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Real bills and the Federal Reserve

September 1, 2003


Douglas Clement Editor, The Region
Real bills and the Federal Reserve

The real bills doctrine—developed by John Law, James Steuart and Adam Smith in the 18th century—concerns the relationship of money supply, business credit and banking policy.

Briefly said, the real bills doctrine is the idea that banks should issue credit only on the basis of "real" bills—bills of exchange for goods of real value, such as business inventory—and not in exchange for "fictitious" bills for goods whose value is speculative, such as real estate or financial securities. By issuing notes to merchants for their "real" bills of exchange, said proponents, banks would ensure that repayment is credible, since the loans would be short term and self-liquidating.

The real bills doctrine is noninflationary, advocates claimed, since demand for credit (and issuance of banknotes) is inherently limited by the needs of commercial trade. Real bills proponents thus argued that the means of payment in an economy would expand or contract with the volume of goods produced. As Smith put it in The Wealth of Nations, "the coffers of the bank ... resemble a water-pond, from which, though a stream is continually running out, yet another is continually running in, fully equal." Opponents of real bills, including David Ricardo and Henry Thornton, said distinguishing between real and fictitious goods is difficult if not impossible, and more importantly, the demand and supply of credit is not self-limiting.

Real bills doctrine had a significant role in England's Bullionist Controversy of the early 1800s, and later appeared in debates over that country's Banking Act of 1844. Decades later it reemerged across the Atlantic, playing a prominent part in the framing of the Federal Reserve Act of 1913.

Return to interview with Allan Meltzer.

Douglas Clement
Editor, The Region

Douglas Clement was a managing editor at the Minneapolis Fed, where he wrote about research conducted by economists and other scholars associated with the Minneapolis Fed and interviewed prominent economists.