Munich Personal RePEc Archive

A new justification for full reserve banking?

Musgrave, Ralph S. (2018): A new justification for full reserve banking?

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Most of the money in circulation is created by commercial banks, and it is precisely that form of money creation that explains most bank failures. In contrast, full reserve banking is a system under which that form of money is banned: all money is created by the central bank. There is a very simple reason for such a ban which most if not all advocates of full reserve seem to have missed, which is as follows. Under the existing bank system, those who deposit money at banks with a view to their bank lending on their money so as to earn interest are into commerce, in just the same way as where they deposit money with a stock-broker, mutual fund, private pension scheme or similar with a view to their money being loaned on or invested. And it is a widely accepted principle that taxpayers should not rescue commercial ventures which fail. Yet taxpayer backed deposit insurance is provided for those bank depositors. Thus if the latter principle were adhered to consistently, then there would be no deposit insurance for “interest earning” deposits, while of course totally safe non-interest earning deposits would be available for those who want them. And that “two types of deposit” system is what full reserve has always consisted of. The above point about commercial and non-commercial depositors is similar to, but not quite the same as the more conventional argument for full reserve, which is along the lines that governments cannot allow a series of major bank failures, which inevitably means banks are featherbedded or subsidised (a non-commercial activity) thus some way must be found of removing that subsidy, and one way is full reserve. The first 1,300 or so words below briefly introduce full reserve. The basic argument put in this paper then starts under the heading “Taxpayers should not back commerce.”

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