23.10.12

The Chicago Plan Revisited - Μια ρεαλιστική πρόταση για οριστική έξοδο από την κρίση

by Jaromir Benes and Michael Kumhof

 I. Introduction 

The decade following the onset of the Great Depression was a time of great intellectual ferment in economics, as the leading thinkers of the time tried to understand the apparent failures of the existing economic system. This intellectual struggle extended to many domains, but arguably the most important was the field of monetary economics, given the key roles of private bank behavior and of central bank policies in triggering and prolonging the crisis.

During this time a large number of leading U.S. macroeconomists supported a fundamental proposal for monetary reform that later became known as the Chicago Plan, after its strongest proponent, professor Henry Simons of the University of Chicago. It was also supported, and brilliantly summarized, by Irving Fisher of Yale University, in Fisher (1936). The key feature of this plan was that it called for the separation of the monetary and credit functions of the banking system, first by requiring 100% backing of deposits by government-issued money, and second by ensuring that the financing of new bank credit can only take place through earnings that have been retained in the form of government-issued money, or through the borrowing of existing government-issued money from non-banks, but not through the creation of new deposits, ex nihilo, by banks. Fisher (1936) claimed four major advantages for this plan.

First, preventing banks from creating their own funds during credit booms, and then destroying these funds during subsequent contractions, would allow for a much better control of credit cycles, which were perceived to be the major source of business cycle fluctuations.

 Second, 100% reserve backing would completely eliminate bank runs.

Third, allowing the government to issue money directly at zero interest, rather than borrowing that same money from banks at interest, would lead to a reduction in the interest burden on government finances and to a dramatic reduction of (net) government debt, given that irredeemable government-issued money represents equity in the commonwealth rather than debt.

Fourth, given that money creation would no longer require the simultaneous creation of mostly private debts on bank balance sheets, the economy could see a dramatic reduction not only of government debt but also of private debt levels. We take it as self-evident that if these claims can be verified, the Chicago Plan would indeed represent a highly desirable policy.

Profound thinkers like Fisher, and many of his most illustrious peers, based their insights on historical experience and common sense, and were hardly deterred by the fact that they might not have had complete economic models that could formally derive the welfare gains of avoiding credit-driven boom-bust cycles, bank runs, and high debt levels.

We do in fact believe that this made them better, not worse, thinkers about issues of the greatest importance for the common good. But we can say more than this. The recent empirical evidence of Reinhart and Rogoff (2009) documents the high costs of boom-bust credit cycles and bank runs throughout history. And the recent empirical evidence of Schularick and Taylor (2012) is supportive of Fisher’s view that high debt levels are a very important predictor of major crises.

The latter finding is also consistent with the theoretical work of Kumhof and Rancière (2010), who show how very high debt levels, such as those observed just prior to the Great Depression and the Great Recession, can lead to a higher probability of financial and real crises.

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