What role do we want the monetary base to serve?

Over at Econlog, I have a new post discussing the Fed’s opposition to narrow banking, and specifically John Cochrane’s excellent post criticizing the Fed’s position. I’ll eventually get to narrow banking in this post, but first I’d like to consider some basic questions about the monetary base, which are rarely asked.

Before 1913, the US had no Fed and the monetary base was 100% composed of currency (and coins.) There were no bank deposits at the Fed. It’s perfectly possible to run the world’s largest economy on that basis. Yes, there were occasional financial crises, but the 1931-33 banking crisis was far worse, so creating the Fed didn’t solve the problem. When I was in school, I was taught that it was FDIC that actually ended banking crises, but then we had 2008. Crisis-free Canada didn’t have a central bank until the 1930s and had no deposit insurance until the 1960s, so whatever causes financial crises it’s certainly not a lack of government intervention.

When the Fed was created in 1913, base money was expanded to include deposits at the Fed, not just currency. But why? Why add these reserve deposits, and if it’s a good idea, why not let anyone have a deposit at the Fed? I’ve never seen a good explanation.

I once wrote a post suggesting that we go back to the pre-1913 currency-only monetary base, half jokingly and half seriously. I’m sure John Cochrane would have been horrified, as he has quite rightly noted that the government can produce safe liquid assets quite cheaply, and hence on efficiency grounds there’s something to be said for saturating the economy with the stuff (say via the “Friedman rule”.)

But I wonder if that isn’t penny wise and pound foolish. Or as Tobin once said, “it takes a heap of Harberger triangles to fill an Okun Gap”. (Which means micro efficiency costs are an order of magnitude smaller than the costs of demand side recessions, i.e. the cost of inadequate monetary policy.)

Suppose we had had a currency-only monetary base in 2008. If the Fed had done $3 trillion in open market purchases, what would the impact of all that extra currency have been, given the currency stock was only $850 billion going into the recession? I’m not sure, but I suspect the Fed would have gotten more bang for the 3 trillion bucks.

Since my currency only idea is a pipe dream, let’s go the other direction. Let’s say deposits at the Fed are a great idea. I still want to know why they are restricted to banks. It’s only a matter of time before we go to all electronic money. Is it feasible to have a monetary regime where it is illegal for anyone but a banker to hold lawful money? I doubt it. In that case, it seems like Morgan Ricks’ proposal for allowing the public to have accounts at the Fed is only a matter of time.

Indeed the logic of this is so powerful that “narrow banks” are already trying to create a backdoor into the Fed, by having bank deposits where 100% of the money is placed in interest-bearing reserves. Basically, you’d have a checking account at the Fed, but there’d be a middleman to preserve a fig leaf for the idea that in the era of FDIC and interest-bearing reserve accounts, the commercial banking system is actually a useful way of providing liquidity to the public. It isn’t. Banks should be taking illiquid funds (CDs, etc.) and creating illiquid assets (loans, etc.).

Somewhere between ultra-safe reserves and risky loans we have bills and bonds. Who should serve as the intermediary in that case? Mutual funds?

If you want to have low inflation and zero interest rates, the central bank balance sheet will get large. Eventually the Fed may go beyond Treasuries and start buying private bonds. But big central bank balance sheets are a choice; it’s not hardwired into the modern world, as so many pundits seem to believe.

If you allow narrow banking, it may have the effect of increasing the demand for base money. John Cochrane suggests that the Fed has the option of not increasing the supply, which is true. But if rates are stuck at zero when demand for reserves increases, then not increasing the supply is highly contractionary.

So now we have another issue to consider, balance sheet size and monetary policy effectiveness. In theory, the government can create reserves costlessly, and meet any market demand. But real world central banks seem reluctant to have excessively large balance sheets, largely for psychological reasons. Unless this mental block can be overcome, perhaps through therapy, a greatly expanded central bank balance sheet might complicate monetary policy.

