Full-Reserve Banking Goes Mainstream
Imagine that all bank deposits — the dollars in your checking account — were 100% backed, one-for-one, by your bank’s reserve holdings at the Fed (the modern, fiat-money-world equivalent of gold reserves). Runs on bank deposits would be impossible, because the outfit that issues reserves and currency can’t run out of reserves and currency — any more than a bowling alley can run out of points. You could always take your money out of the bank.
Meanwhile all lending would come from actual investment funds, in which the investors (via equity or debt) are explicitly putting their funds at risk in hopes of getting better returns.
As pointed out by Matthew C. Klein — recently transplanted from The Economist to Bloomberg View — this notion…
…has a long and distinguished academic lineage. Luminaries such as Irving Fisher, Milton Friedman and James Tobin have all advocated it.
For instance, the “Chicago Plan” was developed in the 1930s by Fisher and Henry Simons. Friedman later endorsed it as well. Two researchers at the International Monetary Fund have written an up-to-date appraisal – and the proposal, in theory, does everything its designers claimed 80 years ago. The first 20 pages of this paper are an excellent primer.
Tobin explained the essence of the idea in 1987 at the Federal Reserve’s annual economic symposium in Jackson Hole:
“I think the government should make available to the public a medium with the convenience of deposits and the safety of currency, essentially currency on deposit, transferable in any amount by check or other order…The Federal Reserve banks themselves could offer such deposits, a species of ‘Federal Funds.’”
More recently, Boston University economist Larry Kotlikoff has argued that we need to completely separate money from credit by introducing what he calls “limited purpose banking.” It’s basically the same idea.
Matthew says “This is the remedy advocated by Bloomberg View’s editors.” That’s pretty mainstream.
I’d go even farther and recommend Steve Randy Waldman’s idea of “starter savings accounts,” in which you could get a guaranteed 0% real return — no matter the level of inflation — on up to $200,000 in deposits. This would insulate the real economy from the vagaries of the financial system’s floods and droughts. Got confidence?
These ideas are not as simple as they sound — there are institutional and incentive issues to address. But separating the mundane business of administering holdings and payments from the ever-more-arcane business of lending and investment is not some wacky internet econocrank idea. It’s downright conservative.
Cross-posted at Asymptosis.
I asked somebody at a central bank about this idea once, and they told me their main concern was that the supply of money-at-risk would be too small and the cost and availability of loans would rocket.
Right now we all put our money at risk even though everybody pretends it isn’t (and risk is taken by government deposit insurance etc.) which means banks have little trouble funding loans.
I think this might have something to do with SRW’s idea that sleight of hand has its uses in banking.
@Luis Enrique: Klein does mention that issue. But I always go back to this: at least for independent businesses, lending and finance are *always* at the bottom of the list of business constraints.
And big businesses can always issue bonds or equity.
The financial players really want us to believe that their activities are crucial to the real economy. But in fact it seems that many of them just aren’t.
Steve, in this scenario do we assume that banks create money endogenously? If so, then what effect does this have on “money- supply”?
Problem is the notion of “money,” which is ill-used throughout economic discussion. If I issue new stock certificates or bonds, or make you a loan, am I issuing money? In a very real sense, yes.
You give me $10 in bills. I give you an IOU. There is now $10 in bills *and* an IOU in the world. There wasn’t before.
Run don’t walk to JP Konig:
Thanks Steve, yes referring to banks issuing “money” out of thin air, which if one believes that (Some don’t), then how does full reserve banking effect it. Also some believe banks lend reserves, and some do not. Again, the full reserve banking scenario has different meanings.
Isn’t this kind of what we had with Glass Steagall? The investment activity separated from the you and me banking needs?
In this proposed use of the Fed bank, how would a bank fail? If it’s reserves were used up? But the Fed keeps backing the deposits, so…the reserves get used up?
“lending and finance are *always* at the bottom of the list of business constraints. “
right. well maybe lending and finance would move up the list if the supply of loans contracted sharply.
whichever way you look at it, lots of people (firms, households) borrow money. If full reserve banking would have a large impact on that, well I can see why reasonable people might worry
So, a return of postal savings accounts? We did away with that because we created the FDIC.
Three economic reforms are essential, and full-reserve banking is first. It is the only way we can issue debt-free money without the banks leveraging that money to cause inflation. However, when rich people can no longer magnify their money to lend
even more no credit check loans , they will be inclined to get out of banking and instead buy up our land, making land less affordable for ordinary people. Iceland can avoid that by collecting enough of a tax on land values to make land speculation unprofitable.
Whoever it was at “a central bank” that told you that under full reserve, “supply of money-at-risk would be too small”, is on shaky ground, and for the following reasons.
The amount of money-at-risk would certainly be smaller under full reserve, but under the current fractional reserve system, banks are subsidised. Under full reserve they are not. In short, under full reserve, the amount of money at risk is market determined (which, absent market failure, is presumably the optimum amount of “money-at-risk”). So full reserve is not at fault for putting TOO LITTLE money at risk: the fault is with fractional reserve for putting TOO MUCH money at risk.
As to the idea that introducing full reserve would have a deflationary effect, that’s certainly possible or even likely. But the solution is stimulus. In the U.S. that is difficult, of course, because Congress consists of economically illiterate Neanderthals. In other countries, politicians are less stupid (by a very small margin).
Under full reserve, the only money issued is issued by the government / central bank – i.e. commercial banks aren’t allowed to issue money. No doubt the Wall Street crooks and fraudsters would try to work their way round any such laws. But they then they spend their days trying to evade the law ANYWAY. Wall Street skulduggery is just a given.
A return to postal savings accounts? Yes, that’s right. Or to be more exact, under full reserve, depositors have to choose between, first, 100% safe accounts. Those are in effect government backed, and the relevant money is not invested in commerce: e.g. it could just be lodged at the central bank. Second, depositors can choose to let their bank invest or lend on their money. But in that case depositors foot the bill if it all goes belly up.
At least the latter “two choice” system is central to the full reserve system advocated by Laurence Kotlikoff and by this lot: