Who Needs Monetary Policy Anyway?

The first central banks were founded by the end of the 17th century in Sweden (Swedish Riksbank) and England (Bank of England). The interference of the state in monetary affairs has a still longer history. The main reason for the development of central banks was providing revenues for the state, since the levying of taxes was both inefficient and unpopular. Usually, the monopoly for coining money was given by the state to a private bank, and the state would take most of the profits. In time the role of the central bank changed and it’s field of work expanded enormously. Firstly, the gold security of 100% was abandoned, which did not entirely exist in an entirely free banking system, but in that system, the banks were limited in that fraudulent field of work, since the emission of too many papers without security could lead any bank to ruin. The Central Bank could easily solve that problem, since it was propped up by the state. Then the function of the “lender of the last resort” was established, which further stimulated banks to expand their credit, lending money that is not the property of the bank. The state’s interference in monetary policy reaches it’s zenith in the 20th century with the abandonment of the classic Gold Standard, with the introduction of the compulsive reserves, and other “monetary instruments.“ Terrible shocks erupted as a result of government planning. The Great Depression, and the hyperinflation in Germany or Serbia are just the most obvious examples, frequent crises and shocks became commonplace, as well as endemic inflation from the 60ties.

Today, the state interference in monetary affairs is dogma, and even the economists that propagate free market in all other cases, in the case of money become statists. Defenders of freedom like Milton Friedman and other monetarists entirely disregard free market of money and advise state monopoly on money and inflationary policy.

When faced with the accusation that government interference causes market crises, keynsians and socialists of different colors respond that the crises are the product of market imperfections and that the state is the guarantee of stability and growth. They will indignantly discard any notion of free choice when money is concerned. The Gold Standard is an ridiculous and obsolete idea, and quite impossible in the conditions of a “modern economy.” According to them, the state (the Central Bank in particular) should supply the economy with “the needed amount of money,” should maintain “stable prices,” low interest rates or use primary emission (and euphemism for printing money) as a “growth stimulation” by increasing aggregate demand. Is the gold standard really impossible, or are the arguments for central planning and monopoly just sophisms? Do free people really need “monetary policy” and can the economy function without “enough currency,” the measure of which is decided by a bureaucrat that calls himself The Banker of All Bankers?

The answer is obvious; a market economy can function without the “creative monetary policy,” and do it quite well. If it were not so, how can one explain the results of countries like Estonia, Lithuania or Bulgaria, countries that had given up on “monetary policy” and central banking and introduced the Currency Board or the example of countries where monetary competition is allowed, or where only one foreign currency is used. The advocates of statism do not care to explain those occurrences and are persistently avoiding any kind of meaningful discussion. They call the Currency Board and “sleeveless shirt” and are weaving tales about national sovereignty, which is by the way, responsible for the most horrifying wars in history, and whose causes can be traced to statism.

Statist planners are against the Currency Board for an obvious reason, because of the similarity that exists between a variant of the Currency Board and the Gold Standard. If it becomes obvious that the Currency Board works, that means that the Gold Standard is quite possible, and not just that, but that it is far more superior than the paper money that is without gold coverage, whose value is “guarded” and guaranteed by the State. The Currency Board has a long history, as first of these appeared in English colonies in the 19th century. The colonial currency was fixed to the pound, and the reserves were in pounds, gold or silver. All the changes in monetary mass depended on trade and capital flows. Since the colonies traded mostly with the home country (England), the trade deficit was covered in capital influx, so a significant change in prices due to currency fluctuation was a rare occurrence. The Currency Board had it’s renaissance during the end of the 20th century, when it was adopted by some countries in South America, and Estonia, Lithuania, Bulgaria and Bosnia.

In a Currency Board system, the local currency has 100-120% coverage in a reliable foreign currency. The currency reserves are usually divided threefold. Firstly, cash reserves, that can be used to respond to the average demand, secondly, highly liquid reserves that can be easily converted into money to answer the increased demand for foreign currency. Thirdly, a part is invested into assets that need not be highly liquid, as the experience has shown it is not needed. The total coverage is a guarantee for the trust of the local currency, and negates the possibility of speculative attack, which are the weaknesses of the fixed exchange course with a Central Bank. The monetary mass in a Currency Board regime is free flowing; depending from the current and capital part of balance of payment. The supply of the currency is mostly dependent on import/export, foreign investment and private transactions. The Currency Board does not have the “creditor of last resort” function, and business banks do not have mandatory and liquidity reserves, which creates a higher discipline of the banking sector. Banks could not lend demand deposits, but have to keep significant part of it in their reserves to save their liquidity.

