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The Chicago Plan revisited - 2d Paper IMF

The Chicago Plan revisited - 2d Paper IMF

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At the height of the Great Depression a number of leading U.S. economists advanced a proposal for monetary reform that became known as the Chicago Plan. It envisaged the separation of the monetary and credit functions of the banking system, by requiring 100% reserve backing for deposits. Irving Fisher (1936) claimed the following advantages for this plan: (1) Much better control of a major source of business cycle fluctuations, sudden increases and contractions of bank credit and of the supply of bank-created money. (2) Complete elimination of bank runs. (3) Dramatic reduction of the (net) public debt. (4) Dramatic reduction of private debt, as money creation no longer requires simultaneous
debt creation. We study these claims 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, and steady state inflation can drop to zero without posing problems for the conduct of monetary policy.
At the height of the Great Depression a number of leading U.S. economists advanced a proposal for monetary reform that became known as the Chicago Plan. It envisaged the separation of the monetary and credit functions of the banking system, by requiring 100% reserve backing for deposits. Irving Fisher (1936) claimed the following advantages for this plan: (1) Much better control of a major source of business cycle fluctuations, sudden increases and contractions of bank credit and of the supply of bank-created money. (2) Complete elimination of bank runs. (3) Dramatic reduction of the (net) public debt. (4) Dramatic reduction of private debt, as money creation no longer requires simultaneous
debt creation. We study these claims 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, and steady state inflation can drop to zero without posing problems for the conduct of monetary policy.

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The Chicago Plan Revisited
 Jaromir Benes and Michael Kumhof 
Revised Draft of February 12, 2013
Abstract
 At the height of the Great Depression a number of leading U.S. economists advanced aproposal for monetary reform that became known as the Chicago Plan. It envisaged theseparation of the monetary and credit functions of the banking system, by requiring 100%reserve backing for deposits. Irving Fisher (1936) claimed the following advantages for thisplan: (1) Much better control of a major source of business cycle fluctuations, suddenincreases and contractions of bank credit and of the supply of bank-created money.(2) Complete elimination of bank runs. (3) Dramatic reduction of the (net) public debt.(4) Dramatic reduction of private debt, as money creation no longer requires simultaneousdebt creation. We study these claims by embedding a comprehensive and carefully calibratedmodel of the banking system in a DSGE model of the U.S. economy. We find support for allfour of Fisher's claims. Furthermore, output gains approach 10 percent, and steady stateinflation can drop to zero without posing problems for the conduct of monetary policy.The views expressed in this paper are those of the author(s) and do not necessarilyrepresent those of the IMF or IMF policy. The authors are grateful for helpful commentsand suggestions from George Akerlof, Olivier Blanchard, Michael Burda, Michael Clark,Timothy Congdon, Ulf Dahlsten, Herman Daly, Heiner Flassbeck, Erhard Glötzl, CharlesGoodhart, Carol Hopson, Joseph Huber, Michael Hudson, Jesús Huerta de Soto, ZoltanJakab, Steve Keen, Uli Kortsch, Larry Kotlikoff, Douglas Laxton, Stefan Lewellen,Bernard Lietaer, Falk Mazelis, Thorvald Grung Moe, Dirk Muir, Antonio Pancorbo,Johannes Priesemann, Romain Rancière, Liliya Repa, Adair Turner, Kenichi Ueda,Richard Werner and Steven Zarlenga, and from seminar participants at the Bank of England, European Central Bank, Global Utmaning, Humboldt University Berlin, IMF,LSE, New Economics Foundation, Norges Bank, UNCTAD and Virginia Tech.JEL Classification Numbers: E44, E52, G21Keywords:Chicago Plan; Chicago School of Economics; 100% reserve banking; bank lending; lending risk; private money creation; bank capital adequacy;government debt; private debt; boom-bust cycles.Authors’ E-Mail Addresses:benes@imf.org;mkumhof@imf.org 
 
2
Contents
I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4II. Answers to Common Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . 14A. The Transition Period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15B. Debt-Financed Investment Trusts and Near-Monies . . . . . . . . . . . . 15C. Maturity Transformation . . . . . . . . . . . . . . . . . . . . . . . . . . . 16D. Competitiveness of the Banking System . . . . . . . . . . . . . . . . . . . 17E. Deation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17F. Ination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18G. Government Control over Money . . . . . . . . . . . . . . . . . . . . . . . 19H. Government Control over Credit . . . . . . . . . . . . . . . . . . . . . . . 19I. Compromise Solutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21J. Open Economy Considerations . . . . . . . . . . . . . . . . . . . . . . . . 22III. The Chicago Plan in the History of Monetary Thought . . . . . . . . . . . . . 23A. Government versus Private Control over Money Issuance . . . . . . . . . 23B. The Chicago Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28IV. The Model under the Current Monetary System . . . . . . . . . . . . . . . . . 32A. Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33B. Lending Technologies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36C. Transactions Cost Technologies . . . . . . . . . . . . . . . . . . . . . . . 38D. Equity Ownership and Dividends . . . . . . . . . . . . . . . . . . . . . . 39E. Unconstrained Households . . . . . . . . . . . . . . . . . . . . . . . . . . 40F. Constrained Households . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41G. Unions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42H. Manufacturers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43I. Capital Goods Producers . . . . . . . . . . . . . . . . . . . . . . . . . . . 44J. Capital Investment Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . 44K. Government . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 441. Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 442. Prudential Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . 453. Fiscal Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 454. Government Budget Constraint . . . . . . . . . . . . . . . . . . . . 45L. Market Clearing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45V. The Model under the Chicago Plan . . . . . . . . . . . . . . . . . . . . . . . . 46A. Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46B. Households . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48C. Manufacturers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49D. Government . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 501. Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 502. Prudential Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . 523. Fiscal Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 534. Government Budget Constraint . . . . . . . . . . . . . . . . . . . . 535. Controlling Boom-Bust Cycles - Additional Considerations . . . . . 54
 
3VI. Calibration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55VII. Transition to the Chicago Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . 61VIII. Credit Booms and Busts Pre-Transition and Post-Transition . . . . . . . . . . 65IX. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69Figures1. Changes in Financial Sector Balance Sheet in Transition Period (percent of GDP) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 792. Changes in Government Balance Sheet in Transition Period (percent of GDP) 803. Changes in Financial Sector Balance Sheet - Details (percent of GDP) . . . . 814. Transition to Chicago Plan - Financial Sector Balance Sheets . . . . . . . . . 825. Transition to Chicago Plan - Main Macroeconomic Variables . . . . . . . . . . 836. Transition to Chicago Plan - Fiscal Variables . . . . . . . . . . . . . . . . . . 847. Business Cycle Properties Pre-Transition versus Post-Transition . . . . . . . . 85

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