George Selgin on monetary reform

At various times, I’ve advocated simplifying the US monetary system.  I’d like to see us abolish reserve requirements, discount loans and interest on reserves. The only goal of OMOs would be to stabilize NGDP growth.  The Fed would have no involvement with the banking system.  Once I even went so far as to suggest going back to the early days when deposits at the Fed did not exist, and the entire monetary base was cash.  Admittedly, this is a somewhat regressive step from a technical perspective (Woodford and Cochrane would be horrified), but I thought the gains would outweigh the costs.  It would clarify that the Fed’s only purpose is to adjust the supply of the medium of account until NGDP growth was stabilized, with that goal of achieving more stable labor and credit markets.  This has almost nothing to do with banking.  In 2008, they went far off course by focusing on banking and ignoring NGDP.

If the government wants to get involved with banking, I would assign that task to the Treasury.  They might impose capital requirements, or a regulation forcing banks to make bonds convertible into equity in a crisis.  Maybe they would bail out banks that are “too big to fail” (my least favorite option).  But all of this would be completely divorced from Fed policy.

Of course these ideas are far too radical to be enacted.  So what would a more pragmatic proposal look like, which moved in this general direction?  I’d highly recommend reading George Selgin’s (Heritage) paper on a “flexible open market alternative” to the current mish-mash of ad hoc Fed policies.  Here George provides the basic framework for thinking about these issues:

More fundamentally, recent experience suggests that the conventional dichotomy of “emergency” and “ordinary” central-bank liquidity provision, though it may have had some merit in the distant past, has outlived its usefulness. When implementing “ordinary monetary policy” meant little more than maintaining the gold standard, last-resort lending posed a separate, if not conflicting, challenge. A modern fiat-money-issuing central bank, in contrast, has but one fundamental duty to fulfill. That duty consists of supplying cash, meaning currency and bank reserves, in amounts sufficient to meet macroeconomic targets, and doing so efficiently, that is, so that newly created cash is assigned to those parties that can gain, and are therefore willing to pay, the most for it.

Here is the centerpiece of the proposal:

Once flexible OMOs are established, the Fed should permanently close its discount window, which such operations will render redundant at best and a source of inefficient credit allocation at worst. Any institution that resorted to the discount window as a source of last-resort credit in the past will be able to participate in the Fed’s routine credit auctions using the same collateral it might have employed in securing a discount-window loan. However, instead of being guaranteed support, under pre-established terms, or having the Fed unilaterally determine to support it, it must secure funds by outbidding rival applicants. Thus the flexible OMO alternative improves upon bilateral Fed lending, not only by avoiding the stigma connected to the latter, but also by checking moral hazard.

Finally, Congress should improve oversight of the Fed’s broadened open-market operations, to assure that those operations are conducted in a manner consistent with efficient credit allocation, and especially with the avoidance of any implicit subsidization of risk-taking.

And here George summarizes the goals of this proposal:

What distinguishes the flexible-OMO plan from these precedents is that it envisions a single facility only, supplying both routine and emergency credit, and doing so in a way that relies to the fullest extent possible on market forces, rather than on decisions by bureaucrats, to achieve an efficient allocation of liquidity among competing applicants. By allowing a broad set of potential applicants, using a wide range of eligible collateral, to compete for available funds, not only in private markets, but, when necessary, at a single Federal Reserve facility, flexible OMOs minimize the Federal Reserve’s credit footprint, and thereby prevent it from taking part in either deliberate or inadvertent credit-allocation exercises for which fiscal rather than monetary authorities ought to be responsible.

These excerpts don’t do full justice to this excellent paper.  For instance, George discusses how some of his ideas have already been implemented by other central banks, such as the BoE.  I strongly recommend that people interested in monetary policy read the whole thing.

PS.  David Beckworth interviews George Selgin on this topic.



25 Responses to “George Selgin on monetary reform”

  1. Gravatar of Scott Freelander Scott Freelander
    11. May 2017 at 08:52

    Selgin is one of the best monetary policy thinkers I’ve read. It’s too bad more of the internet Austrians don’t pay more attention to him, instead of blindly pushing for a return to the gold standard, for example.

  2. Gravatar of Matthias Görgens Matthias Görgens
    11. May 2017 at 13:55

    Reading George Selgin’s papers (mostly on free banking) actually made me more sympathetic to gold standard than I was before.

    The Internet Austrians could benefit by learning from Selgin about the virtues of fractional reserve banking.

