Sjaastad on Deposit Insurance: A Comment

Larry Sjaastad has done what is hard to do. He has written a provocative paper on a subject that has been thoroughly researched and much discussed. The paper begins with a bang. Fractional reserve banking, he tells us, (1) "has changed little over the centuries," (2) "is inherently unstable," and (3) "totally irrational". To preserve fractional reserve banking, despite these flaws, governments have developed deposit insurance and the lender of last resort function. He thinks a better solution would eliminate fractional reserve banking by requiring 100% reserves. This change, he claims, would eliminate the inherent instability.