Giving Credit Where Credit is Due: Defending Bank-issued Money Against the Resurgent Calls for 'Narrow Banking'

32 Pages Posted: 11 Nov 2015 Last revised: 30 Nov 2017

Scott Burns

Ursinus College; American Institute for Economic Research

Cameron Harwick

The College at Brockport SUNY

Date Written: November 28, 2017

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

JEL Classification: E42, E44, E58, G21, N11, N12, N21

Suggested Citation

Burns, Scott and Harwick, Cameron, Giving Credit Where Credit is Due: Defending Bank-issued Money Against the Resurgent Calls for 'Narrow Banking' (November 28, 2017). 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 Burns (Contact Author)

Ursinus College ( email )

Collegeville, PA 19426-2562
United States
2259371098 (Phone)
2259371098 (Fax)

HOME PAGE: http://www.scottburnsecon.com

American Institute for Economic Research

PO Box 1000
Great Barrington, MA 01230
United States

Cameron Harwick

The College at Brockport SUNY ( email )

Brockport, NY 14420
United States

HOME PAGE: http://https://cameronharwick.com

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