On the social usefulness of fractional reserve banking

Research output: Contribution to journalArticle

3 Citations (Scopus)

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.

Original languageEnglish (US)
Pages (from-to)1-13
Number of pages13
JournalJournal of Monetary Economics
Volume65
DOIs
StatePublished - Jul 2014

Fingerprint

Usefulness
Social benefits
Banking
Social costs
Payment
Communication technologies
Bank runs
Bank deposits
Private benefits
Payment system
Reserve requirements
Monetary policy
Deflation
Incentives
Free entry
Competitive environment
Costs

Keywords

  • Bank runs
  • Cash in advance models
  • Friedman rule
  • Pecuniary externalities

Cite this

On the social usefulness of fractional reserve banking. / Chari, V. V.; Phelan, Christopher.

In: Journal of Monetary Economics, Vol. 65, 07.2014, p. 1-13.

Research output: Contribution to journalArticle

@article{fe170c311af54136b80b3c8c217ed713,
title = "On the social usefulness of fractional reserve banking",
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.",
keywords = "Bank runs, Cash in advance models, Friedman rule, Pecuniary externalities",
author = "Chari, {V. V.} and Christopher Phelan",
year = "2014",
month = "7",
doi = "10.1016/j.jmoneco.2014.04.008",
language = "English (US)",
volume = "65",
pages = "1--13",
journal = "Journal of Monetary Economics",
issn = "0304-3932",
publisher = "Elsevier",

}

TY - JOUR

T1 - On the social usefulness of fractional reserve banking

AU - Chari, V. V.

AU - Phelan, Christopher

PY - 2014/7

Y1 - 2014/7

N2 - 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.

AB - 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.

KW - Bank runs

KW - Cash in advance models

KW - Friedman rule

KW - Pecuniary externalities

UR - http://www.scopus.com/inward/record.url?scp=84904513230&partnerID=8YFLogxK

UR - http://www.scopus.com/inward/citedby.url?scp=84904513230&partnerID=8YFLogxK

U2 - 10.1016/j.jmoneco.2014.04.008

DO - 10.1016/j.jmoneco.2014.04.008

M3 - Article

AN - SCOPUS:84904513230

VL - 65

SP - 1

EP - 13

JO - Journal of Monetary Economics

JF - Journal of Monetary Economics

SN - 0304-3932

ER -