Should Banks Create Money?

Christian Wipf

Diskussionsschriften from Universitaet Bern, Departement Volkswirtschaft

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.

JEL-codes: E42 E51 G21 (search for similar items in EconPapers)
Date: 2020-08
New Economics Papers: this item is included in nep-ban, nep-cba, nep-mac, nep-mon and nep-pay
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