Proposals for Full-Reserve Banking: A Historical Survey from David Ricardo to Martin Wolf
This paper is closed for comments.
Full-reserve banking, which prohibits private money creation, has not been implemented since the 19th century. Thereafter, bank deposits became the dominant means of payment and have retained their position until today. The specific contribution of this paper is to provide a comprehensive outlook on the historical and contemporary proposals for full-reserve banking. The proposals for full-reserve banking became particularly popular after serious financial crises.
As Patrizio Laina documents, most ably, there has been a long history of proposals to introduce ‘narrow banking’, what he in his paper calls ‘Full Reserve Banking’ (FRB), whereby those banks offering transactions balances, i.e. deposits withdrawable into cash on demand, are restricted in the assets which they can hold to absolutely safe assets, i.e. primarily short-dated government securities. In some versions of such proposals, such narrow banks are controlled in such a way that the growth of transaction balances (M1) is totally determined by the State, though in others it may be set via a reversion to a commodity standard, such as the Gold Standard, or by some form of Hayekian competition between ‘free’ banks. Patrizio Laina does extremely well in setting out this history is some detail, including some aspects of the story that were new to me, in particular the discussions between monetary economists and the government, (FDR and Morgenthau) in the USA in the 1930s, though much of this came from the work of Ronny Phillips, which I had not previously read.
So such suggestions represent a ‘hardy perennial’, resurfacing whenever concern mounts about the current working of the banking system. Its putative benefits include the prevention of bank runs, less procyclicality, a more stable growth rate of the monetary base, protection of payment services and banks with less need for public sector (taxpayer) bail-out. But, like many hardy perennials, it can also be described as a common weed in the garden of monetary analysis. I have been arguing against such proposals now for over 25 years; in particular, in my paper on ‘Why do Banks Need a Central Bank?’, Oxford Economic Papers, 1987, and ‘Can We Improve the Structure of Financial Systems?’, European Economic Review, 1993. These were reprinted in my 1995 book on The Central Bank and the Financial System, (Macmillan, as Chapters 1 and 2). I include some key pages from these two chapters as Appendix A and Appendix B to this note. What goes around, comes around. By the time the same set of issues has come around several times, it is an indication that it may perhaps be about time for me to retire!
Let us start with financial stability. If the risky banks, making the loans to the private sector, can issue short-dated liabilities, (even if they cannot issue demand deposits) whether wholesale or retail, say with a tenor of about seven days, then absolutely nothing has been done to make financial stability greater, rather the reverse. The risky banks would still make loans by writing up both sides of the balance sheet, with the exception that the liability side would initially be in the form of a seven day time-deposit rather than a demand deposit. As set out in my earlier work, as replicated in the appendices, this actually would have the counter-productive result of making the banking system more procyclical, more dangerous and more subject to runs. In order to deal with this issue, the liability structure of the risky banks would have to be constrained so that the original maturity of any fixed interest deposit or other borrowing would probably have to be of the order of three months or longer, so that the liability structure would consist entirely of equity and long-dated initial-maturity fixed interest liabilities. Remember that Lehman Bros, whose failure sparked the Great Financial Crisis, had no transactions balances whatsoever; but they did have a large proportion of short-dated wholesale liabilities, which ran.
For obvious reasons, such funding would be considerably more expensive than that facing banks at present. Patrizio Laina argues that opposition to this format came primarily from the banks who might lose their profitability. I am not actually sure that the (risky) banks would become less profitable. For a variety of reasons the charges applied by banks for managing and operating the payments systems do not currently come near to meeting the costs of that exercise. People can make payment in cheque form and use ATMs for free, when actually the process is quite costly for banks, which they do not recoup in charges. There is a great deal of cross-subsidisation in banking at the moment, and banks might actually be more profitable if they did not have to operate the payment system!
