Chapter

Free Banking

Howard Bodenhorn

in State Banking in Early America

Published in print December 2002 | ISBN: 9780195147766
Published online November 2003 | e-ISBN: 9780199832910 | DOI: http://dx.doi.org/10.1093/0195147766.003.0008
Free Banking

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Modern interpretations of free banking argue that lightly regulated banking systems are either unstable and undesirable, or that free competition in banking generates the same favorable outcomes as competition in any other industry. The historical evidence shows that America's experience with free banking can support either position depending on the time and place under study. Free banking laws in antebellum America induced massive entry and, often, equally rapid exit in its early years (sometimes referred to as wildcatting), but later experience was more favorable. After 1845, failure rates among free banks fell to about the same rate as chartered banks. Free banking created some perverse incentives for banks, however. Free banks under‐issued banknotes relative to profit‐maximizing banks and free banknote issues demonstrated less seasonal elasticity. Both features were the result of the requirement that free banks hold unbalanced portfolios, top heavy with government bonds.

Keywords: bank failures; banknotes; competition; free banking; government bonds; market entry; perverse incentives; regulation; seasonal elasticity; wildcatting

Chapter.  16324 words.  Illustrated.

Subjects: Economic History

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