Narrow Banking: History and Merits

George Pennacchi discusses narrow banking in an article in the Annual Review of Financial Economics. He concludes as follows:

During the nineteenth century, US banks were more narrow than they are today, and the narrowest (e.g., those under the Louisiana Banking Act of 1842) appeared resistant to panics. Common modern-banking practices, such as maturity transformation and explicit loan commitments, arose only after the creation of the Federal Reserve and the FDIC.

… There appears to be little or no benefits available from traditional banks that could not be obtained in a carefully designed narrow bank financial system. Most importantly, a narrow-banking system could have huge advantages in containing moral hazard and reducing the overall risk and required regulation of the financial system.

In contrast, the reaction by US regulators to the recent financial crisis was to expand the government’s safety net by raising deposit insurance limits and by giving more financial firms access to insured deposits. Expanding, rather than narrowing, the activities that are funded with insured deposits is justified if one believes that regulation can contain moral hazard when firms have many, complex risk-taking opportunities. Unfortunately, this belief appears dubious if one recognizes that regulators face political and information constraints.

In my view, there is a need for research that considers the optimal design of a financial system when a government regulator is limited in its ability to assess risk. … Research needs to better identify those financial services where government support would produce a net social benefit. Services such as maturity transformation and liquidity insurance may not deserve costly government guarantees. Finally, should further research support the general concept of narrow banking, there are still open questions regarding the specific features of these banks. In particular, how narrow should be these banks’ assets and should their liabilities should be deposits or equity shares (at fixed or floating NAVs) are questions that need better answers.

Capital Flows To and From Switzerland

In a Vox column, Pinar Yeşin argues that

abnormally low values of net flows were not necessarily driven by surges of private capital inflows. In fact, declined capital outflows that are less correlated with capital inflows appear to be the main factor. These findings suggest that the financial crisis generated a breaking point for capital flows to and from Switzerland.

“Notenbankgeld für Alle? (Reserves for Everyone?),” NZZ, 2015

Neue Zürcher Zeitung, February 20, 2015. PDF, HTML. Ökonomenstimme, February 24, 2015. HTML.

  • Allowing the general public to hold reserves at the central bank could help reduce the risk of bank runs and the negative consequences of deposit insurance.
  • It would end the need to accept bank deposits as means of payment although they are not legal tender; this need arises due to prohibitions on cash payments, for tax reasons.
  • But it could also have negative consequences: Money and credit creation by banks would be undermined, with social costs and benefits.
  • Price stability and financial stability could be threatened during the transition period.
  • More technical questions would have to be addressed as well: They concern the payment system or the conduct of monetary policy.
  • Proposals to go further and to abolish cash are not convincing. One suggested benefit—more leeway for monetary policy makers—is over estimated: Negative rates can also be engineered (effectively) through fiscal policy, and they can fully be implemented with a flexible exchange rate between reserves and cash.
  • Another suggested benefit—better monitoring of tax dodgers and criminals—is also overrated; the fixed cost to circumvent the measure would deter minor illegal activity but not major one.
  • But abolishing cash would have severe negative consequences for privacy and could negatively affect financial literacy.
  • Enforcing an abolishment of cash would be difficult. In a free society, any reform to the monetary system is constrained by the requirement that money must remain attractive for its users.

Poverty in Germany

A new report by the Paritätische Gesamtverband argues that income inequality in Germany is on the rise. The data source is a micro census.

Roughly 16% of the population are poor—living in a household with adjusted income of less than 60% of the median household income. For a family of four, the threshold income value amounts to 1873 Euros per month. The share of poor people among the unemployed is roughly 60%, among single parents roughly 40%, and among children roughly 20%. Only 15% of retirees are poor according to the above definition, but this share is rising rapidly. Differences between poverty quotas in more and less poor areas are rising.

Non-Neutral Helicopter Drops

In an August 2014 Economics article, Willem Buiter discussed the conditions for a Friedman-type helicopter drop of money to be effective.

First, there must be benefits from holding fiat base money other than its pecuniary rate of return. Only then will base money be willingly held despite being dominated as a store of value … Second, fiat base money is irredeemable: it is view[ed] as an asset by the holder but not as a liability by the issuer. … Third, the price of money is positive.

Deflation … are therefore unnecessary. They are policy choices. This effectiveness result holds when the economy is away from the zero lower bound (ZLB), at the ZLB for a limited time period or at the ZLB forever.

The feature of irredeemable base money that is key … is that the acceptance of payment in base money by the government to a private agent constitutes a final settlement … It leaves the private agent without any further claim on the government, now or in the future. The helicopter money drop effectiveness issue is closely related to the question as to whether State-issued fiat money is net wealth for the private sector, despite being technically an ‘inside asset’ …

… because of its irredeemability, state-issued fiat money is indeed net wealth to the private sector … even after the intertemporal budget constraint of the State (which includes the Central Bank) has been consolidated with that of the household sector.

Forecasting Exchange Rates

In a Vox column, Michele Ca’Zorzi, Jakub Mućk and Michał Rubaszek argue that exploiting the “Rogoff’s consensus” helps beat the random walk forecast.

… a calibrated half-life PPP model beats overwhelmingly the random walk in relation to real exchange rate forecasting.

… if the speed of mean reversion is estimated, rather than calibrated, the model performs significantly worse than the random walk due to estimation error.

… the mean reverting nature of real exchange rates can be exploited to outperform the random walk in relation to nominal exchange rate forecasting. For both the case of the euro and the dollar we find that the nominal exchange rate has contributed to the mean reversion process of the real exchange rate rather than just followed a random walk.

