[The fourth of a series of posts on MMT, ‘The Chicago Plan Revisited’, and related issues; see also part 1, part 2, & part 3]
Summary: MMT understands the monetary system in depth, particularly a fiat monetary system. “Full Reservers”, because they have not always fully grasped the significance of the fact there is no money multiplier and that the loanable funds model is wrong, often have a misplaced emphasis on the reserve ratio and sight deposits. Nevertheless, they can be understood ultimately to be worried about endogenous money, and in effect are arguing for a pure fiat money system. Steve Keen shows the magnitude of the negative effects of endogenous money on the economy. If Keen is properly understood, and what are in effect the anti-endogenous money policies of Full Reserve plans implemented, the end point is a pure fiat money system. And the starting point of a true chartalist system, the natural home for neo-chartalism.
There are actually two concerns most advocates of Full Reserves have
1. Solvency – there are few solvency issues with full reserves; not surprisingly a major concern in the 1930s for Simons, Fisher, The Chicago Plan etc.
2. (Endogenous) money creation
The second is much the more important, but the two are often confusingly conflated.
Partly this is because the significance of the fact that the loanable funds model is wrong and there is no money multiplier is not always fully appreciated by Full Reservers.
Banks do not make loans based on reserves or loanable funds but based on demand, perceived profitability, and the capital they hold. The government covers reserve requirements later. Raising reserve requirements can raise costs but does not stop money creation. Even the focus on sight deposits (i.e., PositiveMoney) misses the point – not only do reserve requirements not stop money creation, neither does stopping lending based on sight deposits. Banks loans pull money from the central bank, with the limit being the ratio of capital to risk-weighted assets.
So, unless Full Reservers are only worried about bank solvency, which is doubtful, they are really addressing concerns that have their root in endogenous money.
Anti endogenous money, pro- true chartalism proposals
The main benefits of plans such as AMI, PositiveMoney, Kotlikoff, the Chicago Plan, Werner etc are, or would be with any needed tweaking, that:
Issuing fiat would be rightfully reserved for the issuer of the fiat decree: the government. A monopoly on money (but not on banks; entities that invest people’s money and distribute the gains would exist much the same as now). As L. Randall Wray notes, “money is a social creation. The private credit system leverages state money, which in turn is supported by the state’s ability to impose social obligations mostly in the form of taxes.” (Wray, 35)*. As the system stands, a public good is leveraged for narrow private gain, in a process that entails public costs through intrinsic systemic instability.
Implementing restrictions on the type of lending that leads to endogenous money creation would be “no big deal” according to Warren Mosler. (The details of how this would work, and why credit, investment in capital, and instruments for earning interest would still exist are in the various plans; Mosler suggests they would only be allowed to invest their equity capital. Some details are here).
The effect of this, however, would be a very big deal indeed. It would be the creation of a true fiat system of money, instead of the mixed state-credit financial system (as Steve Keen calls it) we have now. All money would be outside, exogenous, vertical, HPM.
Endogenous money creation is a vestige left over from older systems, where either banks were powerful enough to challenge sovereigns, or rich enough to buy off lawmakers, or where commodities actually were leveraged with bank notes. And before digital accounts, weakening banking regulation and related developments completely untethered credit-money creation from reality.
Whatever the past utility of endogenous money, in the modern economy it serves no socially useful purpose that could not be retained under a true chartalist, pure fiat money system. Worse, endogenous money is increasingly understood to be extremely socially costly (especially in the work of Steve Keen).
Pro Full Reserve advocates, if the goals of their proposals and root of their worries are reviewed carefully and in light of the fact that loanable fund and money multiplier models are incorrect, are most concerned with the same problems Keen has also so clearly shown, that endogenous money is destabilizing and harmful.
It is evident that (neo)chartalist policies would work better under (true) chartalism than under the mixed state-credit financial system we operate under now.
That is why I say that Modern Monetary Theory & Full Reserve Banking are Connected by Fiat.
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*L. Randall Wray “The Credit Money, State Money, and Endogenous Money Approaches: A Survey and Attempted Integration” Link
Although the simplifying assumptions are not perfect, Endogenous Supply of Fiat Money highlights some incentive problems with bank credit-money creation.
P.S. This post was partly inspired by a perceived lack of interest on the part of MMTers in full reserves, and vice versa (and downright hostility to MMT from the AMI Full Reservers). Good discussion here.
I see MMT, the aims of Full Reservers, and followers of the enlightening work of Steve Keen as natural allies.