On the other hand, it would prove much more expensive, uncertain and disadvantageous to bank borrowers generally, notably and especially SMEs. At the moment businesses facing normal seasonal and other typical fluctuations in cash flows can arrange overdrafts, at very low costs when unused, which can be used as and when the need occurs. Moreover, the cost of using such overdrafts is settled in advance at a margin above the official policy rate, in conditions in which the rules of the game whereby such policy rate gets varied are commonly known and understood. In contrast, with risky banks unable to make loans until they have obtained sufficient financing to do so (i.e. no ability to write up both sides of the balance sheets simultaneously), businesses would have to hold much higher precautionary balances at a very low yield to see them over seasonal and other cash flow fluctuations, and they would be much less certain about the future determination of the rates at which they could borrow and the availability of such borrowing. It is, I think, reasonable to argue that the present structure of the banking system has been set up largely with the interests of the borrower, notably SMEs, at heart, and that a narrow banking system would impinge most adversely on such borrowers. For such reasons, I doubt whether a narrow banking system would prove attractive in practice to the majority of bank clients.
This does not mean that I think that the banking structure, as of 2007, was in the right place; indeed the GFC showed that it was not. There is, of course, the obvious criticism that the banks then were far too highly levered, with insufficient loss-absorbing capital, and with insufficient liquid assets on their own books. Much has now been done to rectify this, on which I have written both to praise and criticise what has been done elsewhere. But I do not think that quite enough has yet been done to improve the structure of the banking system. In particular, the main weakness that I see in the present banking system is the massive shift of banks into the provision of housing mortgages, and long-dated commercial mortgages. As Schularick and Taylor have evidenced in many recent papers, the expansion of such mortgage lending has been the main driver of credit growing much faster than retail deposits, with the gap being filled by short-dated wholesale funding by informed uninsured lenders, ready to run at a moment’s notice; this has also led to a massive worsening of maturity mismatch and leverage. If we really wanted to get banks back to their original safer form, we should do this by a reform of property lending, with such lending undertaken on the basis of long-dated liabilities, such as covered bonds and equity. I have recently written a short note on this, with Enrico Perotti, (forthcoming, 2015).
For all the reasons outlined above and in the appendices, it has been my view, at least for the last 30 years, that the recurrent proposals for narrow banking represent a cul de sac. If you really want to go back to the historical debates on how banking should be operated, I have a very much softer spot and leaning towards the old ‘real bills’ doctrine.
One of the problems of the present banking system is that it seems too procyclical, in that banks are allowed to create credit too expansively in the upturn, leading to a bubble, then in the bust credit gets cut back too severely. But one of the problems with most of the narrow banking (FRB) proposals, is that they make the provision of monetary base far too inelastic. Thus Patrizio Laina notes that David Ricardo’s proposal to restrict the UK note issue, as incorporated in the 1844 Bank Act, was a form of FRB; but he fails to note that in the subsequent 25 years, whenever a real panic occurred, the Bank Act had to be suspended. Also, the Federal Reserve System was introduced in 1913 for the purpose of providing ‘an elastic currency’, following the 1907 crisis. Many of the mechanisms which Patrizio Laina advocates would actually make panics far more severe and devastating because the authorities would be constrained, e.g. by rules, from expanding liquidity in the way that was done in 2008/9. In a panic the authorities have to do whatever it takes, and to some large extent whatever it takes varies with conditions. Thus an FRB which is not operated by the discretion of an (independent) central bank might prove to be far worse for financial stability than the present arrangements for the banking system.
Finally, Patrizio Laina, like many others proposing these sorts of suggestion, appears to assume that they know what form money takes. But in practice, our monetary and financial system evolves over time, and is an ever-changing social structure. If we try to regulate it in such a way that it does not meet the immediate desires of society, society will change the (institutional) form in which credit is provided and payments are made. I have tried to argue that forcing all credit provision to be done on the basis of long-term liabilities would not be in the best interests of most of society, and, if so, they will get around such government regulations. Financial intermediation is probably on the verge of considerable structural change anyhow, since information is at the heart of financial intermediation and information technology has yet to bring about the full range of likely future structural changes that may occur over the next decade or two. In the face of such potential structural changes, the attempt to constrain the core of the financial system into the proposed division of narrow banks and risky lenders will not work in any case.
