Should Iceland abolish fractional reserve banking?

You are all familiar with their recent financial mishaps in Iceland, note also theirs is not a history of financial stability:

It is fair to say that Iceland’s monetary history has been a turbulent one.  Currency controls in the 1920s to the 1950s were followed by chronic inflation in the 1970s to 1980s, with annual inflation reaching a high of 83% in 1983.  In 1981 it was considered necessary to redenominate the krona with 100 units being replaced by 1 new unit.

That is from a new Frosti Sigurjónsson report (pdf) advocating 100 percent reserve banking for Iceland.  In the “good old days” we had so many arguments against this arrangement — “disintermediation!” — but do those critiques hold up when so many nominal interest rates are in any case negative or close to zero?  In many countries banks may be fated to become money warehouses as it is.

An interesting question is whether Iceland can, with its current size and export profile, ever have monetary and financial stability.  With their exports and thus gdp so depending on fish and aluminum smelting and tourism, no other country shares their economic fluctuations, even roughly.  A fixed rate thus means a non-optimum currency, but a floating rate for 323,002 people may mean perpetual whipsawing from international capital flows, not to mention the risk of acquiring an oversized, hard to bail out banking system, as Iceland did before its Great Recession.

Should I file under Department of Why Not?  What if Scott Sumner asks me how to do this without inducing a collapse in nominal gdp?  If I interpret p.78 of the study correctly, the government will create new money by printing and injecting it into the economy through fiscal policy, as a means of forestalling this problem if need be.  Under this scenario, how powerful does the state become?  On what do they spend the money?

Frosti’s report, by the way, was commissioned by the Prime Minister and it is being taken very seriously.

I believe I first saw notice of this link from Stephen Kinsella.  Here are some responses to the idea.  Zero Hedge seems sympathetic.


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