Asymptosis

Imagine that all bank deposits — the dollars in your checking account — were 100% backed, one-for-one, by your bank’s reserve holdings at the Fed (the modern, fiat-money-world equivalent of gold reserves). Runs on bank deposits would be impossible, because the outfit that issues reserves and currency can’t run out of reserves and currency — any more than a bowling alley can run out of points. You could always take your money out of the bank.

Meanwhile all lending would come from actual investment funds, in which the investors (via equity or debt) are explicitly putting their funds at risk in hopes of getting better returns.

As pointed out by Matthew C. Klein — recently transplanted from The Economist to Bloomberg View — this notion…

…has a long and distinguished academic lineage. Luminaries such as Irving Fisher, Milton Friedman and James Tobin have all advocated it.

For instance, the “Chicago Plan” was developed in the 1930s by Fisher and Henry Simons. Friedman later endorsed it as well. Two researchers at the International Monetary Fund have written an up-to-date appraisal — and the proposal, in theory, does everything its designers claimed 80 years ago. The first 20 pages of this paper are an excellent primer.

Tobin explained the essence of the idea in 1987 at the Federal Reserve’s annual economic symposium in Jackson Hole:

[snip]

“I think the government should make available to the public a medium with the convenience of deposits and the safety of currency, essentially currency on deposit, transferable in any amount by check or other order…The Federal Reserve banks themselves could offer such deposits, a species of ‘Federal Funds.'”

More recently, Boston University economist Larry Kotlikoff has argued that we need to completely separate money from credit by introducing what he calls “limited purpose banking.” It’s basically the same idea.

Matthew says “This is the remedy advocated by Bloomberg View’s editors.” That’s pretty mainstream.

I’d go even farther and recommend Steve Randy Waldman’s idea of “starter savings accounts,” in which you could get a guaranteed 0% real return — no matter the level of inflation — on up to $200,000 in deposits. This would insulate the real economy from the vagaries of the financial system’s floods and droughts. Got confidence?

These ideas are not as simple as they sound — there are institutional and incentive issues to address. But separating the mundane business of administering holdings and payments from the ever-more-arcane business of lending and investment is not some wacky internet econocrank idea. It’s downright conservative.

Cross-posted at Angry Bear.

Update April 4: Steve Waldman kindly links to this post, and I’m rather abashed that he does because it’s wrong as written. As pointed out by Ramanan. (Though the spirit is right.) I should have said:

He expresses befuddlement at Steve Randy Waldman’s typically brilliant post, K is not capital, L is not labor.

S equals I (and properly understood, I = E) only in an imaginary private sector of producers/consumers with no financial sector, no government sector, no international sector, no lending, and no borrowing — really a barter economy in which not consuming corn is “saving.”

This is the walled-off imaginary sector constructed by Kuznets and company in the ’30s and embodied in the National Income and Product Accounts — NIPAs. (It was only properly supplemented years later with Flow of Funds accounting incorporating other sectors properly.) By necessity they had to construct it as if (to quote Garrett Jones). “Everything you delay gratification for is capital.” (I would add: “real” capital.)

This is basic sectoral accounting, a subject in which neoclassical (and “market monetarist”) economists seem to have received no training.

Cross-posted at Angry Bear.