1.3 BANK PORTFOLIOS AND CENTRAL BANK SUPPORT
It would appear, therefore, that the provision of payments’ (monetary) services on units offered by collective investment intermediaries would not, ipso facto, require the involvement of the authorities (the Central Bank) to monitor and regulate the provision of such services. The next question is whether the withdrawal of commercial banks from the provision of payments’ services, (so that demand deposits, NOW accounts, and the like were no longer offered), would absolve the Central Bank from its central concern with the well-being of the banking system. If banks offered only time deposits, CDs, etc., leaving payments’ and transactions’ services to others, would there be any need for special support for the banking system?
The answer to this, I believe, is that cessation of payments’ services would make little difference to banks’ riskiness or to the real basis of Central Bank concern with the banking system. There is little, or no, evidence that demand deposits provide a less stable source of funds than short-dated time deposits, CDs or borrowing in the inter-bank market; rather the reverse appears to be the case. Recent occasions of runs on banks have not involved an attempt by the public to move out of bank deposits into cash, but merely a flight of depositors from banks seen as now excessively dangerous to some alternative placement (not cash). The Fringe Bank crisis in 1971-4 in the the UK, and Continental-Illinois, are instances of this, and earlier U.S. historical experience examined by Aharony and Swary (1983) points in the same direction. Earlier, it was suggested that flows of funds from one collective investment fund to another would not have damaging repercussions for the payments’ system, were such funds offering monetised units and providing the (bulk of) such services. Yet I shall argue that, even were banking to be entirely divorced from the provision of payments’ services, such flows between banks would be extremely damaging for the economy, and would require a continuing support role for a Central Bank to prevent and, if necessary, to recycle such flows.
The reasons why this is so are to be found in the fundamental raison d’être of banking itself. In particular, consider why there is a need for banks to act as intermediaries in the first place? Why cannot people simply purchase the same diversified collection of assets that the bank does? There are, of course, advantages arising from economies of scale, and the provision of safe-keeping services, but these could be obtained by investing in a collective investment fund. The key difference between a collective investment fund and a bank is that the former invests entirely, or primarily, in marketable assets, while the latter invests quite largely in non-marketable (or, at least, non-marketed) assets.
Why do borrowers prefer to obtain loans from banks rather than issue marketable securities? The set-up costs required to allow a proper market to exist have represented, in practice, formidable obstacles to the establishment of markets in the debt and equity obligations of persons and small businesses. Underlying these are the costs of providing sufficient public information to enable an equilibrium fundamental value to be established (e.g. the costs of issuing a credible prospectus), and the size of the expected regular volume of transactions necessary to induce a market maker to establish a market in such an asset. In this sense, as Leland and Pyle (1977), Baron (1982) and Diamond (1984) have argued, the particular role of banks is to specialise in choosing borrowers and monitoring their behaviour. Public information on the economic condition and prospects of such borrowers is so limited and expensive, that the alternative of issuing marketable securities is either non-existent or unattractive.
Even though banks have such an advantage (vis-à-vis ordinary savers) in choosing and monitoring prospective borrowers, they too will be at a comparative disadvantage, compared with the borrower, in assessing the latter’s condition, intentions and prospects. Even though there would be advantages in risk sharing resulting from extending loans whose return was conditional on the contingent outcome of the project for which the loan was raised, it would reduce the incentive on the borrower to succeed, and the bank would have difficulties in monitoring the ex post outcome. Businessmen, at least in some countries, are sometimes said to have three sets of books, one for the tax inspector, one for their shareholders, and one for themselves. Which of these would the banks see, or would there be yet another set of books.
