Legislating Instability

The salient financial crisis of the Scottish free-banking period, the obtrusive exception to the hypothesis of greater financial stability under free banking in Scotland, was made more rather than less likely by precisely those regulated or “unfree” elements of Scottish banking which the author of The Wealth of Nations promoted. Further, this conclusion should hardly be cause for surprise once we realize that it was none other than the oldest, largest, and most established banks in Scotland that had lobbied for Smith’s legal restrictions on banking; regulations that raised barriers to entry, lowered competition in the provision of short-term credit, increased the efficient scale of banking, and therefore amplified the level of systemic risk in Scottish credit markets.

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