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Should Banks Create Money?

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  • Christian Wipf

Abstract

The paper compares the welfare properties of two competing organi- zations of the monetary system: The current fractional reserve banking system versus a narrow banking system where inside money is fully backed by outside money issued by the central bank. Using a New Monetarist model, the analysis shows that fractional reserve banking is bene cial because of the interest payments on inside money. Since inside money funds loans, it pays interest, compensating the agents for the in ation tax and thus reducing the welfare costs of in ation. Since narrow banking provides no such compensation fractional reserve banking typically domi- nates narrow banking in terms of welfare. This also holds if outside money pays interest. Only if fractional reserve banking is suciently constrained, narrow banking can yield higher welfare.

Suggested Citation

  • Christian Wipf, 2020. "Should Banks Create Money?," Diskussionsschriften dp2015, Universitaet Bern, Departement Volkswirtschaft.
    • Handle: RePEc:ube:dpvwib:dp2015
    as

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    File URL: https://repec.vwiit.ch/dp/dp2015.pdf
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    References listed on IDEAS

    as
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    Full references (including those not matched with items on IDEAS)

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    More about this item

    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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