The Chicago Plan Revisited

My thanks to a couple of people who have pointed me to a new paper by a Jaromir Benes and Michael Kumhof from the IMF called "The Chicago Plan Revisited". The paper will be presented at next meeting of the American Monetary Insitute next month (see the program here). I also note that the appearance of this paper caused the people at the Positive Money group to enter a state of mild shock! It is indeed a real surprise to see an IMF working paper offering support for full reserve banking!

The paper looks really important because, finally, it has a look at some of the key claims made by the authors of the original Chicago Plan - published in the mid 1930s by a group of prominant economists. They were proposing exactly the sort of reforms that an increasing number of authors are arguing for today - including myself. Namely, the abolition of the ability of commercial banks to create credit (money) out of thin air, and the replacement of the money creation mechanims by central banks.

Here's what the abstract of the article says:

"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."

 The text is full of interesting material. For example, when discussing the idea that central banks have can influence the amount of money creation by the commercial bank sector, the authors note that, "the “deposit multiplier” of the undergraduate economics textbook, where monetary aggregates are created at the initiative of the central bank, through an initial injection of high-powered money into the banking system that gets multiplied through bank lending... is simply, in the words of Kydland and Prescott (1990), a myth. And because of this, private banks are almost fully in control of the money creation process."

Nice to hear real economists admitting that this idea is a complete fiction. Commercial banks do precisely what they want.

The authors also note that "This is of course the reason why quantitative easing, at least the kind that works by making greater reserves available to banks and not the public, can be ineffective if banks decide that lending remains too risky." I think we can probably replace the "can be ineffective" by "is ineffective".

Perhaps someone could mention this to Mervyn King and Mario Draghi before they embark on yet another round of completely pointless Quantitative Easing.

Note added 22nd August:

Bill Still has a great and inspirational presentation on this subject  - "IMF Paper Supports Monetary Reform"
Do watch it!