Abstract
The full reserve vs fractional reserve debate has been haunting the Austrian school of economics as a thorn in our side. In this article I articulate the solution to the question of which banking system leads to a greater rate of economic growth and elucidate how the adoption of either system would be unlikely to lead to economic disaster.
Introduction
Both full and fractional reserve banks have effects on the economy at large. Fractional reserve banks, through their amalgamation of loanable funds, lower the interest rates on loans for both productive and consumptive endeavors. A full reserve banking system, by locking savings out of the economy, lead to the purchasing power of money being higher than it otherwise would have been for, again, both production and consumption.
Economic Growth
When asking which banking system grows the economy quicker, what is fundamentally being asked is which system puts more purchasing power in the hands of producers relative to consumers. If loanable funds are generally put into the hands of producers as a larger percent of total loanable funds then the general percent of spending is spent on producer goods, then a fractional system will usually encourage more economic growth than it's full reserve counterpart. In the reverse, if loanable funds are usually used for consumption and a higher proportion of outright spending is used on production, then a full reserve system, through its facilitation of an increase in the general purchasing power of money, will be the superior system regarding economic growth.
Incentive Effects
There is still another aspect of the banking system which is important to mention. The interest paid to fractional reserve clients is a positive incentive to save, while the fees paid to a full reserve bank are an incentive to spend. While nothing can be said about the opposing incentive schemes in a positive analysis, to take a normative tone I will comment that an increase in general savings does tend to reduce the chance that a series of, or single unfortunate event will lead someone to become destitute and a burden on society. This leads me to be biased in favor of a fractional reserve banking system, all else equal.
References
https://www.youtube.com/watch?v=UDLCa7maGZA
The full reserve vs fractional reserve debate has been haunting the Austrian school of economics as a thorn in our side. In this article I articulate the solution to the question of which banking system leads to a greater rate of economic growth and elucidate how the adoption of either system would be unlikely to lead to economic disaster.
Introduction
Both full and fractional reserve banks have effects on the economy at large. Fractional reserve banks, through their amalgamation of loanable funds, lower the interest rates on loans for both productive and consumptive endeavors. A full reserve banking system, by locking savings out of the economy, lead to the purchasing power of money being higher than it otherwise would have been for, again, both production and consumption.
Economic Growth
When asking which banking system grows the economy quicker, what is fundamentally being asked is which system puts more purchasing power in the hands of producers relative to consumers. If loanable funds are generally put into the hands of producers as a larger percent of total loanable funds then the general percent of spending is spent on producer goods, then a fractional system will usually encourage more economic growth than it's full reserve counterpart. In the reverse, if loanable funds are usually used for consumption and a higher proportion of outright spending is used on production, then a full reserve system, through its facilitation of an increase in the general purchasing power of money, will be the superior system regarding economic growth.
Incentive Effects
There is still another aspect of the banking system which is important to mention. The interest paid to fractional reserve clients is a positive incentive to save, while the fees paid to a full reserve bank are an incentive to spend. While nothing can be said about the opposing incentive schemes in a positive analysis, to take a normative tone I will comment that an increase in general savings does tend to reduce the chance that a series of, or single unfortunate event will lead someone to become destitute and a burden on society. This leads me to be biased in favor of a fractional reserve banking system, all else equal.
References
https://www.youtube.com/watch?v=UDLCa7maGZA
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