I offer a macroeconomic perspective on the “Reserves for All” (RFA) proposal to let the general public use electronic central bank money. After distinguishing RFA from cryptocurrencies and relating the proposal to discussions about narrow banking and the abolition of cash I propose an equivalence result according to which a marginal substitution of outside for inside money does not affect macroeconomic outcomes. I identify key conditions on bank and government (central bank) incentives for equivalence and argue that these conditions likely are violated, implying that RFA would change macroeconomic outcomes. I also relate my analysis to common arguments in the discussion about RFA and point to inconsistencies and open questions.
Radio Bern RaBe, May 15, 2018. HTML with link to podcast (interview starts at 08:15).
- Interview with Radio Bern RaBe about Vollgeld and the Vollgeld initiative.
SRF, April 28, 2018. HTML with link to audio file (interview starts at 13:15).
- Interview with Swiss public radio about Vollgeld and the Vollgeld initiative.
- The Vollgeld initiative may point to a problem but it does not propose a viable solution.
- Even with Vollgeld, the time consistency friction with its Too-Big-To-Fail implication would persist.
- A more flexible, liberal approach appears more promising.
- It would give the general public a choice between holding deposits and reserves.
- Financial institutions and central banks around the world are pushing in that direction.
In his recent book Geld aus dem Nichts (Money out of Nothing), Mathias Binswanger discusses the role of banks in creating money, and money’s role in affecting the macro economy. The book is written for a non specialist audience and the arguments are often quite loose.
In the first part of the book, Binswanger describes how money mostly is created by commercial rather than central banks.
Part II provides a nice historical overview. Binswanger describes the origins of modern banking with goldsmiths first storing gold for their merchant clients, then lending some of the stored gold to third parties, and finally issuing more “receipts” than what corresponds to the gold deposits they actually accepted. From there, he argues, it was a small step to state licensed national banks like the Bank of England. On p. 120 Binswanger describes how minimum reserve requirements got out of fashion, not least because they suffered from circumvention when they were binding.
Part III lacks precision and is misguided (see also pp. 30 or 66). It covers the link between money creation and growth but confuses national accounting concepts and their relation to money and credit. Clearly, growth can occur without credit (think of an economy with just one agent to see this most directly) but Binswanger seems to dispute this point, in line with earlier writings by his father. A “model” on p. 144 does not help to clarify his views because it is orthogonal to the argument. Binswanger criticizes mainstream economics for refusing to accept the presence of long-run links between money and growth but this critique remains vain. Part IV deals with money creation and its effect on financial markets.
Part V, on reform, is sensible. Binswanger rejects proposals to move (back) to the gold standard or a 100%-money regime (or, essentially equivalent, “positive money”). His arguments against the Swiss “Vollgeld” initiative resonate with points I made here and elsewhere, including the point that it would be difficult to enforce a “Vollgeld” regime (see also p. 122). Binswanger criticizes the “Vollgeld” initiative’s vagueness concerning actual implementation of monetary policy. He ends with more limited, rather standard proposals (relating to regulation, monetary policy objectives and capital requirements) to address problems in financial markets.
Iceland is considering fundamental monetary reform. A report (PDF) by Frosti Sigurjónsson, Member of Parliament, discusses problems under the current fractional reserve system as well as possible alternatives. The report was commissioned by the prime minister (website of the Prime Minister’s office).
The report argues that the Central Bank of Iceland lost control over the money supply. Commercial banks lent pro-cyclically; they effectively forced the Central Bank to provide base money when needed; the Central Bank’s interest rate policy didn’t suffice to keep the growth of broad monetary aggregates in check; money creation by commercial banks shifted seignorage revenue from the Central Bank to commercial banks; and the deposit insurance accompanying the fractional reserve system encouraged risky lending, distorted competition and gave way to taxpayer funded bailouts when systemic banks collapsed.
The report discusses the Sovereign Money proposal (Fischer 1930s; Huber and Robertson 2000; Dyson and Jackson 2013) according to which all physical and electronic money is created by the Central Bank; commercial banks administer transaction payments and serve as intermediaries; new money is brought into circulation by way of transfers from the Central Bank to the Treasury; and the Central Bank may also lend funds to commercial banks which in turn lend these funds to businesses.
