The Uneasy Case for Fractional- Reserve Free Banking


  • Ludwig van den Hauwe Ph. D. of the Université Paris-Dauphine.



Since a few decades several sub-disciplines within economics have witnessed a reorientation towards institutional analysis. This development has in particular also affected the fields of macroeconomics and monetary theory where it has led to several proposals for far-reaching financial and monetary reform. One of the more successful of these proposals advocates a fractional-reserve free banking system, that is, a system with no central bank, but with permission for the banks to operate with a fractional reserve. This article exposes several conceptual flaws in this proposal. In particular several claims of the fractional-reserve free bankers with respect to the purported working characteristics of this system are criticized from the perspective of economic theory. In particular, the claim that a fractional-reserve free banking system would lead to the disappearance of the business cycle is recognized as false. Furthermore an invisible-hand analysis is performed, reinforcing the conclusion that fractional-reserve free banking is incompatible with the ethical and juridical principles underlying a free society.

Key words: monetary and banking regimes, comparative institutional analysis, fractional-reserve free banking, business cycle, invisible hand.

Clasificación JEL: B53, E32, E42, E5, G18, H11, K39, P3, P34

Resumen: Desde hace algunas décadas varias subdisciplinas de la economía se ven reorientadas hacia el análisis institucional. Este desarrollo ha afectado más específicamente también a los campos de la macroeconomía y la teoría monetaria donde ha llevado a varias propuestas de reformas financieras y monetarias de gran alcance. Una de las propuestas más exitosas aboga por una banca libre con reserva fraccionaria, o sea un sistema sin banco central en el cual, sin embargo, los bancos puedan operar con una reserva fraccionaria. Este artículo comenta varios defectos conceptuales de dicha propuesta. Más específicamente, varias alegaciones de los banqueros de la banca libre con reserva fraccionaria relativas a las supuestas características operativas de este sistema se critican partiendo de la teoría económica. Más en particular, se denuncia como errónea la alegación de que una banca libre con reserva fraccionaria llevaría a la desaparición del ciclo económico. Además, se realiza un análisis de mano invisible lo cual refuerza la conclusión que la banca libre con reserva fraccionaria es incompatible con los principios éticos y jurídicos propios de una sociedad libre.

Palabras clave: banca libre con reserva fraccionaria, ciclo económico, mano invisible.


ALONSO, M.A. (2004), «La macroeconomía del capital en el siglo XXI», Análisis Económico, no. 40, vol. XIX, 23-47.

BARRO, R.J. and GORDON, D.B. (1983a), «A positive theory of monetary policy in a natural rate model», Journal of Political Economy, 91 (4), 589-610.

— (1983b), «Rules, discretion and reputation in a model of monetary policy», Journal of Monetary Economics, 12, 101-21.

BLOCK, W. (1988), «Fractional Reserve Banking: An Inter-disciplinary Perspective», Chapter 3 in Man, Economy, and Liberty: Essays in Honor of Murray N. Rothbard, W. Block and L.H. Rockwell, Jr., eds., Auburn: Ludwig von Mises Institute, pp. 24-32.

CHECKLAND, S.G. (1975), Scottish Banking – A History, 1695-1973, London: Collins.

DAUGHERTY, M.R. (1942), «The currency-banking controversy Part 1», Southern economic journal, vol. 9, Oct., 140-55.

— (1943), «The currency-banking controversy: II», Southern economic journal, vol. 9, Jan., 241-51.

DIAMOND, D.W., and DYBVIG, P.H. (1983), «Bank runs, deposit insurance, and liquidity», Journal of Political Economy, 91 (June), 401-19.

DOWD, K. (1993), Laissez-faire banking, London: Routledge.

— (1996), Competition and Finance – A Reinterpretation of Financial and Monetary Economics, London: MacMillan Press.

EDGEWORTH, F.Y. (1888), «The Mathematical Theory of Banking», Journal of the Royal Statistical Society, 51, 113-127.

FETTER, F.W. (1965), Development of British Monetary Orthodoxy 1797-1875, Cambridge: Harvard University Press.

