Sunday, 13 January 2013

Do Diamond and Dybvig oppose full reserve banking or not?

This is the last of a little series of posts on criticisms of full reserve put by Messers Diamond, Dybvig, Goodhart and Wolf. Previous items in the series see here, here and here.
A strange aspect of DD’s thinking on banks is that while they criticise full reserve here, in another paper they actually advocate a system that is not a hundred miles from full reserve. To be exact, they propose that, given a crisis, depositors’ freedom to withdraw funds from banks is restricted.
Well now, that is very close to Kotlikoff and Werner’s full reserve proposals.  That is, part of both K and W’s proposals involves restricting the speed at which those who have asked their bank to lend on or invest their money can withdraw such money. 
To expand on that, full reserve is a system under which commercial banks cannot create money. And as regards money which depositors want their bank to lend on or invest, those investors lose access to or have limited access to their money as long as it remains invested.
That way, banks cannot engage in the “money creation” trick of lending on depositors money while promising depositors they still have instant access to their money. The latter “trick” means that every £X deposited effectively becomes £2X because both depositor and borrower have access to £X.
However, DD’s system is crude in that (far as I can see) it makes no distinction between, 1, depositors who SPECIFICALLY WANT instant access to their money and are prepared to pay a penalty for that privilege, and 2, depositors who want their money loaned on or invested.
Some depositors VERY SPECIFICALLY want and need instant access. There would be chaos if millions of depositors who expect instant access were suddenly denied it (wholly or partially). As long as those depositors don’t engage in the “have my cake and eat it” charade of wanting their money invested at the same time as demanding instant access, there is no reason they shouldn’t have instant access.

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