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Central banking is a form of central planning

Central banking and the debate over central planning passed each other like two ships in the night in the early 1900s. Central banking was becoming the standard monetary system that economists recommended. Financial conferences held by the League of Nations in Brussels in 1920 and Genoa in 1922 proposed that countries, as least independent countries, should have central banks. The idea was that politically independent central banks would take control of monetary policy from government treasuries that had become the de facto monetary policymakers during World War I and had created substantial inflation in many countries.

At the same time, Ludwig von Mises published an article in 1920 called “Economic Calculation in the Socialist Society” and a 1922 book, Socialism: An Economic and Sociological Analysis, arguing that comprehensive central planning of the economy would be disastrous because central planners lacked market prices and market institutions to inform their actions, hence they would waste resources on a vast and even fatal scale.  Because most economists did not understand the depth of Mises’s challenge, economists generally did not acknowledge his argument as valid until communism collapsed from 1989 to 1991.

Not until Lawrence H. White’s 1984 book Free Banking in Britain and George Selgin’s 1988 Theory of Free Banking did economists confront these two powerful currents of thought directly with each other. And even though mainstream economics now blames the Federal Reserve and the Bank of France for the intensity of the Great Depression and acknowledges that too many central banks have created runaway inflations, mainstream economists have been slow to answer the challenge that free banking theory now poses to central banking. The only real exception has been Charles Goodhart, the world’s leading expert on central banking. Goodhart’s writings on central banking and his criticisms of free banking are well worth reading, but such an important issue needs multiple thinkers on both sides working to bring out its many facets.

Central planning failed as a comprehensive economic system; why should we expect central planning limited to particular fields of economic activity to do better? Central banking is a form of central planning. Rather than leaving the selection and production of the monetary base open to competition, it concentrates them in a monopoly sponsored by and nowadays almost always owned by government. As part of this monopolization, it typically prohibits would-be competitors from issuing notes and coins that might displace those the government has issued.

David Glasner has two posts claiming that central banking is not central planning. I do not find them convincing. Central banks are government monopolies that consciously try to steer the economy. If that is not central planning, nothing is. (And by the way, it will not do to cite the younger Hayek in support of central banking when the older Hayek in Denationalisation of Money wrote about “the obvious corollary that the abolition of the government issue of money should involve also the disappearance of central banks as we know them” [page 105].)

I think, however, that pointing out that central banking is a form of central planning is not sufficient by itself as an argument. Monetary theory and practice have for decades been built on the idea that ultimate power in monetary matters properly rests with governments. Displacing ideas and institutions that are now long established is not merely a matter of writing a few books, much less a few blog posts.

In my next post I will discuss a surprising advocate of free banking.

  • JonCatalan

    I agree, and I’ll repeat what I wrote over at the Mises blog. I think it’s a mistake to equivocate socialism and central planning. Socialism requires central planning, but socialism is completely central planning of the economy. But, you don’t need collective ownership over all means of production to centrally plan.

    • Redmond

      By having a central bank, you Can effectively plan and steer the entire economy.

      And in any case, as Mises said, “Middle of the road leads to socialism”

      Plank five of that famous document…

      5. Centralisation of credit in the hands of the State, by means of a national bank with State capital and an exclusive monopoly.

  • BillWoolsey

    Central banking is nothing like comprehensive central planning. It almost exactly like monopolizing the provision of any other essential good or services.

    • George Selgin

      Bill, I agree with Martin Brock in thinking that this goes too far the other way. After all, we condemn central planning because we believe that it is no substitute for using market-determined relative prices to guide the use of resources. The “central planning” of money differs from the central planning of any other good because (1) the profit motive alone ceases to be a reliable guide to optimal money creation and (2) suboptimal money creation introduces “noise” into the price system, and so undermines somewhat the working of that system, and hence its advantages relative to central planning. You don’t get these problems when the state monopolizes, say, electricity-generation or automobile production.

