Ep. 440 Ian Deters Studies Free Banking with a Computer Simulation
Mathematician Ian Deters returns to the podcast to summarize the results of his computer simulations of a simple model of “free banking,” as guided by Bob’s instructions. His report has some good news and bad news for Bob.
Mentioned in the Episode and Other Links of Interest:
- The YouTube version of this conversation.
- This episode’s sponsor, ExPatMoneySummit.com.
- The website of Ian Deters, including contact info. Ian Deters’ appearance on the BMS ep. 287 defending the use of infinite sets in higher mathematics.
- Bob’s recent Human Action podcast episode explaining the Rothbardian view of free banking (and the in-built limits to credit expansion).
- The Selgin-White 1994 JEL article laying out their model of free banking.
- Bob’s QJAE article critical of the Selgin-White approach to free banking.
- Help support the Bob Murphy Show.
About the author, Robert
Christian and economist, Chief Economist at infineo, and Senior Fellow with the Mises Institute.
Hi guys,
Interesting stuff. I would say on the claim that banks cannot promise to maintain a certain reserve ratio, that they can perhaps borrow against, or sell, their debt assets to raise cash.
Yes, that is certainly something they can try. But bank runs still happened historically (before FDIC) and they still occur even with FDIC. Especially in the midst of a broader financial panic, a bank can’t necessarily turn its other assets into cash. You’re right that in the model we aren’t handling that, but in fact we don’t have the bank holding other assets at all.
So glad you are having Ian back.
Bob,
I have questions on your simulation stuff.
Seems like you and Ian are setting up the simulation so that it is tailor made for Markov chain analysis, and so very uniform (e.g., all persons spend exactly X% of their holdings each period where X is a parameter, though there is some randomness, I guess, as to who a particular person pays).
Not realistic in the sense of uncertain return of investment (in fact there is no investment), uncertain expenditures by persons (see X above), or even uncertain in terms of peoples response to “cost of money” (e.g., people spend or borrow more or less depending on perceived quantity of borrowable funds). Doesn’t this miss the whole point of what causes the business cycle. Easy credit leading to boom/bust cycle and bank bankruptcies (as certain banks that lend too freely getting caught short of gold holdings, etc).
How difficult would it be to beef up the simulation to include more of this?
As it stands, it’s almost set up to lead to a uniform long run stable solution, as opposed to the more interesting unpredictable boom/bust caused by the artificial credit creation, and the response to borrowers to the perceived surplus of funds..
Just curious.
Good Evening Charles,
We did not set up a simulation so that any particular mathematical technique would be suitable for its analysis. Rather, my thought that we (i.e. the liberty-minded community) need not have prolonged philosophical conversations about what would or would not occur with fractional reserve banking. Rather, we could simply look. Hence, I asked Bob what he imagined, and he specified what we discussed on the show. That the behavior of the system could be described by the product of random matrices was a happy result. Similarly, that the eigenspace for the expected value of the commerce matrix was the same for all spending parameters was equally happy. As I said near the end, I have a scheme for how to start with an asymptotic distribution in mind and solve for the expected value of the commerce matrix, though I am not sure if we will pursue that. Most importantly, we have a sort of existence theorem / example. We showed one can imagine systems in which gold flows out of lower reserve ratio banks into higher reserve ratio banks and vice versa. In such systems, no one is safe save those who maintain 100 percent reserves.
As for increasing the complexity of the simulation, I do not imagine it will be too hard. It was not hard to write this first one. However, it is worth noting that it does not use matrix multiplication internally. While that is the correct mathematical tool for analysis, it is computationally expensive and therefore avoided. If you are interested in the importance of both mathematical and computational reasoning, I have a video where it figures prominently in a different context: https://www.youtube.com/watch?v=DPm3gF6Nw-A .
Please let me know if you have any questions.
Cordially,
Ian
Thanks for sharing. I’ll check
Out the video
If you did a simulation like the above, it won’t give you closes form solutions that would come from a Markov Chain type model. Instead, to get stats, you would have to run it many many times.
I listened more to the end of the podcast and see now that this was just the start of your work (hopefully) on this. Looking forward to the next installment. Thanks
heh OK. I was going to explain that we didn’t intend this as a full-blown simulation of the market economy, originally I was just trying to assess the two claims that I’ve been making when I talk about free banking.
Thanks for this. At first I was worried when it seemed like you and he were talking about long run asymptotic behavior only. However, again, towards the end, Ian and you made the point that, unless a bank is 100% reserve, there is always a non zero probability of bankruptcy. These sample paths are unavoidable outside of 100% reserve policies. This is such an important point. I suspect that once you increase the sophistication of the simulation, you will probably see those probabilities only increase. So glad you guys are looking into this.
As an aside, what framework is Ian using for the simulation. A commercial package like AnyLogic? Or a multi-purpose programming language like Java? Or something else? If/when you publish this, will you include the code (if it’s open source like Java) for others to play with.
Good Evening Charles,
I am simply using R. It is not a long program. I intended to disclose the code if we publish. I prefer all this work open to criticism so that we come to consensus sooner than later on the facts, even if the consequent policy prescriptions differ.
Cordially,
Ian
Thank you Ian.