  3. Gravatar of Major-Freedom Major-Freedom
    11. May 2017 at 14:44


    Internet Austrian here. Austrians in general have no problems with fractional reserve banking, so long as people are not misled by the nature of the contracts, specifically, it cannot be falsely presented as money instead of what t really is, which is unpacked debt. Yet historically bankers, with government sanction and support, have misled their clients about what it is they are doing when they deposit money into their (fractional reserve) bank account. Governments have also historically instituted “bank holidays” that are in effect legalizations of violations of prior contracts.

    As long as the debts are clearly marked as such and communicated as such, then caveat emptor.


    Summer wrote:

    “The Fed would have no involvement with the banking system”

    This is like saying a state enforced monopoly supplier of fuel “would have no involvement” in arsonists setting fires of all the supplier did was provide fuel to the arsonists.

    Economics teaches us that central banks expanding and contracting the money supply via the banking system has deterministic effects on interest rates, as it is impossible for bankers to know market rates as long as they are forced to work within the monopoly system.

    Can’t have your cake and eat it too.


  4. Gravatar of Major-Freedom Major-Freedom
    11. May 2017 at 14:54

    After Sumner tells us his utopian socislist system for money, I am curious to know what he recommends for legal recourse, liability, that the hapless peons and serfs can appeal to when the monopolist cheats, or when the peons and serfs simply want out of the system entirely, and remain in the house they live in and remain working for the company they work for.

    Is it still just the same old thugs with guns, do as I say with your person and property, or else?

  5. Gravatar of bill bill
    11. May 2017 at 15:22

    Excellent post. I will read Selgin’s paper.
    I can already sense that the rent-seekers are figuring out ways to object.

  6. Gravatar of Benjamin Cole Benjamin Cole
    11. May 2017 at 16:08

    Interesting post.

    I like the idea that banks must issue a thick layer of convertible bonds, but comply with no other (or very few) regulations.

  7. Gravatar of Benjamin Cole Benjamin Cole
    11. May 2017 at 16:10

    You know what is interesting?

    Go to the American Bankers Association website. If the ABA has any complaints about Dodd-Frank, they do not show up on their own website.

  8. Gravatar of Jerry Brown Jerry Brown
    11. May 2017 at 21:30

    “It would clarify that the Fed’s only purpose is to adjust the supply of the medium of account until NGDP growth was stabilized, with that goal of achieving more stable labor and credit markets.”
    Where in the laws that created the Fed is it said that the Fed’s only purpose is to adjust the supply of the medium of account- for whatever reason? You might think that is what it should only do, but I don’t think that is what it was designed to do, or what it does do, or what it even could do given our monetary system.
    In my understanding of the history, the Federal Reserve was mostly created for the purpose of maintaining and protecting the payments system (as in banking) from the recurrent crises it had been experiencing. If that is true, then the Fed is mostly going to be obligated to ensuring that adequate reserves are always available so that the system doesn’t collapse. That very much undermines the ability to limit the supply of money by the Fed.

  9. Gravatar of tpeach tpeach
    12. May 2017 at 02:11

    Hi Scott

    I have just started working for a bond dealer and it has greatly re-kindled my interest in market monetarism. I used to be an avid reader of this blog and over the past few weeks have been consuming lots of your old blog posts to try and get my head around everything again.

    I have a question that I’ve been trying to get an answer for, but can’t seem to crack it. It kind of relates to the interest rate cuts of late 2007/early 2008.

    I understand how base money stopped growing around that time, hence the contractionary monetary policy. I also understand how interest rates affect velocity.

    My question is, what would have happened if the Fed hadn’t cut rates between Dec 07 and Apr 08? What would have happened to the base and velocity if the fed kept the rate stable while the Wicksellian or market rate plumetted during that time? Would the base shrink? If so, what are the mechanics behind that process? Also, how can the fed adjust the rate without changing the base? And why didn’t velocity drop when they cut rates during this time?

    I know it’s a bit random, so i hope it’s ok to ask this question on an unrelated post.

  10. Gravatar of ssumner ssumner
    12. May 2017 at 06:21

    Jerry, The Fed was created to deal with a gold standard regime. When we switched to fiat money its mandate was changed. My proposal is consistent with their current mandate.

    tpeach, It’s very difficult to say how the base would have moved if the Fed had not cut rates. Higher rates can reflect tighter money, or they may reflect expectations of faster NGDP growth.

    I do not know why velocity did not drop during that period.

  11. Gravatar of tpeach tpeach
    12. May 2017 at 08:04

    Scott, i get that. What i don’t get is how the fed can change rates unilaterally without changing the base (ignoring IOR).

