Do we need central banks?

I have recently been trying to collect opinions as to why we assume we need central banks (prompted somewhat by the lead-up to the december 2015 rate hike).

I was thus happy to come across The Adam Smith Institute’s Sound Money (published January 2016), which argues that, along with other reforms, we actually should aim for free banking (i.e. no central bank).

Sound Money - Executive Summary

Definitely worth the read, if for no other reason than to challenge the things we take for granted (most responses I get to “why do we even need central banks?” take the form of “because we need a lender of last resort” or that “it would be infeasible to not”).

The arguments for NGDP (nominal GDP) targeting are also compelling.

Firstly, if you have a positive real shock (i.e. productivity rises) this will put downward pressure on prices. Under an inflation target central banks would respond by easing policy, but this could generate asset bubbles. An NGDP target would allow prices to fall to reflect the increased productivity. Indeed according to George Selgin’s “productivity norm” prices should be allowed to fall. Maintaining an inflation target of 2% would not only generate loose monetary conditions but also deprive us of a benign price deflation.

Secondly, if there is a negative real shock (e.g. a natural disaster) then prices should rise, because the price system is supposed to reflect real scarcities. But an inflation-targeting regime would have to respond to the inflationary pressure by tightening policy, and reducing growth.

Do we need central banks?