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Stock market booms, endogenous credit creation and the implications of broad and narrow banking for macroeconomic stability

Author

Listed:
  • Carl Chiarella

    (University of Technology, Sydney)

  • Peter Flaschel

    (Bielefeld University)

  • Florian Hartmann

    (University of Osnabruck)

  • Christian R. Proaño

    () (Department of Economics, New School for Social Research)

Abstract

In this paper we study the implications of the present broad banking system for macroeconomic stability. We show that when commercial banks are allowed to trade in financial assets (here equities) as a substitute for traditional lending, the macroeconomic system is likely to be an unstable one. We then consider a narrow banking system defined by a Fisherian 100 percent reserve ratio for checkable deposits and the ban for commercial banks from trading in stocks and other financial assets. Within the stylized theoretical framework set up here, we show that in the second system macroeconomic stability is guaranteed by some weak assumptions on the behavior of economic agents. Moreover, while a sufficient loan supply can be guaranteed in such a framework, the rationale for bank runs can be eliminated, in contrast to what is likely to happen under traditional broad banking. Though narrow banking is an extreme banking system unlikely to be adopted in the short-run, its features highlight the stability and efficiency properties that the separation between commercial and investment banking bring about.
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Suggested Citation

  • Carl Chiarella & Peter Flaschel & Florian Hartmann & Christian R. Proaño, 2011. "Stock market booms, endogenous credit creation and the implications of broad and narrow banking for macroeconomic stability," Working Papers 1107, New School for Social Research, Department of Economics.
  • Handle: RePEc:new:wpaper:1107
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    File URL: http://www.economicpolicyresearch.org/econ/2011/NSSR_WP_072011.pdf
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    References listed on IDEAS

    as
    1. repec:eee:joecas:v:7:y:2010:i:2:p:105-137 is not listed on IDEAS
    2. Gary B. Gorton, 2010. "Questions and Answers about the Financial Crisis," NBER Working Papers 15787, National Bureau of Economic Research, Inc.
    3. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
    4. Xavier Freixas & Jean-Charles Rochet, 2008. "Microeconomics of Banking, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262062704, January.
    5. James R. Barth & R. Dan Brumbaugh & James A. Wilcox, 2000. "Policy Watch: The Repeal of Glass-Steagall and the Advent of Broad Banking," Journal of Economic Perspectives, American Economic Association, vol. 14(2), pages 191-204, Spring.
    6. Tobias Adrian & Emanuel Moench & Hyun Song Shin, 2010. "Macro Risk Premium and Intermediary Balance Sheet Quantities," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 58(1), pages 179-207, August.
    7. Jean-Charles Rochet, 2008. "Introduction to Why Are There So Many Banking Crises? The Politics and Policy of Bank Regulation," Introductory Chapters,in: Why Are There So Many Banking Crises? The Politics and Policy of Bank Regulation Princeton University Press.
    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Nikolaidi, Maria, 2014. "Margins of safety and instability in a macrodynamic model with Minskyan insights," Structural Change and Economic Dynamics, Elsevier, vol. 31(C), pages 1-16.
    2. Florian Hartmann & Matthieu Charpe & Peter Flaschel & Roberto Veneziani, 2016. "A Basic Model of Real-Financial Market Interactions with Heterogeneous Opinion Dynamics," Working Papers 104, Institute of Empirical Economic Research, Osnabrueck University, revised 26 May 2016.
    3. repec:eee:dyncon:v:91:y:2018:i:c:p:257-288 is not listed on IDEAS
    4. Patrizio Laina, 2015. "Money Creation under Full-reserve Banking: A Stock-flow Consistent Model," Economics Working Paper Archive wp_851, Levy Economics Institute.
    5. Matthieu Charpe & Peter Flaschel & Florian Hartmann & Roberto Veneziani, 2012. "Towards Keynesian DSGD (isequilibrium) Modelling: Real-Financial Market Interactions with Heterogeneous Expectations Dynamics," IMK Working Paper 93-2012, IMK at the Hans Boeckler Foundation, Macroeconomic Policy Institute.
    6. Yannis Dafermos, 2015. "Debt cycles, instability and fiscal rules: a Godley-Minsky model," Working Papers 20151509, Department of Accounting, Economics and Finance, Bristol Business School, University of the West of England, Bristol.
    7. Patrizio Lainà, 2015. "Proposals for Full-Reserve Banking: A Historical Survey from David Ricardo to Martin Wolf," Economic Thought, World Economics Association, vol. 4(2), pages 1-1, September.
    8. Peter Flaschel & Sigrid Luchtenberg, 2012. "Roads to Social Capitalism," Books, Edward Elgar Publishing, number 14812, December.

    More about this item

    Keywords

    Fiancial markets; credit creation; broad and narrow banking; instability;

    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian
    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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