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There are negative interest rates now and into the foreseeable future. This must mean there is too much money being offered compared to the demand for loans. Fractional banking acts as a multiplier on the money available for loan takers, so it drives up the supply.

In this extreme situation, perhaps it would be a good idea to gradually phase out fractional banking and return to a simpler and less risky economy.

What would happen to the economy if fractional banking was gradually abolished?

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Fractional banking acts as a multiplier on the money available for loan takers.

Actually, this is subsequently to having taken loans that the money multiplier increases from 1. Fractional banking potentially increases the "money supply", it does not do so performatively. Incidentally this is even why, western economists are currently discussing the possibility of fighting the next downturn with helicopter money.

If I have borrowed, say, a bike, and that I do not plan to use it during the next week, why preclude someone else from borrowing it from me? And the risk that I change my mind and need my bike during the next week is not unmanageable. Especially that the new borrower may have good opportunities to increase to collective wealth.

What would happen to the economy if fractional banking was gradually abolished?

Resources would be suboptimally employed and we would probably enter a long period of recession. Especially that the world currently "needs" inflation and that credit is the main conventional inflation-engine. That being said, at some point, the entire economic system would likely synchronize with this new credit pace, finally leading the world into a new economic regime, slower, with less volatility and with longer business cycles.

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  • $\begingroup$ Would interest rates be normal again? $\endgroup$
    – Rye bread
    Aug 27 '19 at 6:28
  • $\begingroup$ @Rye Given that any real interest rate can be decomposed as the sum of a risk-free rate and a borrower-dependent risk-premium, I see no theoretical reasons why they would be different from what they are currently. Their volatility would be lower though. $\endgroup$
    – keepAlive
    Aug 27 '19 at 6:58
  • $\begingroup$ The last paragraph is speculation at best. For example, fractional reserve banking may impose a limit to overall lending, but the allocation of loans is driven by profit considerations of the banks. Also, there haven't been any reserve requirements in the UK since 1981, and it has been working just fine. $\endgroup$
    – BrsG
    Sep 8 at 15:22
  • $\begingroup$ @BrsG you miss the point. The counterfactual notion here is not about imposing reserve requirements, but imposing full money, which would change the profit maximization program of banks for sure strongly restricting it as least. Anyway, you are in revenge downvote. No time to loose with you and believe it or not, the downvote you receive was not from me. Cheers. $\endgroup$
    – keepAlive
    Sep 8 at 17:42
  • $\begingroup$ @keepAlive: Maybe I miss the point. To me the question reads just as what would happen if we abandoned reserve requirements? Where is the imposition of full money implied? You also didn't state anywhere that your answer is based on that assumptions. Hence the downvote, not out of "revenge". If it was "revenge" I could have downvoted many of your actually quite good answers! $\endgroup$
    – BrsG
    Sep 9 at 8:46

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