The report recommends that either the Central Bank proactively enforces credit controls or, preferably, that money power is secured with the state owned Central Bank (p. 17). The report recommends to commission a feasibility study of the implementation of the Sovereign Money proposal in Iceland.
Concerning the Sovereign Money proposal, I remain favorable as far as the analysis of the problem is concerned but rather skeptical regarding the proposed solution. In particular, I remain very skeptical as to whether a Sovereign Money regime could be enforced at all. I have previously described and evaluated the Swiss version of the Sovereign Money proposal—the “Vollgeldinitiative.” And I have made an alternative proposal for monetary reform (see also here).
Narrow banking proposals are fashionable. Here is a selective list of contributions to the debate:
- Cantillon (1755) and Mises (1912) argue that money creation leads to distortions.
- The 100% reserve proposal by Irving Fisher and his colleagues in the 1930s is reviewed by William Allen in the article “Irving Fisher and the 100 Percent Reserve Proposal” (Journal of Law and Economics, 1993). The article covers precursors to the 1930s debate; the March 1933 memorandum by University of Chicago economists; the March 1939 “Program for Monetary Reform;” and Friedman’s “Program for Monetary Stability.” See also Wikipedia on the “Chicago Plan”.
- In 1990, Tyler Cowen and Randal Kroszner wrote an article entitled “Mutual Fund Banking: A Market Approach” in the Cato Journal.
- In the early 2000s, Joseph Huber and James Robertson proposed a “plain money” reform (website with links to various documents). Grass root movements pushing for monetary reform in several countries reference their work.
- On May 14, 2009, Laurence Kotlikoff and John Goodman proposed a system of “Limited Purpose Banking” in New Republic, and in 2010 Kotlikoff published the book “Jimmy Stewart Is Dead: Ending the World’s Ongoing Financial Plague with Limited Purpose Banking.” According to the proposal, “all financial corporations engaged in financial intermediation, including all banks and insurance companies, would function exclusively as middlemen who sell safe as well as risky collections of securities (mutual funds) to the public. They would never, themselves, own financial assets. Thus, they would never be in a position to fail because of ill-advised financial bets.” On July 17, 2010, Tyler Cowen criticised the proposal in a blog post; Kotlikoff responded on August, 3 and Cowen responded in turn on August, 4.
- In August 2012, Jaromir Benes and Michael Kumhof published an IMF Working Paper entitled “The Chicago Plan Revisited” (revised paper, slides [pages 18–29 display the balance sheet changes]). Benes and Kumhof write in the abstract: “We study [Irving Fisher’s (1936)] claims [about the advantages of the Chicago Plan] 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 …” Benes and Kumhof also argue that the plan eliminates the zero-lower-bound problem (see my post on other proposals to eliminate the zero-lower-bound problem).
- On April 16, 2014, John Cochrane advertised his paper “Toward a Run-Free Financial System” in a blog post. Key points in the paper are: The recent financial crisis involved a systemic run. Accordingly, one should eliminate run-prone securities rather than guaranteeing them and regulating bank assets. Banks should have to back demand deposits, fixed-value money-market funds or overnight debt by short-term treasuries; they would have to finance risky investments from equity or long-term debt. Fully equity-financed banks (that are difficult to resolve) could still be held by downstream institutions that issue debt (and are easy to resolve). Leverage should be regulated by means of Pigouvian taxes rather than quotas and ratios. Modern technology and large public debt stocks render narrow banking feasible: Treasury-backed or floating-value money-market fund shares can be used for payments; risky assets are highly liquid and can easily be sold and bought for transaction purposes.
- On June 3, 2014, the Swiss group “Monetäre Modernisierung” started to collect signatures with the aim to force a national referendum on changes to the Swiss constitution. In the tradition of Joseph Huber’s work, the group aims at abolishing all money except for base money. See my post on the initiative.
