Chicagonomics, a new book by Lanny Ebenstein, describes the evolution of the Chicago school. The book is reviewed by Tyler Cowen in a blog post and by the Economist. From the latter review:
Before the 1940s, Chicago’s professors were much closer to the liberalism of British political economists such as Adam Smith, Jeremy Bentham and John Stuart Mill than the libertarianism of Hayek and Friedman in the 1980s and early 1990s. Mr Ebenstein looks at the ideas of scholars such as Jacob Viner and Frank Knight, and concludes that while they favoured individual freedom, their policy prescriptions did not exclude government action. Both perceived Smith as justifying the state intervening in the economy at times, such as with the provision of infrastructure, education for the young and the funding of arts, culture and science.
By the 1940s, the use of redistribution to ensure that everyone had a basic standard of living was accepted by most Chicago economists. For instance, Henry Simons, when he worked at Chicago between 1939 and 1946, set out how redistribution, by diffusing economic power in a society, was necessary in a free society. Even Hayek, in his libertarian polemic of 1944, “The Road to Serfdom”, supported the use of environmental regulation and state-run social-insurance systems.
After they retired Hayek and Friedman became deeply libertarian. Mr Ebenstein says “the virtual neoanarchism that both preached” later on placed them “outside the classical liberal tradition”. Hayek argued that citizens should have the right to have their taxes refunded if they did not consume government services and Friedman railed “against government at almost any time”. Both enjoyed being in the limelight, even though their views did not fit with their earlier scholarly work. Mr Ebenstein bemoans the current popular perception of the Chicago school, as well as conservatives’ embrace of it, as based on these more extreme later utterances.
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.
The Economist worries about deflation, specifically in the Euro area. The central passages are:
Central bankers can no longer set real (that is, inflation-adjusted) interest rates low enough to restore demand. Wages, incomes and tax revenue all stall, undermining the ability of households, businesses and governments to pay their debts—debts which, in real terms, will grow more burdensome under deflation.
… bad deflation results when demand runs chronically below the economy’s capacity to supply goods and services, leaving an output gap. That prompts firms to cut prices and wages; that weakens demand further. Debt aggravates the cycle: as prices and incomes fall, the real value of debts rise, forcing borrowers to cut spending to pay down their debts, which ends up making matters worse.