Chicago Plan

The Chicago Plan refers to a memorandum calling for a radical shift in banking regulation through the implementation of a full-reserve system - as a substitute of the fractional reserve system - for the banking sector. Issued in March 1933 and revised in November 1933, it was written by Knight (1933) and addressed to US President Roosevelt. It was summarized three years later by Fisher (1936). But in the aftermath of the Great Recession, the plan was set aside in favour of alternative measures encapsulated in the US Banking Act of 1935.

The Chicago Plan was revived years later and received some support, notably from Friedman (1960), who argued that it would have improved the monetary stability of the economic system as a whole. Recently, the Chicago Plan was again the subject of renewed interest, in particular owing to the work of Benes and Kumhof (2012), who calibrate a dynamic stochastic general equilibrium (DSGE) model to assess the effects of its imple- mentation on the US economy. Following the subprime crisis of 2007, their work has become the reference for the proponents of a full-reserve system, notably several civil society movements across Europe (Positive Money in England, for instance), who called for giving the State the monopoly over the issuance of money.

The aim of the Chicago Plan was to ensure that banks grant credits only through "the borrowing of existing government-issued money from non-banks, but not through the creation of new deposits, ex nihilo, by banks" (Benes and Kumhof, 2012, p. 4). Such a plan calls therefore for a full-reserve backing of bank deposits by government-issued money, and for a monetary growth rule to control the quantity of money in circulation. In this respect, such a rule determines the quantity of newly issued money injected, through public spending, within the economic system. Against this background, a given bank is able to grant credits only if economic agents (who receive money through public spending) deposit government-issued money within it. Consequently, banks cannot rely on the issuance of money to finance any credit: they have to collect deposits in order to lend. According to Fisher (1936) and Benes and Kumhof (2012), the Chicago Plan therefore has numerous advantages: to wit, a better control of the business cycle (banks do not fuel the credit cycle by issuing money); the elimination of bank runs (credits are backed by government-issued money); a reduction of public and private debts (the rate of interest on the government-issued money is equal to zero); and long-term output gains (the reduction of debts across the economic system leads to a decrease in the real rate of interest), as well as a drop in the rate of inflation (the monetary growth rule ensures the regulation of the supply of money).

Now, beyond the econometric estimations of Benes and Kumhof (2012), the Chicago Plan is flawed on several counts. First of all, a well-known critique addressed to the mon- etary growth rule advocated by the Chicago Plan concerns the instability of the demand for money, which is now firmly established. When a central bank adopts a monetary targeting strategy, its monetary policy has to follow a pre-established rule as regards the supply of money. In fact, however, the latter is an endogenous magnitude: from a post-Keynesian point of view (see Moore, 1988), banks create deposits when they grant credits through the issuance of money. Contrary to what the proponents of the Chicago Plan maintain, banks are not constrained by reserves when they grant new credits. The problem when the central bank tries to pre-determine the supply of money for a given period of time is that it has to change its policy rate of interest (in order to influence the term structure of interest rates) in the case of an unexpected swing in the demand for money. Notably, the central bank increases (decreases) its policy rate of interest when such a swing occurs in order to rein in (stimulate) the demand for money and bring the "money market" back to equilibrium. As a result, an unstable demand for money causes, under a monetary targeting strategy, a high volatility of the policy rate of interest and, consequently, an instability of the term structure of interest rates, which is a major threat for monetary stability, as Volcker's monetarist experiment in the United States showed during the 1980s.

On a more conceptual ground, the determination shown by proponents of the Chicago Plan to change the nature of money - that is, to make money an exogenous magnitude - reflects a dichotomous conception of the economic system. Indeed, the recommenda- tions of such a plan (the implementation of a full-reserve backing of bank deposits by government-issued money and of a monetary growth rule) treat money as a commodity, which, like any other commodity, is produced and circulates within the economic system. This precludes any integration between money and products (it is a matter of metaphysics to integrate two commodities with each other). Against this background, the proponents of the Chicago Plan consider money through the law of scarcity fitted for commodities (a commodity has to be produced with factors of production whose quantity is limited). In other words, the Chicago Plan recommends a loanable-funds approach, according to which savings are scarce.

A better reform of the banking system has to consider the endogenous nature of money, without rendering the latter an exogenous magnitude. Indeed, money is a book- keeping entry devoid of any purchasing power (note that monetary authorities cannot create any purchasing power when they issue money), unless it is associated with output through the payment of wages, as the monetary theory of production explains (see Graziani, 2003). Consequently, the reform of the banking system has to distinguish, in the spirit of Keynes (1930 [2011]), two kinds of banking intermediation: a monetary intermediation, whereby banks issue money (for the payment of wages by firms) to monetize production; and a financial intermediation, in which income - that is, the bank deposit (a financial claim) resulting from the remuneration of labour - is lent for non- productive purposes (see Rossi, 2007, pp. 126-32, for a structural reform regarding the partition of banks' double-entry bookkeeping). Such a bookkeeping distinction avoids the issuance of money for speculative purposes (no money devoid of any purchasing power will fuel inflation on financial markets) without curbing the development of the economic system - as the scarcity of loanable funds implies.

See also:

100% money; Banking and Currency Schools; Bank money; Bank run; Central bank money; Classical dichotomy; Commodity money; Endogenous money; Fiat money; Financial crisis; Financial instability; Fractional reserve banking; Free banking; Friedman rule; Glass-Steagall Act; High-powered money; Interest rates term structure; Monetarism; Monetary circuit; Monetary targeting; Money and credit; Money crea- tion; Money creation and economic growth; Money multiplier; Money supply; Narrow banking; Reserve requirements; Volcker experiment.