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Free Banking and Monetary Calculation

In my Freeman column this week, I discussed the importance of monetary calculation in enabling entrepreneurs to know both what to produce and how to produce it.  The ability to make use of money prices to formulate a forward-looking budget and to calculate backward-looking profits/losses is crucial to entrepreneurial planning and the learning process of the market.  In that piece I didn't have the space to make an additional point that I'd like to note here.

For monetary calculation to be maximally effective, the monetary system matters.  Specifically, the more sound that money is, the more reliable is monetary calculation.  This is a point that Mises made in this 1920 article about economic calculation in the socialist commonwealth and one I developed in a HOPE paper in 1998.  In an economy subject to periodic inflation and deflation, the reliability of money prices is reduced, and what we might call the "epistemic burden" on entrepreneurs is increased as they have to sort out whether a given price change is due to real or nominal factors.  Where money is sound, price movements carry a less ambiguous message. They still require interpretation, but with one less major complicating factor than under inflation or deflation.

Given that different monetary regimes will be more or less likely to avoid inflation and deflation, the monetary system matters for the effectiveness of monetary calculation.  If free banking is better than the alternatives at avoiding monetary disequilibria, then it is also better at creating a sound environment for monetary calculation.  And, if so, it will be better at promoting economic growth.

Many of these ideas are at the core of my Microfoundations and Macroeconomics:  An Austrian Perspective, which if you haven't read, you should!