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The Chicago Plan revisited - 2d Paper IMF

The Chicago Plan revisited - 2d Paper IMF

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Published by user909
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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Published by: user909 on Mar 14, 2013
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A frequently-raised question is whether government can be trusted with control of the
money supply, given the historical record. The very common claim that it cannot will be
comprehensively refuted in Section III, which shows that, both in ancient societies and in
Western nations, it was periods of private control over money issuance that have been
plagued by financial crises, while periods of government control have exhibited much more
stability.

This wealth of historical evidence for comparatively responsible government money
issuance dates back several centuries in many (but not all) cases. As an argument in favor
of the Chicago Plan it is therefore commonly countered by pointing to the many examples
of unsuccessful government monetary policy and inflation throughout the twentieth
century. This however represents a serious logical error. The reason is that the Chicago
Plan proposes, as in the much older experiences, government control of broad monetary
aggregates and the complete elimination of all private debt-based money creation. This
has not been the case, even approximately, in any twentieth century experience. To the
contrary, private banks have had a great deal of monetary control, albeit not always to the
extent of the United States today. This could in fact be used to turn the argument
around, by concluding that recent episodes of monetary instability must have been caused
to a very significant extent by private banks, not by governments. As we will show in
Section III, the German hyperinflation of 1923 is completely consistent with this
alternative interpretation. One really does have to look centuries into the past to find
examples of the type of government monetary control advocated in this paper. This is
what we do in Section III, and that record undeniably supports the Chicago Plan.

This leaves the question of how precisely, in our modern monetary environment, to best
ensure responsible government money issuance. Here we suggest that the management of
money growth should ideally be entrusted to a fourth power of government, with a
constitutional independence similar to that of the Supreme Court. This would insulate the
issuance of money not only from government pressures, but also from pressures that come
from private financial interests.

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