  • Martin Brock

    Central banking is not comprehensive central planning, but money is not just another essential good or service. A monopoly of money is far more powerful than a monopoly of corn or soybeans. It’s more like a monopoly of food generally. Give me a monopoly of food, and I don’t need anything else to plan the economy comprehensively.

  • salsman

    Yes, as I wrote in my 1990 book, a year before the U.S.S.R. dissolved:

    “Central banking has failed to improve upon what Nobel economist Friedrich Hayek called ‘the spontaneous social order’ of free banking, a failure that can be seen as a special case of the general failure of central economic planning. The fundamental difference between free banking and central banking is the difference between a free market and a system of central planning. . . . Free banking offers an exciting, innovative and prudent alternative to the central banking system which has destroyed sound money and sound banking.” [Richard M. Salsman, “Breaking the Banks: Central Banking Problems and Free Banking Solutions” (AIER, 1990), p. 141].

    Richard M. Salsman, CFA
    President & Chief Market Strategist
    InterMarket Forecasting, Inc.

    • RickDiMare

      Richard, assuming U.S. banks and the Treasury Department would freely allow (without being sued, I mean), is there a market for a mutual fund comprised of businesses that rejected central bank money and used only Treasury-Direct currencies?

  • David Johnson

    I find the idea that central banks were supposed to be politically independent interesting. That is certainly one attribute of the Federal Reserve that many supporters cite. I do have sympathy with this idea, in that I would much rather have an “independent” Fed than direct control of the money supply to the politicians in Congress or the White House. But arguing for an independent central bank misses the problem entirely. It is not the dependence that is the problem, it is the central planning of the money supply.

  • RickDiMare

    FYI, the key Supreme Court case that dramatically expanded the central bank’s planning powers in the U.S. is Wickard v. Filburn (1942).

    Law schools do not teach their students about the Fed’s substantial involvement in subsidizing (and monopolizing) food production since the New Deal Era under the Filburn case, but rather they teach that Wickard v. Filburn stands for the idea that Congress has almost unlimited powers to control and regulate almost anything under the Commerce Clause, even if the commercial activity is very private and local.

    This is simply not true, but you’re very unlikely to find a lawyer who disagrees with the notion that the Commerce Clause obliterates almost every Constitutional right.

    As one analyst mentioned in the following linked article noted, “Why not just have just one big farm?”

    Hopefully at least some of the following article is understandable to the non-lawyers out there. It’s written by Jim Chen of Brandeis Law School and entitled “The Story of Wickard v. Filburn: Agriculture, Aggregation and Commerce:”
    (when you get to the site, click “One-Click Download” at the top to get the entire 38 page article.)

  • Paul Marks

    Central banking (even if the Central Bank is formally privately owned) is indeed like government central planning – and neither idea works.

    However, one must remember what Central Banking is actually for.

    As Ludwig Von Mises (and many others) have pointed out, the primary purpose of Central Banking is to “reduce interest rates”, to “expand credit”. In short to make borrowing less of a burder to borrowers than it would be if they had to seek out (George Selgin would use the word “beg”) real savings from real savers (either directly or via banks) at interest rates those savers would voluntarily accept.

    Banks can (and do) try and do this without Central Banking (by various means which is George Selgin is quite right to say are within the existing legal judgements of both statute and common law) – and, again without Central Banking, it still leads to a boom/bust. As borrowing is first pushed up beyond real savings, and then (sooner or later) the house of cards comes down.

    What Central Banking does is to make the boom/bust bigger that it would otherwise be.

    It is a matter of scale – not a matter of principle. Although the matter of scale is indeed very important.

  • Paul Marks

    The obvious recent example is that of Alan Greenspan.

    Time and time again he “saved the world” (in the headlines of the ignorant), by preventing a bust – preventing a crash when bank (or other such) credit-money bubble was bursting.

    However, the Federal Reserve Chairman did not really “prevent” the bust at all – he DELAYED it by (time and time again) pushing in more credit money into the system. Thus meaning that when the crash finally claim (which was a logical inevitablity) it would be vastly worse.