If the financial sector is highly developed, the banks can take chances and, in the case their liquidity is imperiled, use the inner-banking money market, but they will have to pay interest, so the banks are forced to hold substantial reserves, which lessens the possibility of inflation. The choice of the reserve currency has the effect of channeling exports toward its country of origin, also. The similarity between the Currency Board and the Gold Standard is in the 100% standard, as well as in the non-existence of a “creative monetary policy,” as all increase in money supply is autonomous and free any state interference. The adjustment is automatic, although the experience has shown that large monetary fluctuations did not happen, as the possible deficit of current account is covered by surplus of the capital balance . The difference with the Gold Standard is that, with the adoption of a foreign currency, it’s inflation is taken over, as well as the interest rates, and that is an minus compared to the Gold Standard, but since usually the states with high inflation take over the currencies of the states’ with low inflation (in the case of those four European countries, it was Germany) that is not a huge problem. The difference is also in that, that in the Currency Board a reserve of 100% exists for the money that is emitted by the Board, but the money that is emitted by the banks does not have that standard, namely, banks use part of their demand deposits to lend money. However, the most important objection which could be raised against that concerns of existence of monopoly in issuing of money. Though government planning is significantly decreased and discretionary policy abolished, still remains the problem of monopoly of currency board.

The theoretic value that the Currency Board has stems form it’s similarity with the Gold Standard. If an economy can function smoothly in a Currency Board environment, then the Gold Standard is not just obviously possible, but is the only system for a free people. If the state abolishes the monopoly on currency emission, and allows freedom, what would happen? Firstly, there would be an uncontrolled emission of money by the banks and the inflation will skyrocket, but the people would rapidly find an answer. The greatest advocate of the Gold Standard in the 20th century, Murray N. Rothbard, wrote: “The result of freedom in the monetary area was and will always be the same, the Gold Standard.” In the Gold Standard system, the only duty of the state would be to punish fraud, like falsifying money and using others’ money without permission of credits that bank emits on the basis of demand deposits. All the rest is the function of the market and the banks would emit money based on their gold reserves, and approve credits based on savings. The role of the creditor would be taken over by insurance companies, private pension funds, investment banks and funds and other financial organizations.

If all of this is so simple and if the Gold Standard is so possible and attractive, why do we then have monopolies like central banking (its’ funny that the State masquerades as a trust-buster, while here we can see who is really responsible for the creation of monopolies) and government planning which an euphemism “monetary policy” was created. Who needs “monetary policy anyway?”

The answer is simple here, also. Monetary policy is an instrument for aggrandizement of the State’s power. The State finances deficits and prints money whenever it needs to do so. Trough the monopolistic organization, which calls itself the Central Bank, the state controls private banks, prohibits or allows mergers and takeovers and their business expansion. As the first beneficiary of the “primary emission,” the state robs its citizens trough an invisible tax. But the state is not the only one who needs monetary policy, for behind this system are the ideas which led to government monopolies and statism. Those ideas come from “experts” in “monetary policy,” which, according to them, is best led from one place and the head of one man, or a small group of men. That is what those “experts” tell us, and behind those words lies an hostility towards capitalism and free market and the total disrespect toward their fellow man. They are just rent-seekers, and do not care for the “common good” but for this: what would they do in a system that does not need their advice? They would lose their privileges in such a system. Who would regulate the interest rate, mandatory reserves or the expansion of money supply, and lead an efficient monetary policy? The answer is clear – a free market.

Milan Petrovic


  • Murray N. Rothbard, Šta je država uradila našem novcu, Global Book, Novi Sad, 1998.
  • Murray N. Rothbard, Man, Economy, and State, Ludwig von Mises Institute
  • Kurt A. Schuler, Currency Boards, Dissertation, George Mason University, Fairfax, Virginia,1992.