The Chicago Plan Revisited

[Hard_to_Beat]

An interesting working paper from the IMF.

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.

http://www.imf.org/external/pubs/ft/wp/2012/wp12202.pdf

 

[Blue and Silver]

I'm writing an essay on essentially this right now. You should look into Minsky's ideas (not his work, god knows he is a tedious writer, Krugman has a good summary in How to End this Depression Now!) about leverage and the inevitability of financial crisis due to conspicuous spending during booms.

The above was outlined in the Glass-Steagal Bill which was gutted by the Clinton Administration (for Citibank) and was a key aspect of the US banking system for years

 

[Tex_21]

Minksy is fantastic - lovely writer IMO, not as lovely as Keynes, but still a great read.

What Fisher was proposing was an end to Fractional Reserve Banking, which some people get confused with the Federal Reserve and believe began in 1913. That is patently false, and misleading. FRB grew organically in Europe (mostly) in the 17th and 18th centuries, as banks found that, as they stored the gold that was used as currency, and people merely traded gold receipts as money, they could issue more receipts than the amount of gold that was stored in their vaults, as they didn't need 100% coverage. Yes, it does lead to some instability (Keynes spoke of this, as did Minsky, and the Austrians, from Bohm-Bawerk forward, easy read is Hayek's "Pure Theory of Capital"), however the benefit is it allows a much greater level of investment.

The trick is (which is something Post-Keynesians and Austrians broadly agree on, though with very different responses) to manage credit (currency) expansion to not lead to bubbles like we saw in the US mortgage market, and we see in the Australian mortgage market (see Steve Keen's work). Austrians want to do this via a gold standard, with no discretionary policy. Post-Keynesians with regulation and less shit Monetary Policy (currently they would say the RBA has rates too low).

This is also what Milton Friedman made his name on (then used that name to pump the libertarian cause). He promoted monetary policy of a constant money supply growth at the rate to match output growth. This was tried briefly in the early 80s, but was both hard to administer, and unsuccessful, and has been replaced by inflation targeting. He often claimed (far more strongly than he actually believed, as far as my readings gather) that the Depression was made much much worse by a contraction in money supply by the Fed in late 1931 (Krugman debunks this pretty well- the monetary base actually grew, but the overall money supply shrunk), which also has implications for one of Milton's former PhD students - Bernanke.

The debate is also in part a throwback to the 'banking' vs 'currency' school debates of the 19th century on monetary policy, where the question of whether credit should be included as part of the money supply was the crux of the debate.

That paper uses a DSGE model though, which has a range of flaws, so I'd take it with a grain of salt.

And the Glass-Steagall Act was mostly about the separation of investment and commercial banks - it had almost nothing to do with credit creation, aside from restrictions on leverage ratios.

 

[evo]

Nice post, Tex.

If Greenspan had've followed his mentor Freidman's advice in regards to only inflating to keep pace with growth things wouldn't have been nearly as bad as they are now. Bernanke is making things ever worse with this open-ended "stimulus". It's ridiculous.

Personally, it would be great if we could get rid of fractional reserve banking, but unfortunately it is way too late. The horse has bolted - and shit over everything to boot.

I'm pretty confident the U.S economic system will completely collapse in our lifetime. Think pre-war Germany or Mugabe's Zimbabwe.

In my experience, any economic graph that looks like this never ends well:

 

[Tex_21]

Nice post, Tex.

If Greenspan had've followed his mentor Freidman's advice in regards to only inflating to keep pace with growth things wouldn't have been nearly as bad as they are now. Bernanke is making things ever worse with this open-ended "stimulus". It's ridiculous.

Certainly Friedman would argue that, but it's reasonably simplistic, as there was plenty of other factors in play regarding lax regulation and perverse incentives etc. Not sure it would have been the key factor, but it certainly was a fact.

Agree with the criticism of QE. Keynes pointed out very well that in an extended downturn, monetary stimulus is as useful as **** on a bull.

Personally, it would be great if we could get rid of fractional reserve banking, but unfortunately it is way too late. The horse has bolted - and shit over everything to boot.

I don't mind FRB at all. It allows greater investment and innovation, but it does have the stability issue, so it needs to be well regulated.

