Some economists claim that fractional reserve banking is both inherently inflationary and bound to contribute to boom-bust cycles. Theory and history support neither of these claims. Instead, they suggest that an established fractional reserve system may actually prove less inflationary than one restricted to 100% reserves, and that fractional reserves can actually be stabilizing. Because fractional reserves can also carry considerable benefits, including more efficient intermediation and payments, it follows that banning them is likely to do more harm than good. The better way to combat inflation and business cycles is to impose restraints, not on private money creation, but on the money-creating powers of central banks.
George Selgin is the author of The Theory of Free Banking: Money Supply under Competitive Note Issue (1988), Less Than Zero: The Case for a Falling Price Level in a Growing Economy (1997), and Good Money: Birmingham Button Makers, the Royal Mint, and the Beginnings of Modern Coinage (2008).