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On the Instability of Fractional Reserve Banking

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  • Heon Lee

Abstract

This paper develops a dynamic monetary model to study the (in)stability of the fractional reserve banking system. The model shows that the fractional reserve banking system can endanger stability in that equilibrium is more prone to exhibit endogenous cyclic, chaotic, and stochastic dynamics under lower reserve requirements, although it can increase consumption in the steady-state. Introducing endogenous unsecured credit to the baseline model does not change the main results. The calibrated exercise suggests that this channel could be another source of economic fluctuations. This paper also provides empirical evidence that is consistent with the prediction of the model.

Suggested Citation

  • Heon Lee, 2023. "On the Instability of Fractional Reserve Banking," Papers 2305.14503, arXiv.org, revised Apr 2024.
    • Handle: RePEc:arx:papers:2305.14503
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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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