Parallels between Argentina and Greece

On Project Syndicate, Raquel Fernández and Jonathan Portes offer four lessons from the Argentinian default in 2001 for Greece:

… if the economics are on your side, you can and should ignore politicians prophesying disaster. … a short period of political turmoil can cost surprisingly little compared to a long period of mindless pursuit of misconceived policies. But … Greece must acknowledge that its fundamental problems are of its own making. … Greece is unlikely to enjoy the breathing space provided by a commodity boom. If it is to place itself on the road to a sustainable recovery, it has no time to lose.

Another Estimate of the Haircut on Greek Debt to Come

In a Vox column, Thomas Philippon suggests a 3% rather than 4.5% primary surplus target on fairness grounds. His central points are:

Greece ran a reckless fiscal policy during the boom years, wasting much of the money that it received. There is no question that Greece needs a strong dose of fiscal consolidation. However, Greece’s debt should have been restructured much earlier. This restructuring was prevented by legitimate fears of contagion, and it is not fair to ask Greece to pay for that delay, which reflected a general lack of preparedness among Eurozone policymakers.

Philippon’s estimate is similar to another estimate by Paolo Manasse.

Swiss Leaks

The International Consortium of Investigative Journalists published a report that seems to suggest that HSBC’s Swiss branch violated Swiss laws; helped customers to hide assets; and assisted in money laundering activities. The report is based on information that Hervé Falciani, a former HSBC employee-turned-whistleblower, handed over to French authorities in 2008.

The small print (in the footer of the “Swiss Leaks” website) reads:

There are legitimate uses for Swiss bank accounts and trusts. We do not intend to suggest or imply that any persons, companies or other entities included in the ICIJ Swiss Leaks interactive application have broken the law or otherwise acted improperly.

Additional reporting in The Guardian, FT, NZZ, Süddeutsche Zeitung.

Double Taxation Agreement between Switzerland and Liechtenstein

Günther Meier reports in the NZZ that an updated double taxation agreement between Switzerland and Liechtenstein will come into effect. Switzerland rejected Liechtenstein’s proposal that would allow the principality to levy a source tax on the income of Swiss residents who work in Liechtenstein.

The Purple Plans

Laurence Kotlikoff appeals to “fellow economists and concerned citizens” to endorse plans for

Wealth Inequality, Theory and Measurement

In an NBER working paper, David Weil argues that Thomas Piketty overestimates wealth inequality. In the abstract of the paper, Weil writes:

In Capital in the 21st Century, Thomas Piketty uses the market value of tradeable assets to measure both productive capital and wealth. As a measure of wealth this is problematic because it ignores the value of human capital and transfer wealth, which have grown enormously over the last 300 years. Thus the constancy of the wealth/income ratio as portrayed in his data is an illusion. Further, the types of wealth that he does not measure are more equally distributed than tradeable assets. The approach also incorrectly identifies capital gains due to reduced discount rates as increases in the capital stock.

 

Dietrich Schwanitz’ “Bildung (Cultured Education)”

Dietrich Schwanitz’ book (Wikipedia) covers “Wissen” und “Können” against the background of the German “Bildungskanon”, the liberal education of a cultured, well-bred German-speaker. The very ambition of the endeavor is breath taking and provokes disagreement and objection. But Schwanitz delivers. A lengthy book of nearly 700 pages it is concise and dense and contains lots of food for thought.

Among hundreds of tidbits, here are some:

  • Footnote on the footnote (pp. 461–462).
  • On Switzerland (p. 596):

Was die Schweizer auf dem Hintergrund ihrer eigenen Geschichte bei den Deutschen am wenigsten begreifen, ist, daß sie mit der antiautoritären Kulturrevolution alle bürgerlichen Tugenden so restlos über Bord geworfen haben. Es sind die Tugenden, die ehemals als besonders deutsch galten und jetzt nur noch in der Schweiz eine Heimstatt haben: Solidität, eine gewisse Ordnungsliebe und Pedanterie, Zuverlässigkeit im Ausführen von Aufgaben und Präzision bei der Produktion von Apparaten, und ein Standard der Sauberkeit und Wohlanständigkeit weit über dem europäischen Durchschnitt sowie ein fest verankerter Glaube an Normen und Regeln.

  • In the section about intelligence, a ranking of what might have been the 10 most intelligent men ever (p. 604):

1. John Stuart Mill; 2. Goethe; 3. Leibniz; 4. Grotius; 5. Macaulay; 6. Bentham; 7. Pascal; 8. Schelling; 9. Haller; 10. Coleridge.

  • Short summaries of “books that changed the world” (pp. 635–654).

Viktor Frankl’s “… trotzdem Ja zum Leben sagen (Man’s Search for Meaning)”

The English language translations of Viktor Frankl’s book “… trotzdem Ja zum Leben sagen: Ein Psychologe erlebt das Konzentrationslager” (Wikipedia German, English) were published as “From Death-Camp to Existentialism” and “Man’s Search for Meaning: An Introduction to Logotherapy.” Frankl describes his experience in Auschwitz and other concentration camps with a focus on the psychological changes the inmates went through. The narrative is shocking and Frankl’s ability to maintain a positive attitude to life in spite of the horror he experienced admirable. But I was less impressed by the book than millions of readers before me—it neither provides a systematic account nor a personal narrative.

The sketch “Synchronisation in Buchenwald” at the end of the book (featuring Socrates, Spinoza, Kant, KZ inmates and others) is the best part of the short book. Structured as a stage play it provides insights into Frankl’s thinking.