Bob Mitchell (MMT), and Ralph Musgrave (pro-Full Reserve), both explicitly disagree, stating that MMT and Full Reserve have little in common. I will consider Bill Mitchell’s objections in another post. In a nutshell though, Mitchell’s proposals (besides his analysis needlessly wading into the bogs that are Austrian thought) for banking are all very good, needed under any system, and I very much agree with him. However, they are to a large extent trying to undo the damage caused by an inherently flawed pseudo-chartalist system that has all the incentives wrong, a system that creates bank-credit-money bubbles that are the fundamental enablers of much bad activity in the financial sector. You might say that endogenous money adds fuel to the “FIRE” that Mitchell wants to extinguish. Excising endogenous money creation from our fiat money is needed to truly effect the changes Mitchell wants.
Hi Clint,
Just a few observations on your post, if I may. In your first line you state:
“MMT understands the monetary system in depth, particularly a fiat monetary system.”
I quite like a lot of MMT, however I think it would be wrong to claim that the MMT theory is indisputably correct, as you seem to here. There are lots of very eminent economists, many of whom have worked in central banks, private banks, the treasury etc. (i.e. they have an excellent understanding of the monetary system on an operational level) that would disagree (or have not agreed) with some (not all) of the claims of MMT. That is not to say that these people are right (or MMT wrong), merely that there is a debate.
“Even the focus on sight deposits (i.e., PositiveMoney) misses the point – not only do reserve requirements not stop money creation, neither does stopping lending based on sight deposits. Banks loans pull money from the central bank, with the limit being the ratio of capital to risk-weighted assets.”
I think you have misunderstood the PM proposals – we are not proposing a full reserve system, reserve requirements, etc. This is probably our fault for not explaining it clearly.
In our system all money exists on the central bank’s balance sheet, there are no deposits on private bank balance sheets. As such there are no reserve requirements: in a sense everyone is using central bank reserves, and everyone banks at the central bank. This is what I meant in a previous post when I said that there is no longer two circulating forms of money, reserves used by banks, and deposits used by everyone else. Instead there is one integrated quantity of money used by private banks, individuals and businesses alike.
The only thing on (simplified) private banks balance sheets are loans on the assets side, which are balanced by investment accounts on the liabilities side. These investment accounts are not liquid, they are not transferable, and they are not to be used in payment. In effect they are not money, but a record of a transfer of money.
With each individual having their own account at the central bank, when an individual deposits money they are not depositing it at that bank, they are in fact depositing it at the central bank. This money is not available for banks to make loans with.
If a bank did try to make a loan without any money in its account at the central bank (i.e. like it can do today), and then asked for money from the central bank then central bank would just turn round and say no. It can do this because all the depositors money is safe, being on the central bank’s balance sheet and not on the private banks balance sheet. Banks can therefore be allowed to fail with no effect on the money supply, and no loss to depositors.
In contrast, today the monetary system is endogenous because deposits are held on private banks balance sheets. If the central bank refuses the request for reserves, firstly the interest rate on the interbank market would shoot right up, requiring the central bank to inject more reserves to hit the interest rate target. If it did let the interest rate increase financial instability is likely to result, as the bank in question would not have enough reserves to settle its own payments. This could lead to a run on the bank, requiring the central bank (it has a mandate to protect financial stability) or state to step in to save the bank. If the state doesn’t step in financial crisis and debt deflations are possible.
Otherwise I pretty much agree with your conclusions! I am happy to send through a bunch of balance sheets that show the current system and the transition to a PM system if you would like.
Andrew – I agree. I had not read your last post as closely as I should (time constraints)- I was re-reading it just last night and was impressed with exactly the part you highlight above “In our system all money exists on the central bank’s balance sheet, there are no deposits on private bank balance sheets. As such there are no reserve requirements: in a sense everyone is using central bank reserves, and everyone banks at the central bank.”
I was even planning to highlight it in its own post.
It is an elegant solution to the concerns most pro-Full Reserve people have, without all the flaws MMT and others have pointed out with Full Reserves. And it is fundamentally chartalist. MMT is always concerned with “operational realities” but of a deeply flawed system. The plan you suggest would create a true fiat system that would be inherently stable and functional.
This proposal by PositiveMoney resolves most of the concerns critics have, if only they understood it correctly.
I still see a lot of room for cooperation – I think ultimately the PM plan and MMT fit together beautifully.
I will try to get some more posts on the details you discuss up when I can.
Off to Suzhou and Nanjing (China) for the New Years, so will not be able to post for a few days.
Thank you for the excellent and enlightening explanations of the PositiveMoney plan.
Hi Andrew,
As you know, I agree with the BASIC PRINCIPLES advocated by PM (full reserve in particular), but I think there are problems with the way you suggest EFFECTING the idea.
