Credit Expansion, the Prisoner´s Dilemma, and Free Banking as Mechanism Design

van den Hauwe, Ludwig (2008): Credit Expansion, the Prisoner´s Dilemma, and Free Banking as Mechanism Design.

Abstract

Despite the distinctive character of the Austrian approach to “microfoundations for macroeconomics”, the literature on free banking contains a number of arguments which make use of game-theoretic concepts and models such as the well-known Prisoner´s Dilemma model. While there can be no general a priori presumption against the possible usefulness of game-theoretic concepts for Austrian theorizing, in the context of the debate on free banking such concepts and models have been used with varying degrees of perspicacity. One example which is elaborated in the paper is concerned with the interaction configuration between independent banks in a fractional-reserve free banking system, which has sometimes been modeled as a One-Shot Prisoner´s Dilemma. This conceptualization does not provide a sufficient argument for the in-concert overexpansion thesis, nor for the thesis that fractional-reserve free banking will tend to lead to the establishment of a central bank. The author drops the implicit assumption that there exists a one-to-one correspondence between the outcome matrix and the utility matrix. When it is acknowledged that banks in a fractional-reserve free banking system need not necessarily adopt a “myopic”, self-regarding perspective but may recognize the long-run harmony of interests between the banking sector and society at large, a different conceptualization and a different matrix representation emerge.

• Item Type: MPRA Paper
• Language: English
• Keywords: Free Banking; Business Cycle Theory; Prisoner´s Dilemma; Mechanism Design
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations ; Cycles; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E66 - General Outlook and Conditions; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E42 - Monetary Systems ; Standards ; Regimes ; Government and the Monetary System ; Payment Systems; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level ; Inflation ; Deflation; G - Financial Economics > G1 - General Financial Markets > G18 - Government Policy and Regulation; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; D - Microeconomics > D0 - General > D01 - Microeconomic Behavior: Underlying Principles; K - Law and Economics > K3 - Other Substantive Areas of Law > K39 - Other

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