Icelandic Proposal to Give Central Bank Complete Control of Monetary Supply
In a report ironically titled “A Better Monetary System for Iceland,” government officials in the small North Atlantic nation are considering a policy that would strip commercial banks of the power to increase the money supply through lending. Instead, they would hand all money creation to the central bank – in essence, completely nationalizing the banking sector. If this proposal were to pass, it could restrict credit available for entrepreneurs and politicize who is able to get loans.
Under fractional reserve central banking, commercial banks create money when they offer a line of credit to consumers. When a bank decides to make a loan, it creates a credit in the borrower’s account. This credit is new money in the economy.
Iceland faced a particularly severe economic crash in 2008, which officials blame on the expansion of credit of the preceding boom period. They believe it led to over-speculation and rising inflation. Officials think that the central bank should curtail credit expansion to prevent this from happening again.
The problem is that entrepreneurs and businesses rely on credit. They use it for things like starting ventures and building factories. Even mom-and-pop stores often start with a bank loan. As businesses are successful, they make profits and pay back the loans.
Under this proposal, with the central bank as the only avenue to obtaining credit, business would be completely at the whim of politicians and bureaucrats. This could be disastrous for economic growth, and set the stage for even more interventions as the economy continues to shrink.
Putting this policy into place would also enhance the power of the very institution at fault for the 2008 crash. For a greater understanding of why the central bank is to blame and not commercial banks, see this excellent report from the Mises Institute.
The Mises report explains that due to Icelandic central bank policy, “rates were way too low, banks were too big to fail, housing was implicitly guaranteed, and banks were borrowing short term from abroad to finance long term bonds.” Like the Federal Reserve, their unscrupulous policies resulted in a bubble, which burst in 2008 when credit around the world tightened. Why should Iceland reward the perpetrators of their economic collapse with more power over the economy?
Iceland may seem small and remote, but there is a real risk that the United States could follow a similar path when the current Fed-induced bubble pops. The Federal Reserve is already to blame for what our Chairman Peter Schiff calls the Real Crash ahead. Based on past behavior, it will likely blame the private sector yet again for our falling standard of living. And then? Let’s cross our fingers that the Fed doesn’t try to socialize banking completely.
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