You say “With each individual having their own account at the central bank…” I suggest central banks would throw a fit at that suggestion. E.g. in the case of the UK, the Bank of England would not want to open accounts for about 20 million people.
What central banks WOULD BE HAPPY WITH is a full reserve system where each commercial bank and its local branches act as AGENT for the central bank, and just send the central bank the TOTALS of each days transactions (deposits made, amounts put into transaction accounts, etc). Indeed, bank branches do that already: i.e. send in totals at the end of each day to their head offices.
Assuming I’m right, then in effect everyone WOULD HAVE an account at their local branch rather than at the central bank. Indeed, the latter system would be what you’d get if the entire banking industry was nationalised, wouldn’t it?
Having said that, William Hummel advocates full reserve, and advocates everyone having an account at the central bank. But I still don’t think that is workable. See:
http://wfhummel.cnchost.com/monetaryreform.html
PS You write “I am happy to send through a bunch of balance sheets that show the current system and the transition to a PM system if you would like.”
Sure! Do you think there is a way to show them on a blog format? I would love to post them here and invite comment.If they are large files you can send them to my gmail – CJBallinger@gmail.com, and I’ll see what I can with them.
Hi Ralph,
Yes, the central bank would have a fit. That’s why we advocate the private banks acting as middlemen on behalf of businesses and individuals. Essentially you would hire the private banks to communicate with the central bank on your behalf. Crucially though the money in the account at the central bank would be yours, you are not giving up ownership of it to the bank.
“In our system all money exists on the central bank’s balance sheet, there are no deposits on private bank balance sheets.”
And the MMT analysis of that is probably that changing to that doesn’t make an iota of difference over the existing capital constrained system once it has been ‘cleaned up’ by the MMT proposals.
Loans are sold on price, not quantity and always will be.
“These investment accounts are not liquid, they are not transferable, ”
Yes they are – because they are not maturity matched. The commercial pressure will be to have short term investment accounts and long term loans. Therefore in a dynamic system at any point in time you will always have a set of accounts that are maturing. That is the mechanism that the permanent building societies used for over a century.
“If a bank did try to make a loan without any money in its account at the central bank (i.e. like it can do today), and then asked for money from the central bank”
But they wouldn’t do that. There is a long lead period from a loan being sold to the money being advanced. And that time period provides information about what price your investment bonds have to be.
And the investment bonds are not on the same time period as the loans. There is no maturity matching requirement.
So Bank A, having a slightly better brand than Bank B, will get loans into the sales pipeline at a particular price that is slightly higher than the competition. Then during the due diligence period the investment side will obtain funds in the market from the non-maturity matched investment funding that is maturing. They attract it away with slightly higher investment rates or shorter maturity periods or a combination of both.
So what happens is that Bank A forward selling loans causes an investment fund shortage at Bank B. If the central bank then folds its arms and does not accommodate the expansion then Bank B goes bust.
So you have a perfect mechanism for a massive consolidation of banks, and an easy weapon that prevent new entrants. The result of that would be two or three powerful institutions and a load of also rans.
And the evidence on the ground shows this will happen – since that is how Halifax became the biggest building society in the world. They were the first to realise that you didn’t need to ring down to the cash department to see if there was any money left. You could always bid it away from others because of the competitive advantage given by a brand.
Loans are sold on price, not quantity and the central bank will be forced to accommodate the expansion – however you jiggle the accounting – or you will get an interest rate spike until the ‘excess loans’ are eliminated via the bankruptcy on one of the players in the market.
“In contrast, today the monetary system is endogenous because deposits are held on private banks balance sheets.”
Switching to central bank held accounts makes no difference at all. You would still get spikes in interest rates on the investment side – because of the mechanism I describe above.
It’s the lack of maturity matching and a collateralised lending system that causes the instability.
So the PM mechanism is no different from a ‘cleaned up’ version of the existing capital constrained system put forward by MMT And one can be transformed into the other via standard accounting entries.
PM seems to miss what really happens in a capital constrained endogenous system. Bank balance sheets are expanded with ‘lending capacity’ when they increase their capital *not* when they make loans. Loans merely move lending capacity to lending in circulation and deposit potential into deposits.
Operating the existing structure with an expanded balance sheet view shows how this works, and its about a year since I did just that: http://www.3spoken.co.uk/2011/12/double-entry-view-on-keen-circuit-model.html
And the same happens there with capital constraints. The bank patches up their capital requirements based upon their forward sales pipeline to make sure they are ‘compliant’ at the regulation checkpoints. All it does is slow down the process a little – capital is always available at a price.
