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government deficits and pressure to print money to boost the economy artificially until the next election. Because both will always exist with self-interested politicians, the only permanent remedy is to take the monetary steering wheel out of the Federal Reserve’s hands and return it to the people.

This could be done by abolishing the federal role in money altogether, allowing the use of commodity money, or embracing a strict monetary-policy rule to ward off political meddling. Of course, neither free banking nor a allowing commodity-backed money is currently being discussed, so we have formulated a menu of reforms. Each option involves trade-offs between how effectively it restrains the Federal Reserve and how difficult each policy would be to implement, both politically for Congress and economically in terms of disruption to existing financial institutions. We present these options in decreasing order of effectiveness against inflation and boom-and-bust recessionary cycles.

Free Banking. In free banking, neither interest rates nor the supply of money is controlled by the government. The Federal Reserve is effectively abolished, and the Department of the Treasury largely limits itself to handling the government’s money. Regions of the U.S. actually had a similar system, known as the “Suffolk System,” from 1824 until the 1850s, and it minimized both inflation and economic disruption while allowing lending to flourish.”

Under free banking, banks typically issue liabilities (for example, checking accounts) denominated in dollars and backed by a valuable commodity. In the 19th century, this backing was commonly gold coins: Each dollar, for example, was defined as about 1/20 of an ounce of gold, redeemable on demand at the issuing bank. Today, we might expect most banks to back with gold, although some might prefer to back their notes with another currency or even by equities or other assets such as real estate. Competition would determine the right mix of assets in banks’ portfolios as backing for their liabilities.

As in the Suffolk System, competition keeps banks from overprinting or lending irresponsibly. This is because any bank that issues more paper than it has assets available would be subject to competitor banks’ presenting its notes for redemption. In the extreme, an overissuing bank could be liable to a bank run. Reckless banks’ competitors have good incentives to police risk closely lest their own holdings of competitor dollars become worthless.™*

In this way, free banking leads to stable and sound currencies and strong financial systems because customers will avoid the riskier issuers, driving them out of the market. As a result of this stability and lack of inflation inherent in fully backed currencies, free banking could dramatically strengthen and increase both the dominant role of America’s financial industry and the use of the U.S. dollar as the global currency of choice.” In fact, under free banking, the norm is for the dollar’s purchasing power to rise gently over time, reflecting gains in economic productivity. This “supply-side deflation” does not cause economic busts. In fact,