Giving Credit Where Credit Is Due: The Benefits of Letting Banks Issue Money

31 Pages Posted: 11 Nov 2015 Last revised: 27 Sep 2016

Scott Burns

George Mason University, Students

Cameron Harwick

George Mason University - Department of Economics

Date Written: September 26, 2016

Abstract

Economists have long debated the relationship of bank credit to the business cycle. The attribution of economic cycles to the "inherent instability" of fractional-reserve banking has been advanced not only by Austrian scholars in the tradition of Murray Rothbard, but also by a number of prominent economists historically including Irving Fisher and University of Chicago icons like Frank Knight, Henry Simons, and a young Milton Friedman. The recent financial crisis has reignited these calls to abolish fractional reserve banking through "narrow banking" or "sovereign money" proposals. This paper rejects this notion and argues that the "pyramid of credit" plays a fundamental role not only in stabilizing economic activity but also in fostering economic development. The instability commonly attributed to pyramiding can be largely mitigated by policy changes far less drastic than the abolition of bank money, and any residual instability is almost certainly worth the dramatic benefits in normal times.

Keywords: Fractional Reserve Banking; Narrow Banking; Chicago Plan; Milton Friedman; Sovereign Money; 100 percent Reserves

Suggested Citation

Burns, Scott and Harwick, Cameron, Giving Credit Where Credit Is Due: The Benefits of Letting Banks Issue Money (September 26, 2016). GMU Working Paper in Economics No. 15-61. Available at SSRN: https://ssrn.com/abstract=2688617 or http://dx.doi.org/10.2139/ssrn.2688617

Scott A Burns (Contact Author)

George Mason University, Students ( email )

Mason Hall, 1st Floor, MSN 3G4
Fairfax, VA 22030
United States

Cameron Harwick

George Mason University - Department of Economics ( email )

4400 University Drive
Fairfax, VA 22030
United States

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