I think Ralph’s reply is meant to be here (http://clintballinger.edublogs.org/2012/12/28/mmt-full-reserve-banking-connected-by-fiat/#comment-92.
I have to agree, I think Neil is not fully understanding the details of the differences PM proposes or their signicance.
Ralph Musgrave
December 29th, 2012 | 20:05 edit Reply
“Loans are sold on price, not quantity and always will be.” Wrong. It would be perfectly feasible to have a system under which the economy is regulated by the QUANTITY of money created and spent into the economy, with “price” (i.e. interest rates) being left to find their own level: which is exactly what Werner/PM advocate (and I agree).
“The commercial pressure will be to have short term investment accounts and long term loans.” Wrong again. It’s precisely that pressure that full reserve blocks!!!! The “blocking” is not 100% under Werner/PM proposals, which is why I prefer the Laurence Kotlikoff version of full reserve in some ways.
“So what happens is that Bank A forward selling loans causes an investment fund shortage at Bank B. If the central bank then folds its arms and does not accommodate the expansion then Bank B goes bust.” Wrong again. Why on earth would a bank go bust because it cannot get funds lend? It would just abstain from lending!!!!! If bank A out-competes bank B, then bank A gains market share and bank B loses market share, but that of itself does not mean bank B goes bust.
In fact it’s PRECISELY the “fast expanding” banks that have a tendency go bust: e.g. Northern Rock. And then there was Fred the Shred with his daft “fast expanding” ideas (although the reasons for his demise were a bit different to those in the case of Northern Rock).
Neil, your comments are all based on the assumption that we continue with the existing system. The Werner/PM proposals are a very different system (surprise, surprise). How about actually READING thru their proposals before commenting?
Neil writes “PM seems to miss what really happens in a capital constrained endogenous system.”
Please read the original article.
It is precisely about a system that only has exogenous money.
Neil misses the point entirely – I am arguing (and PM is as well) that a system has to be made that has no endogenous money.
I am also arguing that this chartalist system is what neo-chartalists should want as well.
and Neil writes “once it has been‘cleaned up’ by the MMT proposals”
What does that even mean?
Clint,
I’m puzzled by your claim that full reservers don’t understand that the loanable fund model is wrong. PM for example have been screaming from the rooftops ever since PM came into existence that commercial banks can create money from thin air when they lend.
“Loans are sold on price, not quantity and always will be.” Wrong. It would be perfectly feasible to have a system under which the economy is regulated by the QUANTITY of money created and spent into the economy, with “price” (i.e. interest rates) being left to find their own level: which is exactly what Werner/PM advocate (and I agree).
“The commercial pressure will be to have short term investment accounts and long term loans.” Wrong again. It’s precisely that pressure that full reserve blocks!!!! The “blocking” is not 100% under Werner/PM proposals, which is why I prefer the Laurence Kotlikoff version of full reserve in some ways.
“So what happens is that Bank A forward selling loans causes an investment fund shortage at Bank B. If the central bank then folds its arms and does not accommodate the expansion then Bank B goes bust.” Wrong again. Why on earth would a bank go bust because it cannot get funds lend? It would just abstain from lending!!!!! If bank A out-competes bank B, then bank A gains market share and bank B loses market share, but that of itself does not mean bank B goes bust.
In fact it’s PRECISELY the “fast expanding” banks that have a tendency go bust: e.g. Northern Rock. And then there was Fred the Shred with his daft “fast expanding” ideas (although the reasons for his demise were a bit different to those in the case of Northern Rock).
Neil, your comments are all based on the assumption that we continue with the existing system. The Werner/PM proposals are a very different system (surprise, surprise). How about actually READING thru their proposals before commenting?
Ralph – Full reserve people, and especially PM, do focus on the money creating abilities. But many of them still seem to think this is related to fractional reserves or deposits. As I mentioned in another post, some of those people would keel over if they realized the situation is actually worse than that. Neither reserve requirements nor deposits constrain.
The importance of pointing this out is it highlights that the true desire of pro-Full Reserve people is really (once they realize reserves and deposits are not the issue) to get rid of endogenous money. I agree the PM plan does this elegantly.
I am also pointing out that the main goal of Full Reservers is essentially to create true chartalism, and that this would be a logical goal of (neo) chartalists as well. The things they say they want would simply be much easier to achieve with a true chartalist system, while there would be far less asset market volatility etc etc (as Keen shows).
Why some neo-chartalists think there is ANYthing worth keeping from the bastardized system we have now, with its residual bank-credit-money add-on that dominates fiat money, is beyond me.