To me, central banks seem like a spoiled 10-year old boy, who complains about every option you offer him:

1. Do monetary policy “a outrance” to prevent demand shortfalls? They whine that there are “costs and risks” of doing what it takes.

2. But the costs and risks of the Fed buying government bonds are not real, as a central bank is part of the consolidated government balance sheet. Then they whine that it would be embarrassing to ask Congress for a “bailout”.

3. OK, adopt the sort of monetary regime that prevents the zero bound, one of the options now favored by many academic economists (as well as economists like Bernanke before he got to the Fed.) The Australian approach, for instance. Can’t do that, it’s too controversial.

So we’ve got this ever expanding Rube Goldberg device of a financial system, where plugging one leak just causes another to develop. Each step seems logical, but no one is thinking about the ultimate destination. What do we want of our monetary base? What types of base money should exist? Who should get to hold each type of base money? How attractive should it be to hold base money? (I.e. how competitive should the IOR rate be?)

The Fed’s horribly confused defense of its anti-narrow banking policy is an indication that there’s no real long run plan here; they are making it up as they go along. As each step exposes more logical contradictions, more patches are put in place, more plugs placed in leaks at the bottom of the boat. Our political system is not one where you can simply “blow it all up” and start with a more rational system, and maybe that’s for the best (for Hayekian reasons.) So we’ll keep muddling along, and eventually end up in a very different place.


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36 Responses to “What role do we want the monetary base to serve?”

  1. Gravatar of Why does the Fed oppose narrow banking?, by Scott Sumner – Nagaland Jackpot Teer Result News Why does the Fed oppose narrow banking?, by Scott Sumner - Nagaland Jackpot Teer Result News
    16. March 2019 at 12:59

    […] a lot to say on narrow banking, and I’ll have another post over at TheMoneyIllusion.  Here I’ll focus on the cross-subsidy aspects of the issue. While I strongly oppose the […]

  2. Gravatar of Becky Hargrove Becky Hargrove
    16. March 2019 at 13:39

    I try to be careful about context when I use words such as moral, but should we end up with a cashless society (God forbid), the Morgan Ricks proposal might be one of the few moral monetary options left.

  3. Gravatar of BJH BJH
    16. March 2019 at 14:11

    Great post Scott!

  4. Gravatar of Lorenzo from Oz Lorenzo from Oz
    16. March 2019 at 15:57

    Great post.

    Central banks exists so states can have a tame bank for fundraising purposes. Everything after that is rationalisation and justification after the fact. So I am shocked, shocked, that there might be a bit of inconsistency in their patterns of behaviour.

    Scotland and Canada are two excellent examples of good laws means that stable financial systems are perfectly possible without any central bank (or deposit insurance).

    Unfortunately, they were able to do what they did because they were protected by the Royal Navy, whose emergency funding source was the Bank of England. Given various privileges so the English-cum-British state could fund war making and empire building.

    https://lorenzo-thinkingoutaloud.blogspot.com/2018/01/the-illusion-of-free-banking.html

    The enduring problem with US banking has been the protection of “Main Street” local banking, thereby frustrating market mechanisms for spreading risk.

  5. Gravatar of Matthew Waters Matthew Waters
    16. March 2019 at 20:19

    I happened to come across Morgan Ricks’ appraisal of Canada and Scotland “free banking” examples after reading this post. Specifically, footnotes 46 and 47 of Chapter 3 of The Money Problem.

    The main banks for Canada and Scotland were pseudo-central banks. In Canada, the two big pre-1934 banks were heavily intertwined with the government and, on two occasions, got reserves directly from Canada’s Treasury when reserves became too low. Scotland’s big banks were also pseudo-official and also got loans from the Bank of England.

    Most importantly, royal charters and limited liability were not issued at will.