In order, therefore, to reduce information and monitoring costs, banks have been led to extend loans on a fixed nominal value basis, irrespective of contingent outcome (with the loan further supported in many cases by collateral and with a duration often less than the intended life of the project to enable periodic re-assessment). Even so, both the initial, and subsequent, valuation of the loan by a bank does depend on information that is generally private between the bank and its borrowers, or, perhaps, known only to the borrower. Thus the true asset value of the bank’s (non-marketed) loans is always subject to uncertainty, though their nominal value is fixed, subject to accounting rules about provisions, write-offs, etc. Under these conditions it will benefit both bank and depositor to denominate deposit liabilities also in fixed nominal terms. The banks will benefit because the common denomination will reduce the risk that would arise from reduced covariance between the value of its assets and of its liabilities (as would occur, for example, if its liabilities were indexed, say to the RPI, and its assets were fixed in nominal value, or, alternatively if its assets fluctuated in line with borrowers’ profits while its liabilities were fixed in nominal value). The depositor would seek fixed nominal deposits from the bank for the same reason that the bank sought fixed nominal value terms from borrowers: depositors cannot easily monitor the actual condition, intentions and prospects of their bank, so that information and monitoring costs are lessened, and the incentives on the bank to perform satisfactorily are increased, by denominating deposits in fixed nominal terms.
The combination, however, of the nominal convertibility guarantee, together with the uncertainty about the true value of bank assets, leads to the possibility of runs on individual banks and systemic crises. Moreover, once the nominal convertibility guarantee is established, the effect of better public information on banks’ true asset values is uncertain. For example, ‘hidden reserves’ were once justified by practical bankers as likely to reduce the likelihood of runs and to maintain confidence. Again, Central Bankers have been, at most, lukewarm about allowing a market to develop in large syndicated loans to sovereign countries, whose ability to service and repay on schedule was subject to doubt, because the concrete exhibition of the fall in the value of such loans could impair the banks’ recorded capital value, and potentially cause failures. An economist might ask who was being fooled? Yet on a number of occasions financial institutions have been effectively insolvent, but, so long as everyone steadfastly averted their gaze, a way through and back to solvency was achieved.
Be that as it may, under these conditions of private and expensive information, and fixed nominal value loans, any major flow of funds between banks is liable to have deleterious effects on borrowers, as well as on those depositors who lose both wealth and liquidity by having been left too late in the queue to withdraw when the bank(s) suspended payment. Even if the prospects of the borrower of the failed bank are at least as good as on the occasion when the borrower first arranged to loan, the borrower will have to undergo expensive search costs to obtain replacement funds. Assuming the borrower searched beforehand, and found the ‘best’ deal, the likelihood is now that the borrower will obtain less beneficial arrangements.
Bank runs, however, tend to happen when conditions for many borrowers have turned adverse. The suspicion, or indeed the knowledge, of that is what prompted the run in the first place. Accordingly the expected value of the loans of many borrowers will have fallen. If they are forced to repay the failing bank, by the receiver to meet the creditors’ demands, they would not be able to replace the funds required on the same terms, if at all, from other banks. Thus bank failures will place the economic well-being, indeed survival, of many borrowers at risk, as well as impairing depositors’ wealth. Consequently flows of funds from suspect banks to supposedly stronger banks can have a severely adverse effect on the economy, even when there is no flight into cash at all. A Central Bank will aim to prevent, and, if that fails, to recycle such flows — subject to such safeguards as it can achieve to limit moral hazard and to penalise inadequate or improper managerial behaviour.
