Posted by Joseph Y. Calhoun, III

George Selgin has a new paper out titled,  Central Banks as Sources of Financial Instability. An exerpt:

The present financial crisis has set in bold relief the Jekyll and Hyde nature of contemporary central banks. It has made apparent both our utter dependence on such banks as instruments for assuring the continuous flow of credit in the aftermath of a financial bust and the same institutions’ capacity to fuel the financial booms that make severe busts possible in the first place.

Yet theoretical treatments of central banking place almost exclusive emphasis on its stabilizing capacity—that is, on central banks’ role in managing the growth of national monetary aggregates and in supplying last-resort loans to troubled financial (and sometimes nonfinancial) firms in times of financial distress. This one-sided treatment of central banking reflects both the normative nature of much theoretical work on the subject—that is, its tendency to focus on ideal rather than actual central-bank conduct—and the (usually tacit) assumption that however much central banks might depart in practice from ideal, financially stabilizing policies, they at least succeed in limiting the amplitude of booms and busts, compared to what would occur in the absence of centralized monetary control.

I propose to challenge this conventional treatment of central banking by arguing that central banks are fundamentally destabilizing—that financial systems are more unstable with them than they would be without them. To make this argument, I must delve into the history of central banking and explain both why governments favored the establishment of destabilizing institutions in the first place and why there is the modern tendency to regard central banks as sources of financial stability. I hope to show that the modern view of central banks as sources of monetary stability is in essence a historical myth.

As I have argued for years now that the Fed is the source of out troubles, naturally I tend to agree with Selgin’s appraisal of their performance. Read the whole thing and decide for yourself.

Click here if you’d like to receive our free weekly e-newsletter. Here’s last week’s edition.