Free Banking as a Monetary Gauge

14 Pages Posted: 2 Jul 2014 Last revised: 16 Aug 2014

See all articles by Eric Dennis

Eric Dennis

American International Group, Inc.

Date Written: September 1, 2014


Selgin's Theorem -- that a free banking system operating on a fixed supply of commodity reserves acts to stabilize total nominal spending per year -- provides an analytical bridge between this alternative regime and conventional monetary theory. For a system of competing banks subject to stochastic spending decisions on the part of an interacting pool of depositors, I disaggregate Selgin's analysis according to transaction size, and examine the effect on the probability distribution for daily redemption demand at a representative bank. This leads to a generalized theorem involving nominal spending and total transaction number, which in turn suggests an econometric gauge that can assess current monetary policy by reference to a free banking-theoretic ideal. A simple equity/bond trading strategy derived from this gauge, and optimized using US historical data over 1983-2014, is seen to significantly outperform (in-sample) a static equity investment. I also discuss implications of this work for economic scenario generation in the context of portfolio theory and for the design of a cryptocurrency like bitcoin but that could be configured to stabilize more complicated macro variables like nominal spending, rather than money supply.

Keywords: Free Banking, Monetary Theory, Monetary Policy, Bitcoin, NGDP

JEL Classification: E41, E42, E44, E52, C53

Suggested Citation

Dennis, Eric, Free Banking as a Monetary Gauge (September 1, 2014). Available at SSRN: or

Eric Dennis (Contact Author)

American International Group, Inc. ( email )

80 Pine Street
New York, NY 10270
United States

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