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• The early Riksbank played an important role in providing emergency finance for Sweden. • I find that political and legal restrictions on the Riksbank were at least a proximate cause of Sweden's military defeats. • Policy experimentation at the Riksbank led to inflation and corresponding reductions in economic activity. At the beginning of the 18th century, Sweden was an imperial power that had just sustained a century of modest economic growth. In 1800, Sweden's empire was gone, after a series of military defeats. Real GDP per capita had fallen to the same level as the early 1600s. In other words, the 18th century witnessed the end of the Swedish Empire and a startling reversal of economic progress. In this paper, I propose a possible explanation for both of these outcomes. First, I argue that Sweden's limited fiscal capacity played an important role. The creation of the Riksbank should have facilitated government borrowing and military spending as the Bank of England did for the British. However, the Riksbank was not designed or equipped for this role. I document the constraints on financing national defense through the Riksbank and argue that the bank was ill-equipped to finance an adequate national defense. This explains the reversal of the empire. Second, when the Hats took power in the Riksdag in 1739, they used the Riksbank to give loans to firms, which were financed through the issuance of bank notes. The objective was to increase investment and economic activity. I find no evidence that these loans had any effect on real GDP per capita. However, the resulting inflation has a negative and significant effect on output during the period of inconvertible paper money. The combined evidence suggests that Hat policy contributed to the decline in economic activity during the reversal of fortune. [ABSTRACT FROM AUTHOR]

The article discusses the banking concepts of contingent liability, capital requirements, and their relation to banking and financial reform. It discusses the double liability system in the U.S., bank insolvency, and the marketability and tradability of shares. The author argues that a contingent liability system is preferable to limited liability and that sensible banking reform would incorporate a realignment of bank incentives instead of solely establishing higher capital requirements.