  12. Gravatar of ssumner ssumner
    12. May 2017 at 08:40

    tpeach, It cannot do so, unless it changes IOR (which it did not have in 2007)

  13. Gravatar of ssumner ssumner
    12. May 2017 at 08:40

    also check my new post

  14. Gravatar of Vaidas Urba Vaidas Urba
    12. May 2017 at 09:57


    Selgin’s ideas make perferct sense. There is an additional benefit of having a diversified mix of assets in OMOs – you could have a narrower NGDPLT corridor compared to the Treasuries-only OMO policy.

  15. Gravatar of Major-Freedom Major-Freedom
    12. May 2017 at 19:29

    Sumner wrote:

    “Jerry, The Fed was created to deal with a gold standard regime.”

    No, that’s incorrect. Read “The Creature from Jekyll Island” by G. Edward Griffin.

    The Fed was created to protect bankers from going bankrupt for engaging in fractional reserve banking, using coercive state power.

    It was not created to “deal with” the gold standard, as if the money chosen by the market is some sort of social “burden”

    This blog is a socialist cesspool

  16. Gravatar of ssumner ssumner
    13. May 2017 at 05:54

    Vaidas, You’ll have to explain that.

  17. Gravatar of flow5 flow5
    13. May 2017 at 11:28

    “And why didn’t velocity drop when they cut rates during this time?”

    Vi, income velocity, is a contrived figure, but Vi: or gDp/M2 & gDp/MZM both dropped along with Vt, transactions velocity. MZM Vi is more representative of Vt velocity.

    But money stopped growing because the Fed targeted interest rates instead of targeting legal reserves. The money stock can never be managed by any attempt to control the cost of credit. The only tool at the disposal of the monetary authorities, in a free capitalistic society, through which the volume of money can be controlled is legal reserves (not interest rate manipulation).

  18. Gravatar of flow5 flow5
    13. May 2017 at 12:31

    Selgin’s vacuous. He doesn’t understand money and banking 101. Bagehot’s “dictum” is non sequitur. And money is not fungible, one $ is not like any other.

  19. Gravatar of Vaidas Urba Vaidas Urba
    14. May 2017 at 01:07


    One of the reasons the corridor is needed for NGDPLT is to make sure the peg does not break. If the asset mix is more diversified, the risk of losses for central bank is lower, accordingly, the corridor could be narrower in this case.

  20. Gravatar of flow5 flow5
    14. May 2017 at 05:41

    A. Selgin doesn’t know the difference between the supply of money & the supply of loan funds.
    B. doesn’t know the difference between means-of-payment money & liquid assets.
    C. doesn’t know the difference between financial intermediaries & money creating institutions.
    D. doesn’t recognize that interest rates are the price of loan-funds, not the price of money

  21. Gravatar of flow5 flow5
    14. May 2017 at 05:44

    Money is the measure of liquidity, the “yardstick” by which the liquidity of all other assets is measured.

    The “monetary base” is not now, nor has ever been, a base for the expansion of the money supply.

    The “multiplier” is derived from “money” divided by member commercial bank legal reserves, not the monetary base.

    Aggregate monetary demand is measured by monetary flows, volume X’s velocity, not N-gDp

    Income velocity is a contrived figure (WSJ, Sept. 1, 1983)

    The rates of change calculations used by the Fed are specious (always at an annualized rate having no nexus with economic lags; Friedman pontificates variable lags; economic lags are unvarying)

    Friedman (1959) long advocated the payment of interest on reserves at a market rate in order to eliminate the distortions associated with the tax on reserves. However, the DFIs [as a system] acquire free legal reserves via open market operations & on this basis create a multiple volume of new money & credit (and acquire a concomitant volume of additional earning assets). IBDDs are Manna from Heaven.

  22. Gravatar of ssumner ssumner
    14. May 2017 at 07:30

    Vaidas, Not sure why the risk of losses would be lower.

  23. Gravatar of Vaidas Urba Vaidas Urba
    14. May 2017 at 12:09


    haircuts are used to equalize the individual risk between Treasuries and alternative assets, and diversification reduces the portfolio risk.

  24. Gravatar of Scott Sumner Scott Sumner
    15. May 2017 at 05:44

    Vaidas, On the other hand, if you view the central bank as being a part of the Federal government, then there is zero risk in holding Treasuries.

  25. Gravatar of Vaidas Urba Vaidas Urba
    15. May 2017 at 09:26

    Scott, yes, there is zero risk in holding Treasuries assuming they are held until maturity. But what if you have to tighten the monetary policy before Treasuries mature? In that case the central bank has to sell the Treasuries exposing the consolidated government to risk.

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