April 1, 2016 | Issue Brief on Federal Reserve
In the wake of the longest recession since the Great Depression, policymakers have contemplated many monetary policy reforms. While some of these ideas, such as the Fed Oversight Reform and Modernization Act of 2015 (the FORM Act), introduced by Representative Bill Huizenga (R–MI), have received support in the U.S. House of Representatives, the Senate has yet to undertake substantial reforms. Going forward, Congress should implement policies that allow monetary competition in the U.S. It is often assumed that money is best supplied by a central authority, but monetary economists have long-acknowledged that the improved efficiency and reliability of free enterprise can also apply to the provision of money.
Nobel-winning economist Milton Friedman is perhaps best known for advocating that central bank discretion be replaced by a rule that would automatically grow the money supply at some fixed percentage. It is often forgotten, however, that in 1986, Friedman (along with co-author Anna Schwartz) argued that “leaving monetary and banking arrangements to the market would have produced a more satisfactory outcome than was actually achieved through government involvement.” Friedman even proposed putting such a system, based on the work of F. A. Hayek, into place by freezing the monetary base of U.S. dollars and allowing banks to competitively issue notes redeemable in dollars.
Economic instability is often blamed on the fact that there was no U.S. government monopoly of currency until after the creation of the Federal Reserve. Research has shown, however, that government regulations—not competitive note issuance—were major causes of monetary difficulties in the U.S. prior to the 20th century. Regardless, the overall track record of the Federal Reserve shows that the U.S. experiment with central banking has not fulfilled its promise. Aside from the fact that two of the worst economic downturns in the nation’s history occurred on the Fed’s watch, well-documented data deficiencies have caused key pre-Fed-era data to appear more volatile than was previously believed.
Even when the disastrous interwar period is excluded, updated data suggest that the average length of recessions, as well as the average time to recover from recessions, has been slightly longer in the post-WWII era than in the pre-Fed era. Furthermore, while the variability in inflation declined after 1977, when the Fed received a formal price stability mandate, the average rate of inflation increased. In the post-WWII era, the long-term purchasing power of the dollar has declined, the U.S. price level has become more difficult to forecast, and the benign deflation that arises from improved productivity has all but disappeared.
Policymakers should not expect that leaving money and banking to the market will completely eradicate consequences (or sources) of macroeconomic instability such as unemployment and inflation. Neither, however, should they expect legal restrictions and government monopoly to produce such a benefit. Policymakers should apply this perspective to the theoretical case for privately produced money as well as to the history of successful competitively issued money regimes. More than 60 episodes of competitive private note issue have been identified, with well-studied episodes in Scotland, the U.S., Canada, Sweden, Switzerland, and Chile.
Despite the successful history and the theoretical case for privately produced money, it is difficult to imagine any private currency replacing an established national currency such as the U.S. dollar. Such an outcome is particularly unlikely if the Federal Reserve acts as even a moderately good steward of the national currency, but that is precisely why a government monopoly is unnecessary. Monetary policy is likely to be worse when shielded from competition and better when competing against alternative monies. As with any privately produced good or service, no inferior form of money would be expected to replace an economy’s preferred medium of exchange.
Congress should implement reforms that allow the U.S. to move toward a competitive monetary system. Reforms should ensure that the Federal Reserve embraces its role as a facilitator of money creation by competitive banks, and that it does not usurp the role of the private banking sector. Each of the following ideas—many of which are complementary—would help achieve these goals.
 See Milton Friedman, A Program for Monetary Stability (New York: Fordham University Press, 1960), and Milton Friedman, “The Role of Monetary Policy,” American Economic Review, Vol. 58 (1968), pp. 1–17, https://www.aeaweb.org/aer/top20/58.1.1-17.pdf (accessed March 4, 2016).
 Milton Friedman and Anna Schwartz, “Has Government Any Role in Money?” Journal of Monetary Economics, Vol. 17 (1986), p. 59.
 See Milton Friedman, “Monetary Policy for the 1980s,” in John H. Moore, ed., To Promote Prosperity: U.S. Domestic Policy in the Mid-1980s (Stanford: The Hoover Institution, 1984), pp. 21–22, http://0055d26.netsolhost.com/friedman/pdfs/other_commentary/Stanford.01.01.1984.b.pdf (accessed March 1, 2016), and F. A. Hayek, Denationalization of Currency: The Argument Refined, An Analysis of the Theory and Practice of Concurrent Currencies (London: The Institute of Economic Affairs, 1976), https://mises.org/library/denationalisation-money-argument-refined (accessed March 5, 2016). Monetary scholar George Selgin has since extended Friedman’s proposal. See George Selgin, Less Than Zero: The Case for a Falling Price Level in a Growing Economy (London: Institute of Economic Affairs, 1997), pp. 67–69, and George Selgin and Lawrence H. White, “How Would the Invisible Hand Handle Money?” Journal of Economic Literature, Vol. 32, No. 4 (1994), pp. 1718–1749.
 Section 18 of the Federal Reserve Act gave national banks 22 years (until 1935) to retire the bank notes they had issued. Federal Reserve Act, Public Law 63-43, 63rd Cong., December 23, 1913, Section 18, https://fraser.stlouisfed.org/scribd/?title_id=966&filepath=/docs/historical/fr_act/nara-dc_rg011_e005b_pl63-43.pdf#scribd-open (accessed March 5, 2016).
 See Ignacio Briones and Hugh Rockoff, “Do Economists Reach a Conclusion on Free-Banking Episodes?” Econ Journal Watch, Vol. 2, No. 2 (1995), http://econjwatch.org/articles/do-economists-reach-a-conclusion-on-free-banking-episodes (accessed March 5, 2016).
