Broad Banking, Financial Markets and the Return of the Narrow Banking Idea

We use a dynamic Keynesian multiplier and rate of return driven adjustment for stock prices to study the role of commercial banks when embedded into such an environment. We first consider a broad banking system where commercial banks are trading in stocks and credit. We show that such a scenario is likely to be unstable. We then consider narrow banking defined by Fisherian 100 percent reserves for checkable deposits and the exclusion of trade in stocks. It is shown that in such a scenario stability is guaranteed by some weak assumptions. We also study the efficiency properties of such a system.