- On June 5, 2014, the Economist’s Free Exchange blog covered the narrow banking idea, somewhat sceptically. John Cochrane argued that the post suffered from misconceptions.
- On July 27, 2014, John Cochrane discussed Sheila Bair’s opposition against letting the broader public hold reserves. On August 21 and September 22, 2014, he approvingly discussed (here and here) the Fed’s balance sheet policy from a financial stability perspective. He published another related post on September 17. On November 21, 2014, he interpreted minutes of an FMOC meeting as suggestive evidence of plans to establish segregated cash accounts. These deposit accounts would be backed by central bank reserves. They would be safe and run proof, and the link to (interest paying) reserves would facilitate a rate rise by the Fed.
- In August 2014, Ralph Musgrave published a paper that defends the full reserve banking model against various criticisms.
- In December 2014, Romain Baeriswyl published a paper that discusses narrow banking proposals in light of Cantillon (1755), Mises (1912) and Fisher (1936).
I have discussed pros and cons of narrow banking against the background of the Swiss “Vollgeldinitiative.” The issue of segregated cash accounts connects the narrow banking debate to the debate on government provided electronic money that I discuss in another post.
This post has been updated and extended after the initial publication.
On June 3, 2014 the Swiss group “Monetäre Modernisierung” (monetary modernisation) started to collect signatures with the aim to force a national referendum on changes to the Swiss constitution. (The group needs to collect 100,000 signatures within an 18 month period in order to succeed.) The referendum would put the “Vollgeldinitiative” (sovereign money initiative) to vote, an initiative that seeks to fundamentally change Switzerland’s monetary system. The group “Monetäre Modernisierung” is part of a broader international movement with partner groups in the UK, the European Union and the US.
According to the proposal, deposit claims vis-a-vis commercial banks would be transformed into claims vis-a-vis the central bank and deposit liabilities of commercial banks would be transformed into liabilities of those banks vis-a-vis the central bank. Within a certain time span, commercial banks would have to repay those liabilities. Moreover, they would be prohibited from ever creating deposits again—that is, all money should be base money. The proposal envisions the Swiss National Bank to bring new base money into circulation by transferring reserves to the treasury, allowing the government to partly finance its expenditures by means of “original seignorage,” or to citizens. The Swiss National Bank could also lend reserves to banks, against interest, to accommodate fluctuations in money demand. (The resulting interest seignorage would add to government revenues as well.) The initiative aims at a complete separation between money and debt; accordingly, base money would be booked as equity in the central bank’s balance sheet rather than debt.
The proposal goes further than Irving Fisher’s 100% money plan and other proposals for full-reserve banking (and narrow banking) where banks are required to keep the full amount of deposited funds in cash/reserves (or very liquid, safe assets). Under the “Vollgeldinitiative,” the amount of deposited funds does not only have to be kept in cash/reserves but deposits are abolished altogether.
Some background information (in German):
- The text of the proposed constitutional amendment, with explanations.
- Background paper by one of the intellectual father’s of the initiative, Joseph Huber. He explains that the name “Vollgeld” is the short form of “voll gültiges gesetzliches Zahlungsmittel,” or legally speaking, “unbeschränktes gesetzliches Zahlungsmittel.”
