Reply To: How does fractional reserve banking increase prices?


The money stock decreases only if the bank decides not to issue fiduciary media by extending another loan to another borrower. As long as the bank desires to hold no excess reserves, then the money stock will not shrink.

Even if there is no central bank increasing the reserve of money upon which the banking system issues fiduciary media, the banking system can still steadily increase the money stock by reducing the reserve ratio. In a fractional-reserve system, the reserve ratio is set by the practical limits of redemption of bank money substitutes. Under some configurations of fractional-reserve banking, the banking system can progressively lower the reserve ratio even without a central bank.

Take a look at the relevant sections (e.g., chs. 16-18) of MIses’s Theory of Money and Credit:

For a configuration of free banking on 100 percent reserves, take a look at Joe Salerno’s article in Guido Huelsmann’s new book, Theory of Money and Fiduciary Media: