Monetary Theory


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    Professor Murphy,

    I am extremely excited to find out that you are teaching a course. I’ve got some questions about monetary theory that have come up while I am reading Rothbard’s Mystery of Banking:

    1. This is my main, most nagging question. Would it be possible for there to be credit at all (at least from banks) in a 100% reserve system? I’m displaying my ignorance, but that’s why I’m here.

    If banks have to keep full reserves, how would they be able to make loans?

    I can see how runs/redemption pressures would be a check against reckless lending and inflation in a specie based fractional reserve system, and how in such a system lending is still possible, but how would that work in a full reserve system? Would credit markets be possible?

    2. Are you aware of any good summary works/study guides about Rothbard’s Mystery of Banking?

    3. Could bank runs occur in both fractional and full reserve hard money systems?

    4. Could bank runs happen for no reason, or just out of nowhere, threatening the stability of our financial system? I’m not saying out system is inherently stable now, but what are the chances of something like that happening?

    5. What caused the bank runs that caused panics prior to and leading to the establishment of the Fed? What’s the Austrian response to the critics who say that that would just happen again if we followed Rothbard or others?

    6. Is there a standard (or better word:RELIABLE) metric used to measure the severity of a banking crisis? Is the percentage of losses relative to GDP the best way to measure this? Would such a metric be a reliable tool to measure the comparative severities of the banking crises/depressions before and after the Fed?

    7. In the chapter entitled, “Free Banking and the Limits on Bank Credit Inflation”, Rothbard explains that if an individual is not a customer of a given bank whose notes he has been paid in goes to that bank to redeem the note, that will act as a market restraint on inflation. But, why would that person care to redeem the note just to deposit the money into his own bank? Would a small percentage of potential interest that could be paid to him be enough to cause him to move his money? what motivation do you think Rothbard was talking about?

    Thank you very much for your time.


    Hi John,

    Sorry for the delayed response, I forgot to set up my profile here.

    Let me first point you to some general resources (all free) that I think you are going to want to digest (over time), because they will give you a bigger picture. It sounds like you are misunderstanding a few critical concepts and that’s confusing you on particular applications.

    This YouTube lecture explains banking. Make sure you watch the part where I go through a bank’s balance sheet.

    In this book, my co-author and tried to explain fractional reserve banking as simply as possible, but without sacrificing rigor.
    Pay particular attention to chapters 5, 6, 7, 8, 12, 14, and 16. If you take the time to read those chapters (most are pretty short), you will probably have just about all of your questions answered.

    Then if you *really* want to step up your game, you can check out my study guide to Mises’ Theory of Money & Credit:
    However, that’s much harder than the first two things I said.

    Now, for quick answers to your specific questions:

    1) You need to distinguish between “loan banking” and “deposit banking.” We cover that thoroughly in *How Privatized Banking Really Works* (linked above). Short answer: Even with 100% reserves, a bank could still act as a credit intermediary. It could have time deposits, where the depositor knows he can’t touch his money for a certain period. Or, the bank could sell Certificates of Deposit (CDs) yielding a certain interest rate, in order to raise funds that it lends out to borrowers.

    In contrast for true demand deposits (checking accounts), the bank would have to charge a fee to the owner, for the services the bank provides. This is because the bank can’t lend out that money.

    3) No, a 100% reserve bank isn’t susceptible to a bank run.

    4) Well, even during the Great Depression, when thousands of banks went down, it wasn’t merely “contagion” or “panic.” I point out in my book on the Great Depression
    …that the banks subject to runs typically were poorly run, and so the public had good reason to think their money was in jeopardy.

    Having said that, by its very nature fractional reserve banking makes a bank susceptible to a run.

    5) Central banks don’t cause boom-bust cycles in the Austrian view, it’s more accurate to say the creation of unbacked credit does. However, in practice central banks exacerbate the problems by weakening the market’s normal defense/limitation on the issuance of new credit.
    Try this video around 12:00, I soon start talking about banking:

    6) I haven’t really thought about it, but note in this paper they use “standard” metrics and argue that empirically the Fed has failed:

    7) Look, in your personal life, if someone writes you a personal check for $200, do you walk around with the check for a few months? Probably not. You probably deposit that into your bank asap.

    By the same token, if you get paid by a paper note issued by a bank that you aren’t familiar with, you probably aren’t going to hold onto that for months. You are going to quickly deposit it with your bank (or go to a branch of the bank that issued the note and turn it into gold).


    Dr. Murphy,

    I was going through your answer above and found I had no access to this link you gave:

    I receive this response:

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    PS: I am currently enjoying your video on banking and balance sheets at 2X speed….I hate accounting, but this makes it at least entertaining to me….so I love it!


    Hi bigqueue, yes sorry we took that free version down.




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    -1′ OR 3+286-286-1=0+0+0+1 —










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