Archive | Banking

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.

Published 24 November 2010

Australian economic reformist Dr Nicholas Gruen has set out a way to improve banking across the Tasman without wholesale change in the latest Whitlam Institute Perspectives paper, released on Monday. The institute’s director, Eric Sidoti, said Dr Gruen had produced the paper quickly in response to a symposium held by the institute and the University of Western Sydney’s School of Economics & Finance in July, Delivering a 21st century economy for a fair Australia.

Mr Sidoti said: “Australian banks’ profitable navigation of the global financial crisis may be pleasing shareholders, but the political & community reception has been hostile. Dr Gruen proposes a viable, low-risk policy reform which would address the current inequity in the structure of the Australian banking system.

“Dr Gruen’s insight is that the Canadian arrangements enabled the major elements of the mortgage market (including the market for securitisation) to continue to function throughout the global financial crisis, and in that sense performed better than the Australian market. The proposal that follows takes that experience and applies it in a prudent manner to the Australian conditions.”

Dr Gruen said in his introduction: “While the financial crisis cut swathes through the financial sector & real economics of developed countries generally, its effect in Australia was to illustrate a grand paradox. Our banks were revealed to be amongst the strongest in the world, profitable beyond the wildest dreams of the pre-deregulation era. At the same time they were dangerously fragile, requiring unprecedented guarantees not just on deposits but also for wholesale creditors. If the analysis offered in this paper is sound, the policies it proposes will make our financial system not just less fragile, but also substantially more competitive.

“There has been no shortage of proposals for comprehensive re-regulation of finance. Yet even relatively like-minded experts who can often broadly agree on the causes of the crisis still disagree on the correct solution. Thus for instance John Kay, Paul Volcker, or even the Bank of England governor, Mervyn King, appear to back strong action to return the core banking systemto ‘narrow banking’ and avoiding the problem that some banks are ‘too big to fail’, whilst Nobel laureate Paul Krugman is not so sure.

“Many prescribe substantial increases in capital adequacy by banks. But while this may improve the robustness of our banks, it would do little to improve competition between them and nothing for the competitiveness & stability of alternative sources of finance such as securitisation.

“The approach in this paper is slightly different. It does not propose a new regulatory regime arising from a comprehensive view of finance. Instead we go looking for hundred dollar bills on the pavement: That is, areas of inefficiency whose source can be easily seen in both theory & empirically and which can be improved by the application of simple principles & procedures of micro-economic reform…..

“The paper focuses on lending to households in Australia, and particularly on the largest household debt market – the $A1 trillion home loan market, which constitutes around 60% of Australian banks’ assets. However, the principles articulated here would apply to any area of banking which is susceptible to disintermediation through market-traded portfolio funding (also known as ‘securitisation’).

“The central motivating concerns of the paper are these:

Most finance is ‘commoditised’. Yet in contrast to an industry like IT, where a service being ‘commoditised’ leads to dramatic price falls, in finance this has not happenedAs the crisis demonstrated, banking is a public-private partnership. Banks risk capital to earn profits. But given their capital adequacy will always be limited, catastrophic downside risks are assumed by governments. No amount of denial or policy ambition will remove the government’s guarantee. And even if it were possible to remove it, it is not possible to prevent depositors & money markets from perceiving it as likely that bank guarantees would be activated in a crisisWhile the dilemmas of banking will always involve difficult tradeoffs, the current architecture of banking is inefficient, inequitable & fragile. The real economic payoff is in finessing the contours of the private-public partnership that is banking. The assignment of roles should be the product of careful, practical & principled thought, rather than ideological predisposition which privileges the role of either public or private sectorsGiven the complexity, importance & politically contentious nature of finance, there is a premium on evolving industry structure through choices in the presence of competitionCrucially, competitive neutrality is invoked not just to protect private competitors from subsidised competition from the public sector, but also to ensure that the contribution public-sector assets & capabilities can make to productivity are not artificially withheldTo prevent moral hazard and to manage its own exposure, governments heavily regulate banks. There have been similar calls for governments to regulate shadow banking built on securitisation. However given the advantages of limiting regulation to where its benefits outweigh its costs, an alternative is to allow those in the shadow banking sector to purchase the liquidity-provision & risk-bearing services of governments. Thus ‘regulation’ occurs, but on an opt-in basis and only on products that a government agency considers appropriate risksNew technological possibilities, particularly on the internet, have powerful implications for the way this public-private partnership of finance should be crafted. This point will only live in the background in the analysis here but will come to the fore in a subsequent companion paper.”

Dr Gruen has advised 2 Labour cabinet ministers and sat on the Productivity Commission He’s chief executive of Lateral Economics, a regular columnist & prolific blogger. He chaired the Federal Government’s 2.0 Taskforce in 2009 and is a strong public advocate for economic reform & innovation.

The Whitlam Institute, within the University of Western Sydney at Parramatta, commemorates the life and work of 1970s Labour prime minister Gough Whitlam and pursues the causes he championed.

Link: Delivering a 21st century economy for a fair Australia

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Attribution: Whitlam Institute, paper, story written by Bob Dey for the Bob Dey Property Report.