Ben F. November 28, 2011 at 9:54 pm

I could have sworn I remember a passage in the Wealth of Nations where Smith talks about the obvious necessity of a state-privileged bank of some kind. It stood out for me because Smith didn’t offer any support for it beyond historical wisdom, which is unusual for Smith. Does that sound in any way familiar, or am I hallucinating? It has been a while since I read it….

That would really be disappointing, too, because that passage started my current research. I would really be embarrassed to be wrong about this.

Ben F. November 28, 2011 at 10:00 pm

And I recently lost my notes for that book because someone stole my copy….

George Selgin November 28, 2011 at 10:21 pm

The closest thing is the “pass” Smith gives to the BofE as not being a monopoly: he clearly did not appreciate how its at first relatively minor privileges would eventually accumulate in such a manner as would secure for it a complete monopoly of England’s paper money. But while Smith overlooked the anti-competitive implications of the Bank of England’s charter, he never made any positive defense of its unique privileges, let alone a defense of central banking.

Ben F. November 28, 2011 at 10:33 pm

Argh, I definitely need to reread the section on money. But thanks for clarifying things (and to Nicolas, below), and for commenting on Jon’s suggestions above. Until now I’ve been looking primarily through economic articles in top journals for an understanding of the discussion between economists about the central bank. Are books definitely a better source?

Nicolas Cachanosky November 28, 2011 at 10:13 pm

After discussing general aspects, and benefits, related to free banking (starting in p. 292), Smith says the following:

“An operation of this kind has, within these five-and-twenty or thirty years, been performed in Scotland, by the erection of new banking companies in almost every considerable town, and even in some country villages. The effects of it have been precisely those above described. The business of the country is almost entirely carried on by means of the paper of those different banking companies, with which purchases and payments of all kinds are commonly made. Silver very seldom appears except in the change of a twenty shillings bank note, and gold still seldomer. But though the conduct of all those different companies has not been unexceptionable, and has accordingly required an act of parliament to regulate it; the country,notwithstanding, has evidently derived great benefit from their trade. [...] That the trade and industry of Scotland, however, have increased very considerably during this period, and that the banks have contributed a good deal to this increase, cannot be doubted.”
(Wealth of Nations, Vol. I, Book II, Chapter II, p. 297).

Adam Smith November 28, 2011 at 8:39 pm

Let’s be honest about this Fed guy. He is the primum malum. He’s a holocaustic-party planner, an travel agent to locust swarms of carpet baggers, and a shepherd of zombie lawyer buzzard flocks who enforce endless starvation pogroms on a worldwide basis and aspire to gnaw on the bones of every man, woman, and child.
Feddy Kruger got us marching to kill 80% of the Natives who once lived in America, who then worked for us, and who finally ended up heaped into piles and burned in a grand barbecue pyre. We augmented the filet mignon of the industrial revolution with the wasteful flesh of passenger pigeons, buffalo, and godless hunter-gathers in a Thanksgiving Feast at the many Fort Christmas Cannibal Huts founded by Bartholemew Columbus.
Uncle Feddy unleashed generals able to burn a 60 mile swath from Atlanta to the sea and kill 11% of the Southern population and then raise taxes by 1500% on the remainder who toiled during reconstruction. For our barmitzvah he paid for the world war celebration wherein 95 million died, 4% of the world population.
Freedom and free exchange are gone with the wind. Are we all simple minded field slaves, home and office servants, unable to comprehend or articulate the endless deceptions and injustices?
Are we infantile materialist Scarletts, wrongheaded and unable to see the true beneficial nature of the people we live and interact with and of our bettors?
Are we nihilistic raging Rhetts, inaccurately assigning blame to our family and blind to the benefits of voluntary exchanges from men of differing abilities and circumstances?
It is a succession of dementias that mark our 518 years in this new world of plenty. There is no scarcity, only a blind belief in bully pulpiteers who traffic in want. There are mainly good people that surround us, only a small few of whom must be restrained and retaliated against for their aggressions and unjust initiations of force.
It’s not crazy at all once you self-innoculate to the font of lies from Uncle Sam, John Bull, Marianne, and all the rest of the looney lefties and rapacious righties.

Dan J November 28, 2011 at 10:27 pm

You sure have a way with adjectives…..

Dan J November 28, 2011 at 10:31 pm

Rapacious

The Federalist….. First time I happened upon that word. I believe it’s in the first 20 letters.

vidyohs November 29, 2011 at 6:12 am

And since he connected the term just to the right makes me wonder if he actually knows what the word means.

Appears to me that it can be connected to the left just as easily. The looney left doesn’t want all of your dollars…..just the next one.

Adam Smith November 29, 2011 at 10:57 am

I use it in the way of Misha Glenny of the Financial Times’ article: “The real Greek tragedy – its rapacious oligarchs”

http://www.ted.com/speakers/misha_glenny.html

Thank you for your reply. It may be that all my writings are a variation of the stolen concept. Don, Russ, and the commentors here are great people. Why not demand they be even greater? Voila! I’m a genius. Cheers.

Westie November 29, 2011 at 9:07 am

When the time arrives, add my vote for the ejection of the increasingly idiot-pathic commentary of Nikolai Luzhin, Western Provinces from this excellent site.

chad November 29, 2011 at 1:27 pm

Please add Murray Rothbard to the mix. His work was more essential than any named in the post.

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