George Selgin on the Fed

Episode Summary

Executive Summary: Russ Roberts and George Selgin argue that the Fed has not clearly improved U.S. economic performance. They contend bank panics were more tied to weak banking structures and bad loans than to panic alone, that deposit insurance and the RFC—not the Fed—largely stopped runs, and that the Fed repeatedly violated Bagehot’s lender-of-last-resort rule by rescuing insolvent firms, creating moral hazard. Selgin favors decentralized free banking over central planning.

Main Topics: Whether the Fed reduced bank panics (Priority: 5/5): Selgin argues that panics were not meaningfully eliminated by the Fed and that the biggest reduction came from the RFC, deposit insurance, and gold withdrawal suspension in 1933 rather than the Fed itself. Bagehot’s lender-of-last-resort rule (Priority: 5/5): The discussion distinguishes classical emergency lending to solvent institutions from bailouts of insolvent ones; Selgin says the Fed repeatedly ignored this standard, worsening moral hazard. Branch banking, regulation, and bank fragility (Priority: 4/5): Roberts and Selgin examine how unit banking, charter restrictions, and lack of diversification made U.S. banks fragile and more panic-prone than less regulated systems. The Fed’s record on business-cycle stabilization (Priority: 5/5): Selgin challenges the claim that the Fed delivered a lasting Great Moderation, citing revised research showing postwar volatility was not clearly lower than pre-Fed volatility and that the moderation ended with the recent crisis. Systemic risk and too-big-to-fail (Priority: 5/5): They debate whether interconnected institutions justify bailouts. Selgin says systemic-risk claims are often asserted without evidence and that bankruptcy plus faster resolution ('living wills') would be better. Alternative monetary institutions (Priority: 4/5): Selgin argues for decentralizing money creation through competitive free banking, or at minimum constraining central banking with rules, because one central authority concentrates error and political influence. Gold standard versus fiat money (Priority: 3/5): The conversation contrasts a classical gold standard with the interwar gold exchange standard, arguing that many historical criticisms of gold conflate a flawed interwar system with the classical standard.

Key Arguments: Bank panics before 1933 were not clearly less frequent or less severe after the Fed’s creation; in the 1930s, the RFC, deposit insurance, and the suspension of gold withdrawal were more important in ending panics. Historical bank runs usually reflected real weakness—bad loans, insolvency, or exposure to troubled banks—rather than pure irrational panic or 'animal spirits'. Unit banking and restrictions on branching made U.S. banks small, undiversified, and fragile, increasing the likelihood of localized failures and runs. Bagehot’s rule requires lending freely at high rates only to solvent institutions; rescuing insolvent institutions throws good money after bad and creates moral hazard. Fed rescues of Franklin National, Continental Illinois, and LTCM are cited as examples of departures from sound last-resort principles and as precedents that encouraged bigger future risk-taking. Too-big-to-fail claims are often treated as self-evident but lack strong ex post evidence; Selgin argues spillovers can be mitigated by liquidity provision to solvent firms and by faster bankruptcy procedures. The Great Moderation likely reflected good luck, structural changes, or other factors more than superior Fed policy; revised data suggest postwar output volatility was not clearly better than in the pre-Fed era. Central bankers face severe information problems and are influenced by political/public-choice forces, making the ideal textbook Fed unrealistic in practice. A decentralized free-banking system would spread decision-making across institutions, reducing the economy’s dependence on one central authority and lowering the cost of policy mistakes.

Data Points: Fed establishment year: 1913 - Used as the baseline for evaluating whether the Fed improved economic performance Date of episode: December 2, 2010 - Introductory metadata for the EconTalk conversation Bank holiday: 1933 - Selgin says panics were not reduced until the 1933 bank holiday and related reforms RFC: Reconstruction Finance Corporation - Cited as a major factor in reopening banks after the 1933 holiday Postwar period: Post-1945 - Selgin says postwar business-cycle volatility was not clearly lower than pre-Fed volatility overall Great Moderation: roughly 1983 to 2007 - The period of reduced volatility discussed as a possible Fed success story Continental Illinois: 1984 - Example of Fed support for an insolvent institution Long-Term Capital Management: 1998 - Example of an orchestrated rescue that Selgin says did not justify departure from Bagehot’s rule Lehman's spillover example: money market funds; Reserve Primary broke the buck - Used in the discussion of liquidity crises versus insolvency and systemic risk Federal policy target: 2% inflation - Selgin says historical gold-standard inflation shocks were trivial by comparison Possible inflation expectation target mentioned: 3% - Referenced as a higher contemporary target than the historical gold-standard episodes Fed rescue example: Franklin National in the 1970s - Example of likely insolvency-based support and moral hazard Money market fund failure example: breaking the buck - Defined as not being able to pay investors 100 cents on the dollar

Pivotal Quotes: "the panics were not less frequent or less severe than they had been before the establishment of the Fed" — George Selgin: On whether the Fed eliminated bank panics "a lender of last resort is a central bank that lends freely at high rates of interest but only to solvent firms during times of crisis" — George Selgin: Defining Bagehot’s classical doctrine "the only way to avoid major errors of monetary change connected with informational deficiencies ... is to decentralize the decision-making behind adjustments in the money supply" — George Selgin: On why free banking is preferable to a centralized Fed

Implications: The episode challenges confidence in central banking as a superior stabilizer. If Selgin is right, policy should shift toward tighter limits on bailouts, faster resolution of failing firms, and greater monetary decentralization rather than continued reliance on discretionary Fed power.