Some quotes from the Q&A section on the technical implementation of the proposed reform (in German):
Die Girokonten der Kunden werden aus der Bankenbilanz herausgelöst und separat als Vollgeldkonten geführt. Die Guthaben auf den Girokonten bleiben eins zu eins bestehen, werden Vollgeld und somit zu gesetzlichen Zahlungsmitteln gleich Münzen und Banknoten. Ab dann ist nur noch die Nationalbank autorisiert Zahlungsmittel zu schöpfen. Dadurch geschieht mit dem unbaren Giralgeld heute das gleiche wie vor hundert Jahren mit den Banknoten. …
Das bisherige Banken-Giralgeld wird von Gesetzes wegen zu Vollgeld umdeklariert. Liesse man es dabei bewenden, kämen die Banken mit einem Schlag in den Besitz von Vollgeld, obwohl sie nicht das (neue) Vollgeld, sondern nur das (alte) Giralgeld geschaffen haben. Deshalb übernimmt die Nationalbank im Moment der Umstellung alle bisherigen Giralgeld-Verbindlichkeiten der Banken und verpflichtet sich damit, den Bankkunden anstelle von Bankengiralgeld Vollgeld auszuzahlen. Diese Auszahlung erfolgt sofort, damit die umlaufende Geldmenge nicht vermindert wird, und sie erfolgt auf Geldkonten ausserhalb der Bankbilanz, also auf Konten, auf die die Bank keinen Zugriff mehr hat. Für die Bankkunden ist diese Umstellung äusserst relevant: Sie sind jetzt im persönlichen Besitz von gesetzlichem Zahlungsmittel in der Höhe der bisherigen Sichtkonten, die vor der Umstellung blosse Geldversprechen auf Konten der Bank, aber kein Geld waren. …
Nach der Vollgeld-Umstellung gibt es nur noch Nationalbank-Geld. Das elektronische Geld ist genauso vollwertiges Geld wie heute Münzen und Banknoten. Das heisst, die Vollgeld-Zahlungsverkehrskonten der Kunden befinden sich dann nicht mehr in der Bilanz der Banken, sondern diese werden von Banken wie heute Wertpapierdepots verwaltet. Das Geld auf dem Konto gehört nur dem Kunden, wie das Bargeld im Tresor, und ist nicht mehr wie heute, eine Forderung an die Bank. So hat auch der Zahlungsverkehr nichts mehr mit Forderungen und Verpflichtungen zwischen den Banken zu tun, weshalb das heute übliche Banken-Clearing unnötig wird. Wenn ein Kunde eine Überweisung an einen Kunden tätigt, wird einfach Vollgeld von einem Konto auf das andere transferiert. Es passiert dann das, was fast alle Menschen heute meinen, was bei einer Überweisung geschieht.
Diese direkte digitale Übertragung von Vollgeld vereinfacht den Zahlungsverkehr, da die bisherige komplizierte Verrechnung von Forderungen und Verbindlichkeiten zwischen den Banken und eventueller Ausgleich mit Nationalbank-Guthaben entfällt. Statt dessen können Überweisungen sofort ausgeführt und gebucht werden, genauso wie heute der Kauf von Aktien und Wertpapieren. Die bisherige Wartezeit von mehreren Tagen, bis das Geld ankommt, entfällt. Nach wenigen Minuten wird man den Geldeingang auf dem Konto sehen können.
I discuss the initiative here.
- A 100% money regime reduces the risk of credit bubbles, but requires more and better fine-tuning by the central bank.
- Central banks can already implement higher reserve requirements. If the fact that they don’t reflects policy failure, then the 100% money proposal risks handing more power to one source of the problem.
- A 100% money regime increases financial stability, at least temporarily, but it forces banks to find new sources of funding and lowers the interest rate for depositors, which is fine.
- If lender of last resort support by the central bank occurs at too low interest rates then seignorage revenues are privatised and costs socialised under the current regime. Moving to a 100% money regime would help but so would simple Pigouvian taxation.
- How can a 100% money regime be enforced if market participants end up coordinating to use other securities than deposits as means of payment?
- More stable deposits in a 100% money regime do not imply a more stable banking system unless other regulation is imposed that completely prevents “maturity transformation.”
- Aggregate liquidity cannot be created out of nothing, with or without deposit insurance.
- Societies have to take a stand on whether they want to guarantee broader monetary aggregates than base money. If so, the cost of the guarantee should be privatised. Problems arise if societies pretend not to provide such guarantees but central banks nevertheless feel obliged to step in ex post and market participants are aware of that fact ex ante; bad, self-fulfilling equilibria are the consequence.
- Commitment on the part of policy makers is key; it requires independent central bankers and regulators.
- Changes in bank regulation reflect changed views about whether banks contribute to the social good. Those views have become less favourable.
- In Switzerland, bank secrecy is no longer defended because the perceived cost to the general public exceeds the benefits to the banks.
- Similar doubts start to arise regarding money creation by banks. A proposal to shift to a 100% money regime offers some advantages.