GARRISON, R.W. (1996), «Central Banking, Free Banking, and Financial Crises», The Review of Austrian Economics, vol. 9, no. 2, 109-27.

— (2001), Time and Money – The Macroeconomics of Capital Structure, London: Routledge.

GOODHART, C. (1988), The Evolution of Central Banks, Cambridge: The MIT Press.

HAYEK, F.A. (1941), The Pure Theory of Capital, London: Routledge & Kegan Paul.

— (1973), Rules and Order, London: Routledge.

— (1991), Denationalisation of Money – the Argument Refined, reprinted as Ch. 2 in: Economic freedom, Institute of Eco-nomic Affairs, 125-235.

HOPPE, H.-H. (1994), «How is Fiat Money Possible?-or, The Devolution of Money and Credit», The Review of Austrian Economics, vol. 7, no. 2, 49-74.

— (2006), The Economics and Ethics of Private Property, Auburn: Ludwig von Mises Institute.

HOPPE, H.-H., HÜLSMANN, J.G. and BLOCK, W. (1998), «Against Fiduciary Media», The Quarterly Journal of Austrian Eco-nomics, vol. 1, no. 1, 19-50.

HORWITZ, S. (1992), Monetary Evolution, Free Banking, and Economic Order, Oxford: Westview Press.

— (2000), Microfoundations and Macroeconomics, London: Routledge.

HUERTA DE SOTO, J. (1994), «Banque Centrale ou Banque Libre: Le Débat Théorique sue les Réserves Fractionnaires», Journal des Économistes et des Études Humaines, vol. 5, no. 2/3, 379-391.

— (1995), «A Critical Analysis of Central Banks and Fractional-Reserve Free Banking from the Austrian School Pers-pective», Review of Austrian Economics, vol. 8, no. 2, 25-38.

— (1998), «A Critical Note on Fractional-Reserve Free Banking», The Quarterly Journal of Austrian Economics, vol. 1, no. 4, 25-49.

— (1998), Dinero, Crédito Bancario y Ciclos Económicos, Madrid: Unión Editorial.

— (2006), Money, Bank Credit, and Economic Cycles, Auburn: Ludwig von Mises Institute.

HÜLSMANN, J.G. (1996), «Free Banking and the Free Bankers», The Review of Austrian Economics, vol. 9, no. 1, 3-53.

KEYNES, J.M. (1997), The General Theory of Employment, Interest, and Money, Amherst: Prometheus Books.

KLEIN, B. (1974), «The Competitive Supply of Money », Journal of Money, Credit, and Banking, vol. 6 (Nov.), 423-453.

KYDLAND, F.E., and PRESCOTT, E.C. (1977), ‘Rules Rather Than Discretion: The Inconsistency of Optimal Plans’, Journal of Political Economy, 85 (June), 473-91.

LAIDLER, D. (1992), «Free banking: theory», The New Palgrave Dictionary of Money and Finance, 196-7.

MENGER, C. (1892) [1994], On the Origin of Money, in: Kirzner, I. M. 1994. Classics in Austrian Economics, Vol. I, The Founding Era, London: William Pickering, 91-106.

— (1994), Principles of Economics, Grove City: Libertarian Press.

MISES, L. von (1998), Human Action (Scholar´s Edition), Auburn: Ludwig von Mises Institute.

— (1978), On the Manipulation of Money and Credit, New York: Free Market Books.

— (1981), The Theory of Money and Credit, Indianapolis: LibertyClassics.

MISES, R. von (1957) [1981], Probability, Statistics and Truth, New York : Dover Publications.

NOZICK, R. (1974), Anarchy, State, and Utopia, Oxford: Basil Blackwell.

OBSTFELD, M., and ROGOFF, K. (2002), Foundations of International Macroeconomics, London: The MIT Press.

POPPER, K.R. (1983), Realism and the Aim of Science, London: Hutchinson.

REISMAN, G. (1998), Capitalism, Ottawa: Jameson Books.

