Free baking is referred to monetary arrangement according to which banks are not under any special regulations that are beyond those applicable to most of the enterprises. In free banking, the banks are also free to issue paper currency i.e. banknotes, of their own. In free banking system, the market is forced to control the supply of the total quantity of deposits and banknotes that can be supported by the given stock cash reserves. These reserves are consist of either a that source generally consist of total quantity of deposits and banknotes that can be supported by any of the given cash reserves stock. Such reserves are either of limited stock of money that is issued by a central bank or scarce commodity. The supply of money from central bank is permanently frozen, or there is no role played by the central bank, in the strictest versions of free banking. Therefore, there no government insurance of bank deposits accounts or banknotes. Free banking is also known as fractional reserve free banking. There are no specified laws for governing banking, note issues, currency etc. currently, banking systems are mostly centralized systems in which government runs bank sets reserve requirements and interest rates. These systems though, vary among countries and even region to region in some countries. There is no free banking system that exists in today banking systems.
The Theory of Free Banking
In the era of monetary expansion, in the year 1970, Friedrich Hayek made a suggestion that the only way to stop inflation ids to allow the banks to issue their own currency. In early nineties, Lawrence H. White was also one of the prominent people, who then examined and debated about the free banking. After Lawrence White, George A. Selgin developed Hayek's and White's idea in a comprehensive and detailed theory of free banking. (Friedman, 1993)
A bitter-sweet analysis was produced by Selgin. He analyzed the potential and actual institutions of banking in their own capacities for maintaining and achieving equilibrium. Bitter in a sense, that it demonstrated the most basic way of pointlessness, in maintaining a monetary equilibrium through central direction. Neither a purposeful discretionary policy is implemented by an open-minded monetary authority nor a simple monetary rule that is being observed religiously by the central bank, is capable enough of making the proper adjustments in the supply of the money. And sweet because it reveals that the monetary equilibrium remains out of the reach of all the central banks and is the accidental result of competitive note issue. Economist, generally rated market forces above the central direction, have been willing to support an exception of a centrally managed channel of exchange. If the bank notes are wholly generic then each of the banks comes up to gain by expanding its note issues even if the confined effect is boundless inflation. If the notes are taken as the specific liabilities for the banks then all the note issues ...