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On the social usefulness of fractional reserve banking

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  • Chari, V.V.
  • Phelan, Christopher

Abstract

In this paper we argue that if monetary policy has insufficient deflation, private agents have incentives to set up alternative payment systems like fractionally backed bank deposits, which pay interest on the means of payment. In a competitive environment with free entry, these alternative systems are inherently fragile in the sense that they are subject to socially costly bank runs. These social costs are not internalized by private individuals and banks and may exceed their social benefits. We argue that as communication technologies improve, the social benefits of fractional reserve banking decrease, but the private benefits may still exceed the private costs so that such systems continue to be used. In such situations, 100% reserve requirements are optimal.

Suggested Citation

  • Chari, V.V. & Phelan, Christopher, 2014. "On the social usefulness of fractional reserve banking," Journal of Monetary Economics, Elsevier, vol. 65(C), pages 1-13.
  • Handle: RePEc:eee:moneco:v:65:y:2014:i:c:p:1-13
    DOI: 10.1016/j.jmoneco.2014.04.008
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    References listed on IDEAS

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    Cited by:

    1. Hugo Rodríguez Mendizábal, 2017. "Narrow Banking with Modern Depository Institutions: Is there a Reason to Panic?," Working Papers 955, Barcelona Graduate School of Economics.
    2. Jakab, Zoltan & Kumhof, Michael, 2015. "Banks are not intermediaries of loanable funds – and why this matters," Bank of England working papers 529, Bank of England.
    3. Jakab, Zoltan & Kumhof, Michael, 2018. "Banks are not intermediaries of loanable funds — facts, theory and evidence," Bank of England working papers 761, Bank of England.
    4. Sanches, Daniel R., 2014. "Banking panics and protracted recessions," Working Papers 14-37, Federal Reserve Bank of Philadelphia.
    5. Sanches, Daniel, 2013. "On the welfare properties of fractional reserve banking," Working Papers 13-32, Federal Reserve Bank of Philadelphia, revised 04 Feb 2013.
    6. Phelan, Christopher, 2015. "Should We Worry About Excess Reserves?," Economic Policy Paper 15-8, Federal Reserve Bank of Minneapolis.
    7. Ennis, Huberto M., 2018. "A simple general equilibrium model of large excess reserves," Journal of Monetary Economics, Elsevier, vol. 98(C), pages 50-65.
    8. Daniel Sanches, 2016. "On The Welfare Properties Of Fractional Reserve Banking," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 57, pages 935-954, August.

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