Published 13 November 2012
Australian economics professor & columnist Steve Keen – a highly respected critic of US Federal Reserve governor Ben Bernanke – got excited last week about a working paper from the International Fund on the Chicago Plan, byJaromir Benes & Michael Kumhof.
The significance of this is that Professor Keen has acknowledged a paper by neoclassicists from a neoclassical organisation, but has done so because they’ve stepped outside the usual neoclassical thought band.
It matters because the neoclassical approach has held sway through the US stimulus programmes – and, Professor Keen has argued, held sway earlier by encouraging the steep rise in debt pre-global financial crisis.
One reason for Professor Keen’s enthusiasm for the IMF researchers’ paper was its “realistic perspective on banking is the hallmark of the first, very literary, section of the paper, which discusses both the actual mechanisms of money creation now and the historical debate about the nature of money and the proper role of banks. I do urge everyone to read this section, since it is so rare to have the actual practices of banking realistically discussed in a formal academic paper, let alone one issued by the IMF”.
Under the Chicago Plan, devised in the 1930s, the banking system’s monetary & credit functions would be separated by a requirement for banks to have 100% reserve backing for deposits.
US economist Irving Fisher claimed in 1936 this would give much better control of a major source of business cycle fluctuations, sudden increases & contractions of bank credit and of the supply of bank-created money; it would completely eliminate bank runs; it would dramatically reduce net public debt; and it would dramatically reduce private debt because the creation of money no longer required the simultaneous creation of debt.
The authors of the IMF paper said they found support for all 4 of these claims through their study, in which they embedded a comprehensive & carefully calibrated model of the banking system in a DSGE (dynamic stochastic general equilibrium modelling) model of the US economy. In addition, they found output gains approached 10% and steady state inflation could drop to zero without posing problems for the conduct of monetary policy.
According to Wikipedia, the DSGE (dynamic stochastic general equilibrium)methodology “attempts to explain aggregate economic phenomena, such as economic growth, business cycles and the effects of monetary & fiscal policy on the basis of macro-economic models derived from micro-economic principles”.
The authors said the critical feature of their model was that the economy’s money supply would be created by banks through debt, rather than being created debt-free by the Government.
They said it would reduce debt “by making government-issued money, which represents equity in the commonwealth rather than debt, the central liquid asset of the economy, while banks concentrate on their strength, the extension of credit to investment projects that require monitoring & risk management expertise.
“We find the advantages of the Chicago Plan go even beyond those claimed by Fisher. One additional advantage is large steady state output gains due to the removal or reduction of multiple distortions, including interest rate risk spreads, distortionary taxes and costly monitoring of macro-economically unnecessary credit risks.
“Another advantage is the ability to drive steady state inflation to zero in an environment where liquidity traps do not exist, and where monetarism becomes feasible & desirable because the government does in fact control broad monetary aggregates. This ability to generate & live with zero steady state inflation is an important result, because it answers the somewhat confused claim of opponents of an exclusive government monopoly on money issuance, namely that such a monetary system would be highly inflationary. There is nothing in our theoretical framework to support this claim. And there is very little in the monetary history of ancient societies & western nations to support it either.”
Jaromir Benes was a research advisor at New Zealand’s Reserve Bank from 2006-08. He was a member of the DSGE team, responsible for developing & implementing a new forecasting model. For the previous 7 years he headed the Czech National Bank’s macro-economic modelling unit, where he was responsible for developing & implementing the quarterly projection model and the G3 model. From New Zealand, he moved to the IMF in Washington as an economist. Michael Kumhof is deputy chief of the IMF research department’s modelling division in Washington.
Professor Keen is a professor of economics at the University of Western Sydney, which has just decided to cut back on all but one of the economics papers it offers before partly relenting, in response to government funding changes. As a result, he’s in danger of losing his job.
Links: The Chicago plan revisited Steve Keen: The IMF goes radical? Steve Keen, Debtwatch blog Steve Keen: The economic case against Bernanke, 24 January 2010
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Attribution: Steve Keen blog, Business Spectator, IMF paper, story written by Bob Dey for the Bob Dey Property Report.