Sunday, October 24, 2010

How Fractional Reserve Banking Works

The scene in It's a Wonderful Life (1946) where George Bailey deals with a bank run at the building & loan association is actually a pretty decent description of the process--and what happens when panic causes depositors to start pulling their money.  Of course, I'm looking for this because I am looking for an entertaining way to explain fractional reserve banking and the boom and bust cycle of the 1815-1840 period.

Fortunately, the Federal Reserve System was established in 1913 to solve the problem of boom and bust cycles thereafter.  (Try not to snicker too much about its great success.)


  1. It won't help for your 19th century material, but here's a fun video for the 20th century.

  2. Well, a good start would be Rothbard's The Mystery of Banking. I read a couple of outstanding posts on this matter a couple of years ago, and saved the links to them. But now, as I suspected, the links are broken. I had saved the contents, as well, though, and have put them in a Google doc, so you should be able to access the document here.

  3. I can't remember which book by Ludwig von Mises that makes this case, but Von Mises makes a very good case that business cycles are caused by interest rates forced unnaturally low: this causes people to think that there are more resources than there really are, and they over-extend themselves, until a "bubble" bursts; and when it does, we're worse off than before the bubble started to grow.

    The housing market bubble is a very good example of this process in action!

  4. A very good video on the Boom-Bust cycle would be this Hayek vs Keynes rap:

    (I like the subtle hint about how Hayek is almost unknown, but Keynes is almost a rock star, at the beginning.)