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Economic Stability Under Alternative Banking Systems

32 Pages Posted: 18 Sep 2012  

Robert E. Krainer

University of Wisconsin - Madison - Department of Finance, Investment and Banking

Date Written: September 14, 2012

Abstract

In this paper we show that in a world where productive investment is allocated according to the CAPM, a fractional reserve banking system that facilitates investing and money creation is not Pareto efficient and leads to excessive productive investment that in turn amplifies future business cycles. These results follow from a model based on CAPM, rational expectations and a linear homogenous production function. The regulatory process should consider going even further than the Volcker rule by restricting bank investments to currency in vault and deposit accounts on the central bank. Nonbank financial institutions should then carry out the risky financial intermediation function and trading now carried out by banks.

Keywords: Economic stability, 100% reserve banking, CAPM, Business Cycles, Pareto Efficiency

JEL Classification: E32, E44, E52, G1, G18, G21

Suggested Citation

Krainer, Robert E., Economic Stability Under Alternative Banking Systems (September 14, 2012). Available at SSRN: https://ssrn.com/abstract=2147888 or http://dx.doi.org/10.2139/ssrn.2147888

Robert E. Krainer (Contact Author)

University of Wisconsin - Madison - Department of Finance, Investment and Banking ( email )

975 University Avenue
Madison, WI 53706
United States
608-263-1253 (Phone)
608-265-4195 (Fax)

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