ROCKWELL, L.H. (ed.) (1992), The Gold Standard, Auburn: Ludwig von Mises Institute.

ROTHBARD, M.N. (1983), The Mystery of Banking, Richardson & Snyder.

— (1988), «The Myth of Free Banking in Scotland», The Review of Austrian Economics 2, 229-45, now in: Rothbard 1997b, 311-330.

— (1991), The Case for a 100 Percent Gold Dollar, Auburn: The Ludwig von Mises Institute.

— (1994), The Case Against the Fed, Auburn: Ludwig von Mises Institute.

— (1995), Classical Economics, Cheltenham: Edward Elgar.

— (1997a), The Logic of Action I, Cheltenham: Edward Elgar.

— (1997b), The Logic of Action II, Cheltenham: Edward Elgar.

— (1998), The Ethics of Liberty, New York: New York Uni-versity Press.

— (2004), Man, Economy, & State, with Power and Mar-ket (Scholar´s Edition), Auburn: Ludwig von Mises Ins-titute.

SALIN, P. (1998), «Free Banking and Fractional Reserves: A Com-ment», Quarterly Journal of Austrian Economics, vol. 1, no. 3, 61-65.

SAY, J.-B. (2001), A Treatise on Political Economy, London: Trans-action Publishers.

SCHWARTZ, A.J. (1992), «Banking School, Currency School, Free Banking School», The New Palgrave Dictionary of Money & Finance 1, 148-152.

SECHREST, L.J. (1988), «White´s Free-Banking Thesis: A Case of Mistaken Identity», Review of Austrian Economics 2, 247-257.

— (1993), Free banking – theory, history, and a laissez-faire model, Westport: Quorum Books.

SELGIN, G.A. (1988), The Theory of Free Banking – Money Supply under Competitive Note Issue, New Jersey: Rowman & Little-field.

— (1994), «On Ensuring the Acceptability of a New Fiat Money», Journal of Money, Credit, and Banking, vol. 26, no. 4, 808-26.

— (1996), Bank Deregulation and Monetary Order, London: Routledge.

SELGIN, G., and WHITE, L.H. (1994), «How Would the Invisible Hand Handle Money?», Journal of Economic Literature, vol. XXXII, no. 4, also in: Selgin, G. 1996, 15-56.

— (1996), «In Defense of Fiduciary Media-or, We Are Not Devo(lutionists), We Are Misesians!», The Review of Austrian Economics, vol. 9, no. 2, 83-107.

SHAH, P.J. (1997), «The Option Clause in Free-Banking Theory and History: A Reappraisal», The Review of Austrian Eco-nomics, vol. 10, no. 2, 1-25.

SKOUSEN, M. (1990), The Structure of Production, New York: New York University Press.

— (1996), Economics of a Pure Gold Standard, New York: The Foundation for Economic Education.

SMITH, A. (1937), An Inquiry into the Nature and Causes of the Wealth of Nations, Edwin Cannan (ed.), New York: The Modern Library.

SMITH, V.C. (1990), The Rationale of Central Banking and the Free Banking Alternative, Indianapolis: Liberty Press.

WALSH, C.E. (2001), Monetary Theory and Policy, Cambridge, MA: The MIT Press.

WHITE, L.H. (1989), Competition and Currency-Essays on Free Banking and Money, New York: New York University Press.

— (1992), «Mises on Free Banking and Fractional Reserves», in: A Man of Principle – Essays in Honor of Hans F. Sennholz, Grove City College Press, 517-33.

— (1995), Free Banking in Britain (Second Edition), London: The Institute of Economic Affairs.

— (1999), The Theory of Monetary Institutions, Oxford: Black-well.

YEAGER, L.B. (1993), «Book review of Kevin Dowd´s ‘Laissez-faire banking’», Manchester School of Economic and Social Studies, University of Manchester: Department of Eco-nomics, 321-323.




How to Cite

Hauwe, L. van den . (2006). The Uneasy Case for Fractional- Reserve Free Banking. REVISTA PROCESOS DE MERCADO, 3(2), 143–196.