Given that depositors always had the alternative of holding safe short-dated Government debt, such as Treasury Bills, so that banks had to pay a competitive rate for deposits, much of the benefit accruing to banks from explicit/implicit insurance, and hence lower capital ratios, may have been passed on in the form of more competition for, and hence lower spreads on, bank loans. As Kane (1992, p. 362) notes, also see Benston et al. (1986), ‘the public benefits of guarantee programmes are typically conceived as interest rate reductions for targeted parties’. If so, though this conjecture requires empirical study, one effect of splitting the banking system into ‘narrow’ and ‘risky’ banks would be to worsen the terms on which small and medium borrowers could obtain external finance. In view of the other handicaps which these borrowers face, e.g. owing to economies of scale, this adverse shift in their borrowing costs could be regarded as undesirable, as also noted by Vives (1991). Let me be explicit. My argument is that much of the benefit from the putative underpricing of deposit guarantees by the authorities, in one form or another, may have gone largely to reduce loan charges to small and medium borrowers. Before changing the present system, we need to decide whether we can accept the likely consequences, of higher lending rates to such borrowers. There will, nevertheless, be an equilibrium set of relative interest rates that will induce an appropriate division of lenders at any time between ‘narrow’ and ‘risky’ banks. My third concern is that this differential will fluctuate over time, associated with a possibly destabilising shift of funds between the two sets of banks. Under normal circumstances yields must be higher, on both deposits and capital, in the ‘risky’ banks. When times are good, and fears of insolvency fade, there will be a tendency for funds to be transferred to the ‘risky’ banks, reducing the differential between the return on the safe assets held by the ‘narrow’ banks and the return on loans of the ‘risky’ banks. This transfer of additional funds to the ‘risky’ banks will lead them to expand additional loans more aggressively.
In fact the ‘narrow’ bank concept is not new. It was present at the very historical outset of banking. Even then, the higher return on loans, during good times, led to pressures to switch funds into riskier activities. Thus the Swedish Riksbank, founded by Palmstruch as a private bank in 1656, re-organised under the authority of Parliament in 1664, was organised on the basis of two supposedly separate departments, the loan department financing loans on the basis of deposits, and the issue department supplying credit notes on the receipt of coin and specie. Even when Palmstruch’s private bank had been taken over by Parliament, ‘A secret instruction, however, authorized the advance by the exchange department to the lending department of the funds at its disposal though on reasonably moderate terms’ [Flux, 1911, p. 17]. Thus, as early as 1668, the pursuit of a 100 per cent reserve ratio collapsed in the face of commercial pressures.
But the effects of the split between ‘narrow’ and ‘risky’ banks would be even worse during periods of downturn and potential panic. The difficulties, loss provisions and possible failure of the ‘risky’ banks will lead depositors to switch funds back towards the ‘narrow’ banks. Under the present system, adverse economic conditions frequently lead commercial banks to be much more cautious about making new loans, but they very rarely call existing loans. If trouble causes a haemorrhage of funds out of ‘risky’ banks towards the safe haven of ‘narrow’ banks, the ‘risky’ banks, with a high proportion of loans on their books, may be forced to call existing loans.
Such shifts of funds between safe and ‘risky’ banks, and the danger of runs on ‘risky’ banks, would be mitigated, but not removed, by a likely shift in the liability structure of the ‘risky’ banks towards longer-dated time deposits, or bonds. The initial loss of funds in many recent bank runs has come from a difficulty in rolling over maturing, wholesale, CDs rather than from withdrawals of demand deposits. Again, as perceived riskiness increases, the incentive for lenders is to reduce the maturity of their funding (as banks did with LDCs), in order to facilitate possible withdrawal, and perhaps to assist with monitoring. So, as earlier noted, ‘risky’ banks might have to offer considerably higher rates to persuade lenders to provide longer-term fixed funds. Because ‘risky’ bank assets would not, in general, have an immediately ascertainable and exercisable market value, the various mechanisms for protecting claimants on pension funds and insurance companies from losses in bankruptcy, (e.g. requiring companies with ‘defined benefit’ pension funds to top these up), would be much more difficult or impossible to put in place. It is, therefore, perilous to seek to draw an analogy between ‘risky’ banks and these other specialised long-term financial intermediaries, i.e. pension funds.
Thus the division of the banking system into two parts, safe and ‘risky’, is likely in my view to enhance the variability both of the availability of credit, and the risk differential between safe and risky assets. This could exacerbate the extent of the cycle. Admittedly this judgement does depend on lenders having a tendency to overestimate the permanence of current circumstances, i.e. good times in a boom and continuing problems in a slump, but the shortness of life and the associated decay of memory makes this syndrome probable.
