The Broad Consequences of Narrow Banking

TL;DR

This paper examines the macroeconomic impacts of narrow banking using stock-flow consistent models, showing it does not hinder growth and enhances financial stability.

Contribution

It extends the Goodwin-Keen model to include various banking assets and characterizes narrow banking with a full reserve requirement, analyzing its effects.

Findings

Narrow banking does not reduce economic growth in models with finite equilibrium.

Narrow banking improves monitoring and prevents financial breakdowns in explosive scenarios.

Models with narrow banking show different asymptotic behaviors compared to fractional reserve models.

Abstract

We investigate the macroeconomic consequences of narrow banking in the context of stock-flow consistent models. We begin with an extension of the Goodwin-Keen model incorporating time deposits, government bills, cash, and central bank reserves to the base model with loans and demand deposits and use it to describe a fractional reserve banking system. We then characterize narrow banking by a full reserve requirement on demand deposits and describe the resulting separation between the payment system and lending functions of the resulting banking sector. By way of numerical examples, we explore the properties of fractional and full reserve versions of the model and compare their asymptotic properties. We find that narrow banking does not lead to any loss in economic growth when the models converge to a finite equilibrium, while allowing for more direct monitoring and prevention of financial breakdowns in the case of explosive asymptotic behaviour.