May 26, 2022 

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KEMP-ROTH ACT: Officially titled the Economic Recovery Tax Act of 1981, this was a cornerstone of economic policy under President Reagan. The three components of this act were: (1) a decrease in individual income taxes, phased in over three years, (2) a decrease in business taxes, primarily through changes in capital depreciation, and (3) the indexing of taxes to inflation, which was implemented in 1985. This act was intended to address the stagflation problems of high unemployment and high inflation that existed during that 1970s and to provide greater incentives for investment. A primary theoretical justification is found in the Laffer curve relation between tax rates and total tax collections.

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A (hypothetical) method of banking in which banks keep 100 percent of their deposits in the form of bank reserves, meaning there are no deposits available for interest-paying loans. Full-reserve banking is one of two theoretical alternatives designed to help illustrate a contrast to the fractional-reserve banking actually practiced by modern banks. The other alternative is no-reserve banking. With full-reserve a bank essentially operates as a storage business, merely storing customer deposits until they are withdrawn.
Full-reserve banking occurs if banks keep all deposits in reserve. Customers make deposits, which banks then place under the watchful eyes of security guards in their vaults. The money rests peacefully in the vaults until the customers make withdrawals. Every deposit is matched one-for-one by reserves.

Full-reserve banking means that banks have no excess reserves that can be used to make loans. As such banks do not function as financial intermediaries. They do nothing but store deposits.

The Fractional Alternative

Full-reserve banking is a theoretical alternative to fractional-reserve banking. Fractional-reserve banking is a method of banking activity in which banks keep less than 100 percent of their deposits in the form of bank reserves and use the rest for interest-paying loans.

Fractional-reserve banking makes it possible for banks to function as profit-seeking financial intermediaries (matching up lenders and borrowers) while ensuring the safety and liquidity of deposits, especially checkable deposits that are part of the economy's money supply.

Two Goals

Consider how full-reserve banking would work toward the two goals of the modern banking system--profitability as a financial intermediary and safekeeping of deposits.
  • First, the safekeeping goal IS well served with full-reserve banking. Customers are always able to retrieve their deposits. In effect, banks are storage businesses. If bank security is sound, the security guards are alert, and the vault is well-constructed, then deposits should be safely protected.

  • Second, banks would NOT be able to function as financial intermediaries. Banks could make no loans. They would have no excess reserves that could be used for lending. If all banks in the economy practiced full-reserve banking, then some other type of business would have to perform the financial-intermediary function of bringing borrowers and lenders together.

  • Third, banks would not be able to generate profit from interest-paying loans. Profit would have to come exclusively from the storage function. That is, customers would have to pay banks to safely store their money.

  • Fourth, the temptation to use the stockpiles of cash locked away in bank vaults would be enormous. Businesses, consumers, government agencies, and even the bank itself would undoubtedly want to borrow this wealth for capital investment, home construction, car purchases, or government spending. But if banks gave in to this temptation, then they would be back into the financial intermediary business, and doing fractional-reserve banking.

Fred the Goldsmith

A hypothetical example of full-reserve banking is provided by Fred the Goldsmith. Fred is a hypothetical goldsmith who applied his goldsmithing talents (crafting jewelry and other items from gold) during a period in which gold was also used as the medium of exchange.

The key is that Fred naturally acted to keep his own gold, the gold he used as an input in this goldsmithing business, safe and secure in a sturdy vault. The safety offered by Fred's gold-storing vault was not lost on others, such as Bill the Knight, who needed a place to safely store a satchel of gold while he journeyed off to faraway lands doing knightly deeds (dragon fighting, damsel rescuing, etc.).

If Bill the Knight leaves (deposits) 10 pounds of gold with Fred for safekeeping, the retrieves this satchel of gold upon his return, then Fred is practicing full-reserve banking.

The No-Reserve Alternative

To polar opposite to full-reserve banking is no-reserve banking. With this alternative, banks keep 0 percent of deposits in reserve. Every dollar of deposits received by banks is used for loans. In effect, banks are nothing more than a broker or agent that matches up borrowers and lenders. In fact, they probably have no need for a vault.

With no-reserve banking, the profit goal is well served as a financial intermediary, as long as customers continue to make deposits. However, the deposit safekeeping goal is NOT well served. Banks are NOT able to satisfy withdrawal requests from customers, at least not in a timely fashion. With NO reserves, banks cannot "cash" checks. And if customers cannot withdraw funds they are not as likely to deposit funds. If banks have NO deposits then they can make NO loans or function as financial intermediaries.


Recommended Citation:

FULL-RESERVE BANKING, AmosWEB Encyclonomic WEB*pedia,, AmosWEB LLC, 2000-2022. [Accessed: May 26, 2022].

Check Out These Related Terms...

     | banks | banking | fractional-reserve banking | no-reserve banking | reserves | traditional banks | savings and loan associations | credit unions | mutual savings banks | thrift institutions | excess reserves | legal reserves | required reserves | vault cash | Federal Reserve deposits |

Or For A Little Background...

     | money | M1 | profit | industry | monetary economics | government functions | financial markets | liquidity |

And For Further Study...

     | money creation | Federal Reserve System | Federal Deposit Insurance Corporation | Comptroller of the Currency | central bank | monetary policy | bank panic | monetary aggregates | barter |

Related Websites (Will Open in New Window)...

     | Federal Reserve System | Federal Deposit Insurance Corporation | Comptroller of the Currency |

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