College of Humanities and Social Sciences

Banking and Asset Bubbles: Testing the Theory of Free Banking Using Agent-Based Computer Simulations and Laboratory Experiments

William McBride

Major Professor: Daniel Houser

Committee Members: Lawrence H. White, Robert Axtell, Center for Social Complexity

Enterprise Hall, 318
July 06, 2010, 11:00 AM to 01:00 PM


Throughout much of the 18th and 19th centuries, many countries practiced free banking, i.e. competitive note issue without control by a central bank.  Modern day proponents of free banking argue it is capable of limiting business cycles by making for a more stable relationship between the volume of base money present in an economy and corresponding levels of credit and aggregate spending.  The main contribution of this dissertation is to provide a novel test of this claim by using the canonical laboratory double auction asset trading market (CLDAATM) initiated by Vernon Smith and others, which tends to generate asset price bubbles, a key characteristic of business cycles.  Chapter 1 describes a laboratory experiment design which augments CLDAATM using simulated trading and banking agents.  Chapter 2 describes an agent-based model and simulation of CLDAATM using three types of trading strategies: value, momentum, and speculative.  The results closely resemble the asset price bubbles generated in the laboratory.  Chapter 3 augments the design of Chapter 2 by adding an agent-based model and simulation of banking, with the purpose of comparing both free and central banking to CLDAATM.  The results indicate that both free and central banking reduce the tendency to bubble as compared to CLDAATM, and free banking is most effective in this regard.

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