  6. Gravatar of ChrisA ChrisA
    16. March 2019 at 23:18

    Great post Scott. You bring so much clarity to the discussion on monetary policy. On the narrow banking idea, effectively we already have this, but in the worst way, as the events of 2008 proved. Central Banks bailed out failing banks, and sent a clear signal that all deposits were effectively protected 100%. They had to, to prevent bank runs. What is the difference between this informal approach and allowing formal deposits? Except of course the moral hazard.

    Myself I would not only allow deposits at the central bank for anyone, but I would make it illegal for commercial banks to offer protected deposits. If we allow narrow banking but don’t make it compulsory for all deposits I fear we will see even more examples of moral hazard as commercial banks compete for deposits by offering higher interest rates, which can only be sustained by taking more risks, which inevitably the Central Bank will have to assume to avoid a bank run. So just like we ban Ponzi schemes and pyramid schemes, we should ban anyone offering guaranteed returns, bank borrowing should all be done on he basis of equity, either by exchange traded funds or by auctions on the day which then determine the price of a unit investment. This would finally remove the need for any bank run protection by the central bank.

    Of course the criticism of narrow banking is that it will lead to less lending and significantly lower monetary growth. But this is easily handled via NGDP targeting, as the central bank can set a higher monetary base at any time.

  7. Gravatar of Matthias Goergens Matthias Goergens
    17. March 2019 at 00:43

    George Selgin’s Less Than Zero suggests that the private sector would be more than happy to provide all the extra money demanded at very low (or even negative) rates of inflation.

    We have a bit of a cultural stigma against the private sector providing physical cash, but since money is going more and more electronically, that won’t be as much of a constrained in the future.

    So we can have low inflation and interest rates, and small amounts of high powered money. But we need to either actively remove barriers to private sector money creation or at least not erect many new barriers while the private sector quitely routes around existing regulation.

  8. Gravatar of Benjamin Cole Benjamin Cole
    17. March 2019 at 03:05

    Well, interesting blogging but I think going forward that money-financed fiscal programs aka helicopter drops will have to be considered.

    We can try negative interest rates and lots of QE in the next recession, but Japan is already doing that with only modest results.

    The track record in Europe is not overwhelming either.

    Another long recession and you can look forward to AOC in the White House.

    I will confess I do not know if there is a difference between helicopter drops and QE running simultaneous to federal deficits.

    And maybe QE and federal deficits is just a form of MMT.

    For that matter, maybe chronic QE and even federal balanced budgets is a form of MMT.

    Does that make Scott Sumner the latest acolyte in the MMT
    procession?

  9. Gravatar of Matthew D McOsker Matthew D McOsker
    17. March 2019 at 08:04

    Since Banjamin brought up MMT first – here is Warren Mosler regarding the banking crisis of the early 30’s:

    ” The Fed was to be the lender of last resort to insure the nation would never again go through another 1907. Unfortunately, that strategy failed. The depression of 1930 was even worse than the panic of 1907. The gold standard regime kept the Fed from being able to lend its banks the convertible currency they needed to meet withdrawal demands. After thousands of catastrophic bank
    failures, a bank holiday was declared and the remaining banks were closed by the government while the banking system was reorganized. When the banking system reopened in 1934, convertibility of the currency into gold was permanently suspended (domestically), and bank deposits were covered by federal deposit insurance. The Federal Reserve wasn’t able to stop depressions. It was going off the gold standard that did the trick.”

    Mosler’s Banking Proposal: http://moslereconomics-kg5winhhtut.stackpathdns.com/wp-content/pdfs/Proposals.pdf

    Be interesting to see Scott’s thoughts. Warren even has a proposal where the Fed sells credit default insurance, and if he believes that then why not NGDP futures/insurance?

  10. Gravatar of Ralph Musgrave Ralph Musgrave
    17. March 2019 at 08:32

    Lorenzo from Oz,

    Your claim that central banks exist to fund governments isn’t quite right because central banks are effectively a department of government. I.e. governments can issue money even if there are no central banks: the UK Treasury did that in 1914 when it issued so called “Bradbury pounds”.