I'm pretty confident the U.S economic system will completely collapse in our lifetime. Think pre-war Germany or Mugabe's Zimbabwe.

I think it may be a great test of some of Abba Lerner's work.

In my experience, any economic graph that looks like this never ends well:

Nope, it's all just waiting for the next bubble to rush into. Plenty of people warning, but they're all dismissed as cranks.

 

[Upton Sinclair]

Good thread. Feel I've left it more I firmed than when I went into it

 

[The_Reaper]

Nice post, Tex.

If Greenspan had've followed his mentor Freidman's advice in regards to only inflating to keep pace with growth things wouldn't have been nearly as bad as they are now. Bernanke is making things ever worse with this open-ended "stimulus". It's ridiculous.

Personally, it would be great if we could get rid of fractional reserve banking, but unfortunately it is way too late. The horse has bolted - and shit over everything to boot.

I'm pretty confident the U.S economic system will completely collapse in our lifetime. Think pre-war Germany or Mugabe's Zimbabwe.

In my experience, any economic graph that looks like this never ends well:

Is it really as extreme as it looks when you consider that the American population has effectively doubled during this time period?

 

[Tex_21]

Is it really as extreme as it looks when you consider that the American population has effectively doubled during this time period?

You could take a log of it to reduce the exponential nature of the graph a little, but the relevant change would be the money supply to output, not population (borrowing a little from Friedman)

 

[evo]

Is it really as extreme as it looks when you consider that the American population has effectively doubled during this time period?

If it had kept pace with population , that would've been fine. But look how it has grown exponentially. Moreover, it has got a lot worse since that graph ends.

In fact it is telling that the federal reserve don't even publish the M3 figures these days......they are too scary. It is literally off the charts.

 

[Jentleman Geff]

M3 is not strictly under the control of central banks though is it?

 

[J_Moore]

.

In fact it is telling that the federal reserve don't even publish the M3 figures these days......they are too scary. It is literally off the charts.

Well, it was off the charts. We've put our best minds to it, though, and they've decided to lengthen the vertical axis somewhat, meaning it's now back on the chart, buying us a bit more time. It now won't be back off the charts until 2014 at the earliest.

 

[evo]

^ In his September statement, Benanke said that the Quantitative Easing's ( which is code for money supply expansion) scope will be unlimited in duration and extent, so in fact the Y axis is infinite.

 

[Tex_21]

^ In his September statement, Benanke said that the Quantitative Easing's ( which is code for money supply expansion) scope will be unlimited in duration and extent, so in fact the Y axis is infinite.

Bernanke needs to read more Keynes. It's long been shown that in a severe downturn, like now or the Depression, monetary policy is almost useless as a stimulus, because people are paying down debt, stockpiling cash etc (Keynes' animal spirits), and they don;t care how cheaply they can borrow, they're not going to invest while the outlook is shit.

That is the role for fiscal stimulus to play, however most of the rich world has no capacity for fiscal stimulus due to horrendous fiscal policy through the boom years (Gordon Brown can take a bow there).

 

[evo]

Bernanke needs to read more Keynes.

I reckon he needs to read less Keynes!

 

[Tex_21]

I reckon he needs to read less Keynes!

The QE shit he's employing is a far cry from Keynes. Keynes talked about the impotence of monetary policy in similar situations, not that it should be employed completely. If anything the current environment, with low AD for money is showing Keynes was on to something regarding inflation. Currently the money supply is growing hugely, but inflation in the US is still quite low (ditto Europe, slightly higher in the UK, but not commensurate with the increase in supply). This meshes well with the GT (the earlier inflation as a result of AD/AS pressures was from the Treatise), describing an economy away from full employment equilibrium. I think Keynes took it a little too far, discounting the QtoM in the case of full employment, but a situation like now, when demand is certainly deficient, and the economy is off-equilibrium (as much as 'equilibrium' exists), and a long way from F.E., Keynes' theory has a lot of merit.

When the economy eventually gets back to somewhere approaching full employment (US economy here, and leave that assumption for now), then inflation will become a big issue, and likely manifest itself if massive bubbles, again. That's why Post-Keynesians are heavily criticial of the monetary policy stance across much of the west, and QE in particular.

