The real-bills doctrine in the light of the law of reflux

This chapter considers the law of reflux and its alternative interpretations: (1) as a monetary policy rule for stabilizing the price level and (2) as rule for individual banks to follow to remain liquid. The chapter argues that Adam Smith endorsed only the second interpretation, and that the motivation for Smith to endorse the real-bills doctrine was his belief that banks were subject to what John Fullarton would later call the law of reflux. The paper discusses Smith’s reasoning in support of the real-bills doctrine in comparison to Fullarton's analysis of the law of reflux as well as Fullarton's equivocal attitude toward the real-bills doctrine.