It is, of course, true that properly designed narrow banks need no support from a Central Bank Lender of Last Resort. Per contra, could a community comfortably stand a contagious collapse of its ‘risky’ banks? The narrow money supply might continue to grow at a steady, or even increased, rate, but how would the economy fare if credit to smaller and medium borrowers became extremely expensive, or non-attainable, or at worst had to be repaid? Would there not then still be a vital role for the Central Bank to maintain the systemic stability and health of the ‘risky’ bank group?
I am disturbed by reports that this concept of splitting the banking system into the separate components of ‘narrow’ and ‘risky’ banks is gaining adherents in the USA. While there is no harm in allowing bankers to establish narrow-type banks on their own volition, if they so wish – though note that few have done so, though there are no legal prohibition – the legally enforced separation of the system into two parts in this manner would seem to be a bad idea, and one likely to enhance rather than to dampen cyclical fluctuations.
Thank you, Charles Goodhart, for your dedicated comments. I find them very valuable for the recent discussion on full-reserve banking (FRB).
However, your comments seem to focus on the FRB idea in general rather than the contents of the paper, that is, the history of proposals for FRB. The consequences of FRB is a different – although very important – discussion.
I will try to address the issues Charles Goodhart pointed out in his comments in two papers I am working on. One paper will discuss the potential benefits and critique of FRB. For this paper Charles Goodhart’s comments are more than useful. The other paper will model FRB in a stock-flow consistent framework. For this reason I will not go through Goodhart’s points in detail here.
Looking forward to further discussions!
Patrizio Lainà’s paper is most welcome. The topic of full reserve banking is receiving renewed attention in academic and policy circles, so it is very timely to have this account of the history of ideas on the subject. The review is a detailed chronological account of the literature setting out the various versions of full-reserve banking. This involves a lot of valuable detail on plans put forward by different individuals at different times and Lainà is to be congratulated for gathering all this material together.
It would be helpful to say explicitly how the coverage of the paper differs from Phillips’s work, making clear the contribution being made here. It is however somewhat misleading to state that the coverage is the US and the UK, since the bulk of the material covered refers to the US, and other countries are also represented without them being specified (Hayek – Austria/UK, Allais – France, Hotson – Canada, for example).
There is scope for some spelling out of core features of FRB in the interests of clarity, e.g. explaining that FRB aims to separate money from credit (top page 3), and why FRB removes the need for deposit insurance and LOLR facilities (top page 6).
It would help to clarify the arguments for FRB to have some acknowledgement of alternative viewpoints. The possibility that near monies might emerge from FRB is noted in a tantalisingly curt statement on the last line of section 2 but merits more discussion. Similarly there is an equally tantalising mention of ‘obstacles’ on page 16 para 2. In his comment, Charles Goodhart provides a good account of some of these counter-arguments expressed in recent decades, and there are other recent examples (mainly in working paper form, available on the internet).
Page 4 para 3: Gesell had raised the issue of money and depreciation in 1916 – is there any evidence that he had influenced Soddy? This line of thought could usefully be picked out as emerging periodically (explaining the arrangements noted at the top of page 4 and top page 10, in contrast to Friedman’s proposal, para 4 page 11).
Page 5 para 3: was reflation the primary goal of the proposal?
Page 5 para 4: the Emergency Banking Act is only explained later, on page 7.
Pages 9 para 5, page 11 para 6, and page 13 para 1: The relationship between full-reserve banking and free banking needs to be clarified; some free bankers only specify the unit of account, not its supply by the state, for example.
Page 12: it would be helpful to note the link between this idea and New Monetary Economics, and also to pick up the continuity with the re-emergence of the idea (top page 15).
Page 14 last line: again it would be helpful to acknowledge the theoretical basis for this statement (a monetary theory of inflation) – indeed this is implicit in much of the FRB literature.
