Can you have a fiat currency without a central bank?

A question from Yahoo! Answers:

Can you have a fiat currency without a central bank?

Currently the United States dollar, and (as far as I know) the rest of the world’s currencies are fiat, that is there are no commodities (gold) supporting the value of the money system. This system is enforced by the Federal Reserve System in the United States, as well as by the other central banks in other countries, who are charged with maintaining monitary stability. They, however, do not seem very well equiped to do so, as can be attested to by all the problems created in the economy by their bad policies (for instance the current “housing crisis” that was caused by the Fed keeping interest rates too low for too long post 9/11). I believe a market based solution would be a better way of insuring monitary stability, however, I can see no way to do this with our current fiat currency. I believe it would be possible to do so with a commodity based currency, however, to do so would require deflating the dollar enough to a point that the USA would be destitute.

You absolutely can have a fiat currency without a central bank. Just put the Treasury (or Ministry of Finance, or whatever else you call it) in charge of monetary policy. The problem with that approach is that the Treasury, headed by a political appointee, will use monetary policy for short-term political gains. An independent central bank, where governors are appointed for longer terms and on a staggered basis is usually more capable of resisting those pressures.

As to gold supposedly supporting the value of money, you are sorely mistaken. Gold, as J.M. Keynes explained back in 1930s, does NOT support the value of money; it is money (and goods and services it buys) that supports the value of gold. When you break the artificial link between gold and money, gold becomes what it really is, a technical metal traded in a highly volatile market. Just look at the history of gold prices; over the last 30 years, gold was traded for anywhere between below $300 and above $600.

As to monetary stability, it is not as desirable as you would think. In many cases, monetary flexibility is more important. A moderate devaluation of national currency and a monetary easing can help a country to end a recession faster or not get into one in the first place. Also, read up on Robert Mundell’s “unholy trinity”; out of three major policy objectives (inflation, unemployment, and exchange rate) you can with, some degree of confidence, control any two. When you choose the exchange rate as your policy target, you automatically lose your ability to impact either inflation or unemployment.

To summarize, as bad as fiat currencies may be, the alternative (a commodity-based currency) is substantially worse.

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