 Christina D. Romer, “Remeasuring Business Cycles,” The Journal of Economic History, Vol. 54, No. 3 (September 1994), pp. 573–609. Also see Norbert J. Michel, “Federal Reserve Performance: Have Business Cycles Really Been Tamed?” Heritage Foundation Backgrounder No. 2965, October 24, 2014, http://www.heritage.org/research/reports/2014/10/federal-reserve-performance-have-business-cycles-really-been-tamed (accessed March 4, 2016).
 When the entire Federal Reserve period is compared to the pre-Fed period, the frequency of recessions has not decreased. See Michel, “Federal Reserve Performance: Have Business Cycles Really Been Tamed?”
 From 1948 to 1978, the average inflation rate was 3.56 percent, and its standard deviation was 3.03 percent; from 1979 to 2013, average inflation rose to 3.74 percent, with variation of 2.78 percent. See Norbert J. Michel, “Federal Reserve Performance: What Is the Fed’s Track Record on Inflation?” Heritage Foundation Backgrounder No. 2968, October 27, 2014, http://www.heritage.org/research/reports/2014/10/federal-reserve-performance-what-is-the-feds-track-record-on-inflation (accessed March 4, 2016).
 See Michel, “Federal Reserve Performance: What Is the Fed’s Track Record on Inflation?”
 See Selgin and White, “How Would the Invisible Hand Handle Money?” Also see Gerald Dwyer and Norbert J. Michel, “Bits and Pieces: The Digital World of Bitcoin Currency,” Heritage Foundation Backgrounder No. 3047, September 16, 2015, http://www.heritage.org/research/reports/2015/09/bits-and-pieces-the-digital-world-of-bitcoin-currency (accessed March 1, 2016).
 Kurt Schuler, “The World History of Free Banking,” in Kevin Dowd, ed., The Experience of Free Banking (London: Routledge, 1992), pp. 7–47; Kevin Dowd, “Introduction,” in The Experience of Free Banking, pp. 1–6; and Briones and Rockoff, “Do Economists Reach a Conclusion on Free-Banking Episodes?”
 The concept known as Gresham’s law—that bad money drives good money out of circulation—is sometimes erroneously invoked as an argument against currency competition. Gresham’s law applies when government regulation requires different monies to be traded at the same price irrespective of the value to consumers and firms. A more general implication is that people conduct exchanges with the type of money that involves the least sacrifice. Thus, ultimately, the best money wins out. See Robert Mundell, “Uses and Abuses of Gresham’s Law in the History of Money,” Zagreb Journal of Economics, Vol. 2, No. 2 (1998), pp. 3–38, http://www.columbia.edu/~ram15/grash.html (accessed June 23, 2015).
 Details on each of these reform ideas have been discussed in several Heritage Foundation policy papers, each of which is referenced below. Also see Norbert J. Michel, “A Roadmap to Monetary Policy Reforms,” Cato Journal, Vol. 35, No. 2 (Spring/Summer, 2015), http://object.cato.org/sites/cato.org/files/serials/files/cato-journal/2015/5/cj-v35n2-9.pdf (accessed March 1, 2016).
 See Dwyer and Michel, “Bits and Pieces: The Digital World of Bitcoin Currency.”
 See Norbert J. Michel, “Why Congress Should Institute Rules-Based Monetary Policy,” Heritage Foundation Backgrounder No. 2991, February 11, 2015, http://www.heritage.org/research/reports/2015/02/why-congress-should-institute-rules-based-monetary-policy (accessed March 1, 2016).
 See Norbert J. Michel, “Dodd–Frank’s Title XI Does Not End Federal Reserve Bailouts,” Heritage Foundation Backgrounder No. 3060, September 29, 2015, http://www.heritage.org/research/reports/2015/09/doddfranks-title-xi-does-not-end-federal-reserve-bailouts-norbert-j-michel-phd?ac=1 (accessed March 1, 2016).
 See Primary Dealers List, Federal Reserve Bank of New York, https://www.newyorkfed.org/markets/pridealers_current.html (accessed March 30, 2016).
 See Michel, “Dodd–Frank’s Title XI Does Not End Federal Reserve Bailouts,” and George Selgin, “L Street: Bagehotian Prescriptions for a 21st Century Money Market,” Cato Journal, Vol. 32, No. 2 (Spring/Summer 2012), http://object.cato.org/sites/cato.org/files/serials/files/cato-journal/2012/7/v32n2-8.pdf (accessed March 1, 2016).
 See Michel, “Dodd–Frank’s Title XI Does Not End Federal Reserve Bailouts”; Michel, “A Roadmap to Monetary Policy Reforms”; and Marvin Goodfriend and R. G. King, “Financial Deregulation, Monetary Policy, and Central Banking,” Federal Reserve Bank of Richmond Economic Review (May/June, 1988), pp. 3–22.
 See Norbert J. Michel, “Federal Reserve’s Expansion of Repurchase Market Is a Bad Idea,” Heritage Foundation Issue Brief No. 4261, August 14, 2014, http://www.heritage.org/research/reports/2014/08/federal-reserves-expansion-of-repurchase-market-is-a-bad-idea (accessed March 1, 2016); and Norbert J. Michel and Stephen Moore, “Quantitative Easing, The Fed’s Balance Sheet, and Central Bank Insolvency,” Heritage Foundation Backgrounder No. 2938, August 14, 2014, http://www.heritage.org/research/reports/2014/08/quantitative-easing-the-feds-balance-sheet-and-central-bank-insolvency.