December 25, 2012
Can Full Reserve Banking actually even stop credit-money creation? The Chicago Plan v. Positive Money
[This is a comment from a previous post on Post Keynesianism, MMT, & 100% Reserves Project, Post No. 2. It is in answer to the question "Do Full Reserves actually even stop credit-money creation?" Scott Fullwiler at one point said full reserves could not, as well as some other commenters.]
Andrew Jackson, December 25th, 2012
“Does full reserve stop banks being able to create money out of thin air.
Quick disclaimer, I work for Positive Money.
It’s interesting that you mentioned us alongside the Chicago plan in the first post. The Positive Money (PM) proposals do indeed have the same goal as the Chicago plan/full reserve/100% reserve proposals, that is to stop banks creating money in the process of making loans (or buying assets),. However, the method is different. In the case of Chicago plan they do it by forcing banks to hold reserves against their deposits. As some people have pointed out, this doesn’t necessarily stop banks creating money – that is it is quite possible for there to be money creation by the banking sector with 100% reserves (incidentally for exactly for the same reasons a 10% reserve ratio doesn’t constrain deposit creation, although it does require the central bank to play along).
The PM proposal, on the other hand, does not suffer from this problem. Instead of backing deposits with reserves, we give people access to the state created means of payment itself. Thus, unlike in the current system where two types of money circulate separately – central bank created reserves which are only used by the banking sector, and commercial bank created deposit money which is used by everyone else – in the PM system there is no longer a split circulation of money, just one integrated quantity of money circulating among banks and non-banks alike.
This is achieved by removing the sight [on call] deposits from banks balance sheets and placing them onto the central bank’s balance sheet (which will be called transaction accounts). The private banks then obtain a new liability of the same size to the central bank, and correspondingly the central bank an asset from the banks. This banks’ liability to the Central Bank is to be repaid as their assets mature, with the money repaid in this way to be recycled back into the economy by the central bank granting money to government to be spent into circulation.
In effect, the central bank has ‘extinguished’ the banks’ demand liabilities to their customers by creating new state-issued electronic currency and transferring ownership of that currency to the customers in question. In a sense everyone starts baking at the central bank (although we would hire the banks to administer our accounts for us).
Lending occurs in this system when people move their money from their transaction account (held at the central bank) to an ‘investment account’. This will be broadly similar to a time deposit today – there will be minimum notice periods, however, unlike today they will also carry some risk (i.e. if the underlying assets go bad they may lose some of their money). The money transferred to the banks will then be transferred to a borrower. So in this system lending by banks merely transfers money around the system, no new money or purchasing power is created when loans are made. Because in this system because all money is held on the central bank’s balance sheet any bank can be allowed to fail, without any effect on the money supply.
So with the PM system it is possible to achieve the aims of the Chicago plan, whilst retaining double entry bookkeeping. The question is then not if it is possible, but if it is desirable. Obviously you have covered the boom bust cycle, financial crisis etc. and the unemployment and high house prices that go along with it. However there are also other issues, such as higher taxes, the effects on individual debt levels, inequality (interest transfers money upwards), subsidies and the too big to fail problem etc.”
[Andrew Jackson works for PositiveMoney, their homepage is here]