Page 15 para: it is not explained how these ambitious aims of the Positive Money proposal would be achieved by FRB.
Pages 17-18: The section on modelling FRB either needs to be extended with more full discussion, or given less prominence. Much is being presumed about the nature of modelling and what we can conclude from it. For example DSGE modelling reflects a theoretical position which precludes fundamental uncertainty, but that uncertainty is central to Post Keynesian monetary theory and thus to the Post Keynesian response to FRB proposals.
Dear Sheila Dow,
Thank you for your very detailed comments! Obviously, you have taken the time to read the paper with great care. I will try to address your comments below.
“It would be helpful to say explicitly how the coverage of the paper differs from Phillips’s work, making clear the contribution being made here. It is however somewhat misleading to state that the coverage is the US and the UK, since the bulk of the material covered refers to the US, and other countries are also represented without them being specified (Hayek – Austria/UK, Allais – France, Hotson – Canada, for example).“
Ronnie Phillips definitely laid down much of the groundwork for this paper and, thus, it is a very good idea to recognize explicitly his contribution.
I did not mean to limit the coverage of the paper to the US and the UK exclusively. My intention was only to focus on these two countries. Moreover, academic proposals of FRB are not generally limited geographically (contrary to, e.g., parliamentary legislation), although they might discuss it in their home country context (e.g. Irving Fisher (1935) uses US figures in his calculations). Perhaps in the revised version I should make it explicit that the coverage is not limited exclusively to these two countries.
“There is scope for some spelling out of core features of FRB in the interests of clarity, e.g. explaining that FRB aims to separate money from credit (top page 3), and why FRB removes the need for deposit insurance and LOLR facilities (top page 6).”
You are right. I will clarify these issues in the revised version.
“It would help to clarify the arguments for FRB to have some acknowledgement of alternative viewpoints. The possibility that near monies might emerge from FRB is noted in a tantalisingly curt statement on the last line of section 2 but merits more discussion. Similarly there is an equally tantalising mention of ‘obstacles’ on page 16 para 2. In his comment, Charles Goodhart provides a good account of some of these counter-arguments expressed in recent decades, and there are other recent examples (mainly in working paper form, available on the internet).”
I completely agree that alternative views deserve attention, too. However, as I previously responded to Charles Goodhart too, going to the discussion of near-monies and other counter-arguments in this paper would be too demanding in terms of length. Originally, I had the history and critique in the same “paper” but there were 21 000 words! I think no journal would publish such a long paper. Therefore, I decided to divide the paper into two papers. I meant to deal exclusively with the history in this paper. I did not realize that some references to counter-arguments managed to slip into this paper as well. I believe that removing those references will be more productive for the purpose of this paper than opening the counter-arguments in more detail.
“Page 4 para 3: Gesell had raised the issue of money and depreciation in 1916 – is there any evidence that he had influenced Soddy? This line of thought could usefully be picked out as emerging periodically (explaining the arrangements noted at the top of page 4 and top page 10, in contrast to Friedman’s proposal, para 4 page 11).”
I am not aware of any specific link between Gesell and Soddy, but I will look into the references provided by Roger Sandilands and specify it if necessary.
For the revised version I am compiling a table which summarizes the key differences between FRB proposals (Chicago Plan, Sovereign Money, Narrow Banking, Limited Purpose Banking and Full-Commodity Standard).This should highlight the continuity of different FRB proposals.
“Page 5 para 3: was reflation the primary goal of the proposal?”
Reflation was one of the short-term objectives of the first Chicago Plan. There were, of course, other objectives as well (especially in the long-run). However, the proponents seemed to emphasize reflation as an important short-term objective as deflation was the pressing and more direct economic problem of the time. I will reformulate this.
“Page 5 para 4: the Emergency Banking Act is only explained later, on page 7.”
Mentioning Emergency Banking Act here is not particularly relevant. I will remove it from the revised version.
