On the instability of fractional reserve banking

Heon Lee

European Economic Review, 2025, vol. 178, issue C

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.

Keywords: Money; Banking; Instability; Volatility (search for similar items in EconPapers)
JEL-codes: E42 E51 G21 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:eecrev:v:178:y:2025:i:c:s0014292125001618

DOI: 10.1016/j.euroecorev.2025.105111

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