The Chicago Plan Revisited

whatstherush

Any one come across this working paper by two IMF economists.

It re-examines a theory put forward by some Chicago economists in the 30's where by lenders would be forced to hold 100% reserve backing for deposits and if the lenders needed more money to loan than they have in deposits or assets, they would have to borrow the money directly from the government.

Below is the abstract from it, it seems to promise an awful lot, but if I'm reading it right (I'll freely admit a lot of it went straight over my head), with the government being in ultimate control of what money is being lent, would you just not end up in a Weiner Republic situation, when times got tough the government would just turn on the credit tap.

Abstract
At the height of the Great Depression a number of leading U.S. economists advanced a
proposal for monetary reform that became known as the Chicago Plan. It envisaged the
separation of the monetary and credit functions of the banking system, by requiring 100%
reserve backing for deposits. Irving Fisher (1936) claimed the following advantages for this
plan: (1) Much better control of a major source of business cycle fluctuations, sudden
increases and contractions of bank credit and of the supply of bank-created money.
(2) Complete elimination of bank runs. (3) Dramatic reduction of the (net) public debt.
(4) Dramatic reduction of private debt, as money creation no longer requires simultaneous
debt creation. We study these claims by embedding a comprehensive and carefully calibrated
model of the banking system in a DSGE model of the U.S. economy. We find support for all
four of Fisher's claims. Furthermore, output gains approach 10 percent, and steady state
inflation can drop to zero without posing problems for the conduct of monetary policy

Four Advantages listed in the introduction
The first advantage of the Chicago Plan is that it permits much better control of what
Fisher and many of his contemporaries perceived to be the major source of business cycle
fluctuations, sudden increases and contractions of bank credit that are not necessarily
driven by the fundamentals of the real economy, but that themselves change those
fundamentals. In a financial system with little or no reserve backing for deposits, and with
government-issued cash having a very small role relative to bank deposits, the creation of
a nation’s broad monetary aggregates depends almost entirely on banks’ willingness to
supply deposits. Because additional bank deposits can only be created through additional
bank loans, sudden changes in the willingness of banks to extend credit must therefore not
only lead to credit booms or busts, but also to an instant excess or shortage of money, and
therefore of nominal aggregate demand. By contrast, under the Chicago Plan the quantity
of money and the quantity of credit would become completely independent of each other.

The second advantage of the Chicago Plan is that having fully reserve-backed bank
deposits would completely eliminate bank runs, thereby increasing financial stability, and
allowing banks to concentrate on their core lending function without worrying about
instabilities originating on the liabilities side of their balance sheet.

The third advantage of the Chicago Plan is a dramatic reduction of (net) government
debt. The overall outstanding liabilities of today’s U.S. financial system, including the
shadow banking system, are far larger than currently outstanding U.S. Treasury liabilities.
Because under the Chicago Plan banks have to borrow reserves from the treasury to fully
back these large liabilities, the government acquires a very large asset vis-à-vis banks, and
government debt net of this asset becomes highly negative. Governments could leave the
separate gross positions outstanding, or they could buy back government bonds from
banks against the cancellation of treasury credit.

The fourth advantage of the Chicago Plan is the potential for a dramatic reduction of
private debts. As mentioned above, full reserve backing by itself would generate a highly
negative net government debt position. Instead of leaving this in place and becoming a
large net lender to the private sector, the government has the option of spending part of
the windfall by buying back large amounts of private debt from banks against the
cancellation of treasury credit. Because this would have the advantage of establishing
low-debt sustainable balance sheets in both the private sector and the government, it is
plausible to assume that a real-world implementation of the Chicago Plan would involve
at least some, and potentially a very large, buy-back of private debt.

andrew

whatstherush wrote: »

Any one come across this working paper by two IMF economists.

It re-examines a theory put forward by some Chicago economists in the 30's where by lenders would be forced to hold 100% reserve backing for deposits and if the lenders needed more money to loan than they have in deposits or assets, they would have to borrow the money directly from the government.

Below is the abstract from it, it seems to promise an awful lot, but if I'm reading it right (I'll freely admit a lot of it went straight over my head), with the government being in ultimate control of what money is being lent, would you just not end up in a Weiner Republic situation, when times got tough the government would just turn on the credit tap.

I had a look at some of it (but not all of it since it's pretty long). I'm not sure I understand fully the benefits they outline though. I don't really see how 'there'll be less debt' is a good thing, since debt isn't inherently a bad thing. And bank runs, given the existence of deposit insurance, don't really seem to be a thing any more. And would the main benefit (smoother business cycles, assuming they're right) outweigh the general decreased lack of credit in the economy? Or in practice is it even possible to limit the amount of credit available in an open economy, or to prevent the emergence of different kinds of credit which would get around any kind of full reserve limitations?

Since I havn't read the entire paper, these are possibly stupid questions/concerns.