Full Reserve Banking: More ‘Cranks’ Than ‘Brave Heretics’

Abstract

This paper analyses the main features and policy implications of full reserve banking (FRB) proposals. It argues that whilst FRB advocates recognize the essential endogeneity of the money creation process, they have failed to understand the Post Keynesian and monetary circuitist analyses of endogenous money, which leads them to analytical errors, including: lending activity creates seigniorage privilege for commercial banks; inflation is always and everywhere a monetary phenomenon; the inability of distinguishing the actual from the planned supply of bank loans, and money to be spent from money hoarded; and the debt-free money proposition. The paper also argues that an FRB system is likely to exacerbate financial instability for several reasons, including: the obsessive focus on commercial banks, while ignoring non-bank financial intermediaries and shadow banking; a blind fascination for the safety and security of the payment system, with little consideration for the financing needs of capitalist economies; and an inherent deflationary bias. Furthermore, FRB arrangements would soon be undermined by the development of alternative near-moneys. Finally, FRB will nullify the automatic stabilisers of fiscal policy and lead to a de facto dominance of monetary policy and unelected central bankers over fiscal policy and democratic decision making.