 

[evo]

The QE shit he's employing is a far cry from Keynes. Keynes talked about the impotence of monetary policy in similar situations, not that it should be employed completely. If anything the current environment, with low AD for money is showing Keynes was on to something regarding inflation.

This is a Polyannaish (Pollyanna - like?)reading of Keynes. He counselled both fiscal and monetary expansions in response to recessions/ depressions.....

John Maynard Keynes, 1st Baron Keynes,[1] CB FBA (

/ˈkeɪnz/ KAYNZ; 5 June 1883 – 21 April 1946) was a British economist whose ideas have profoundly affected the theory and practice of modern macroeconomics, and informed the economic policies of governments. He built on and refined earlier work on the causes of business cycles, and advocated the use of fiscal and monetary measures to mitigate the adverse effects of economic recessions and depressions.

and


Advocates of Keynesian economics argue that private sector decisions sometimes lead to inefficient macroeconomic outcomes which require active policy responses by the public sector, particularly monetary policy actions by the central bank and fiscal policy actions by the government to stabilize output over the business cycle.

Even if we are generous and say he didn't believe monetary expansions by the reserve banks would mitigate recessions, the money supply is always expanded when governments have to borrow to fund budget deficits, the panacea he pretty much invented.
As a quality economist famously said: "There's no such thing as a free lunch."

Currently the money supply is growing hugely, but inflation in the US is still quite low .

Don't listen to "post Keynesians", or most economic pundits for that matter, Inflation and the growth in the money supply are the same thing. An increase in prices is the result of inflation, not inflation itself.

 

[Seeds]

Bernanke needs to read more Keynes. It's long been shown that in a severe downturn, like now or the Depression, monetary policy is almost useless as a stimulus, because people are paying down debt, stockpiling cash etc (Keynes' animal spirits), and they don;t care how cheaply they can borrow, they're not going to invest while the outlook is shit.

That is the role for fiscal stimulus to play, however most of the rich world has no capacity for fiscal stimulus due to horrendous fiscal policy through the boom years (Gordon Brown can take a bow there).

This is true. Fiscal stimulus is far more effective in promoting growth when companies and households are paying down debts and have no interest in borrowing money even at zero interest rates. However, when government debts are so high and increasing debt may cause the US to hit its own self imposed debt limit then what do?

 

[Tex_21]

This is a Polyannaish (Pollyanna - like?)reading of Keynes. He counselled both fiscal and monetary expansions in response to recessions/ depressions.....

Even if we are generous and say he didn't believe monetary expansions by the reserve banks would mitigate recessions, the money supply is always expanded when governments have to borrow to fund budget deficits, the panacea he pretty much invented.
As a quality economist famously said: "There's no such thing as a free lunch."

There is an issue of severity there. Keynes did, as that says, promote monetary stimulus in short downturns etc (within reason, he also didn't advocate massive deficit spending, at least in regard to consumption - his was in relation to long term investment), but he argued (quite convincingly IMO) that in an extended downturn, the effectiveness of MP would be very very low, due to a lack of activity from private actors - deficiency in Aggregate Demand.

Don't listen to "post Keynesians", or most economic pundits for that matter, Inflation and the growth in the money supply are the same thing. An increase in prices is the result of inflation, not inflation itself.

Not necessarily (and to not listen to the Post-Keynesians, you would have to not listen to Keynes, as they have been most true to his work). For growth in the money supply to always and everywhere be inflation, the Quantity theory of money would have to hold in all cases, at extreme strength. We know that isn't true (even Friedman mentioned as much in his last years). It will usually do so, and certainly in a case where the economy is approaching full employment, but when the economy is demand deficient, and a long way from hitting any constraints, growth in the money supply does not necessarily equal inflation of its own accord. Obviously, if you go to extremes (can be argued Bernanke is), it will likely stoke inflation, eventually - often in the form of asset bubbles as much as general consumer price inflation.

To argue any relationship in economics is always and everywhere is very simplistic and naive. There are relationships that hold a lot of the time, even most of the time, but everything has exceptions.

 

[CLUBMEDhurst]

Damned shame they never taught economics at tech schools, I may have half a clue as to what you guys're on about