“Pages 9 para 5, page 11 para 6, and page 13 para 1: The relationship between full-reserve banking and free banking needs to be clarified; some free bankers only specify the unit of account, not its supply by the state, for example.”
I hope the summary table being compiled will clarify this. However, some free banking proposals are, by definition, excluded from being FRB proposals as there are no reserve requirements at all. Other free banking proposals, such as Hayek (1937), argue for “free banking” (I guess free means here free from any government control) under 100 % gold standard.
“Page 12: it would be helpful to note the link between this idea and New Monetary Economics, and also to pick up the continuity with the re-emergence of the idea (top page 15).”
I am not very familiar with New Monetary Economics, but as far as I know the Sovereign Money proposal by Jackson and Dyson (2012) does not have much in common with it. Thus, it is hard to see any continuity with the idea through re-emergence. Nevertheless, the summary table tries to trace the historic lines of different FRB proposal categories.
“Page 14 last line: again it would be helpful to acknowledge the theoretical basis for this statement (a monetary theory of inflation) – indeed this is implicit in much of the FRB literature.”
At least to me the theoretical basis in Jackson and Dyson (2012) is ambiguous. Yes, they do argue that manipulating the money stock would influence inflation. However, this is quite different from arguing that it is based on monetary theory of inflation in which only the money stock influences inflation (as the famous quote by Friedman and Schwartz goes). As formulated by Jackson and Dyson (2012), many things can influence inflation – one of them being the money stock. It would be quite far-fetched (perhaps as far as the monetarist position) to argue that the money stock would have absolutely no effect on inflation – regardless how much it would change. For this reason at least I am unable to acknowledge any specific theoretical basis (some might be more willing to creatively interpret such statements).
“Page 15 para: it is not explained how these ambitious aims of the Positive Money proposal would be achieved by FRB.”
That is true. I will drop them instead of providing a detailed discussion. I think this discussion belongs to the other paper dealing with alleged benefits and shortcomings (critique).
“Pages 17-18: The section on modelling FRB either needs to be extended with more full discussion, or given less prominence. Much is being presumed about the nature of modelling and what we can conclude from it. For example DSGE modelling reflects a theoretical position which precludes fundamental uncertainty, but that uncertainty is central to Post Keynesian monetary theory and thus to the Post Keynesian response to FRB proposals.”
I agree that all modeling techniques involve theoretical positions. Although I am familiar with the theoretical underpinnings of DSGE modeling, I am not so much aware of the theoretical underpinnings of system dynamics framework or dynamic multiplier framework. The point of the modeling section was to emphasize how little FRB has been actually modeled, although the results seem to be promising at least for the proponents of FRB. As I stated in my response to Charles Goodhart, I am in the middle of a publication process of another paper which models FRB in a stock-flow consistent framework (which, I guess, can be said to be a Post-Keynesian modeling method).
A brief note
One thing Professor Laina may want to address is that his reference to Lauchlin Currie’s proposal for 100% money is not in the reference he gave, viz:
Currie, Lauchlin (1934): A Proposed Revision of the Monetary System of the United States. Cambridge, MA: Harvard University Press.
Rather, that memo – prepared for Jacob Viner at the Fed – was not formally published until the 1966 reissue by Russell & Russell of his 1934 Harvard book (title: The Supply and Control of Money in the United States). This reissue did include his Proposed Revision…, along with a Foreword by Karl Brunner. Laina might also like to read a special issue of the Journal of Economics Studies (2004) devoted to Currie’s monetary contributions. It includes a 1938 memo on the 100% reserve plan and my Editor’s Introduction.
Incidentally, Currie was a top adviser to the Colombian government for many years, and there he supported 100% marginal reserve requirements in the 1970s and 80s as effective in sterilising the potentially dangerous impact of fluctuations in foreign exchange reserves on the domestic money supply.
Dear Roger Sandilands,
You are absolutely right. Thank you for pointing out a mistake in references. I will correct it for the revised version.
Thank you also for the tip on the special issue of the Journal of Economics Studies (2004)!