    Chris A,

    What you advocate is very much what advocates of full reserve banking (aka narrow banking) have advocated for a long time. E.g. see James Tobin’s “The Case for Preserving Regulatory Distinctions” under the heading “Deposited Currency” here:

    https://oll.libertyfund.org/titles/ricardo-the-works-of-david-ricardo-mcculloch-ed-1846-1888

    Plus see Milton Friedman’s book “A Program for Monetary Stability”, Ch3, under the heading “Banking Reform”. Other supporters of that idea include Lawrence Kotlikoff, Irving Fisher and Matthew Klein. (And most important of all: me!!!! (ha ha).

    Benjamin Cole,

    You say “I will confess I do not know if there is a difference between helicopter drops and QE running simultaneous to federal deficits. And maybe QE and federal deficits is just a form of MMT.”

    My answer, for what its worth, is that those three are all pretty much the same, so far as macro goes.

  11. Gravatar of Becky Hargrove Becky Hargrove
    17. March 2019 at 09:24

    I’m becoming increasingly worried about the prospects of a cashless economy,because I’ve not read many posts or articles from economists other than you and George Selgin which have defended the role of a cash economy for individuals of limited income. For anyone who has to be careful with their money, financial costs for virtually every single transaction would put many over the edge in spite of their best efforts to be careful with spending. Would such a requirement on the part of governments even be constitutional? Surely I’m not the only one who is becoming increasingly worried about this! Even though I may not still be alive when it happens, hence won’t have to deal with it personally, I feel for anyone who may face this eventuality.

  12. Gravatar of ssumner ssumner
    17. March 2019 at 10:32

    Matthias, Allowing private sector money creation may be a good idea, but it doesn’t solve the problem of monetary stability. You still need a monetary authority controlling the supply and demand for base money, to keep its value stable.

    Matthew McOsker, You could argue that the Fed caused the Depression of the early 1930s—but I do agree that going off the gold standard helped. I wrote a book on this period, if you are interested.

    Becky, Unfortunately, I suspect it’s coming, but it will take a while to get here.

  13. Gravatar of George Selgin George Selgin
    17. March 2019 at 11:35

    Matthew Waters writes:

    “The main banks for Canada and Scotland were pseudo-central banks. In Canada, the two big pre-1934 banks were heavily intertwined with the government and, on two occasions, got reserves directly from Canada’s Treasury when reserves became too low. Scotland’s big banks were also pseudo-official and also got loans from the Bank of England.

    “Most importantly, royal charters and limited liability were not issued at will.”

    This is the sort of thing people write about the Scottish and Canadian arrangements when they are simply unable to imagine a system operating without a central LOLR. In fact neither the chartered Scottish banks nor the Bank of Montreal played any particular LOLR role in those systems heyday. The Bank of Montreal was the Canadian government’s depository, but that’s another matter. And although banks, and larger onres especially, occasionally lent to other banks, there is no evidence suggesting that they did so for non-commercial reasons, which of course might include wishing to avert panic.

    Central bank apologist like to have it both ways: (1) “Oh, look: private banks don’t make emergency loans to other banks. Therefore one must have a public lender of last resort”; (2) “Oh, look, private banks sometimes make emergency loans to other banks; therefore those banks were ‘really’ central banks.” Either way the conclusion is that central banks are indispensable! Talk about a protective belt!(http://people.loyno.edu/~folse/Lakatos.html).

    Nor was limited liability crucial to the Scottish system: unlimited liability banks competed alongside ltd. liability banks, and when ltd. liability was made generally available in 1862 few provincial banks availed themselves of it (see https://books.google.com/books?isbn=1349113980 pp. 43ff.).

    It’s time for scholars to take the performance of past relatively free banking systems seriously, seeing them as their contemporaries saw them and not as wannabe central banking systems that just hadn’t “arrived.” And those contemporaries generally saw them as superior to central banking systems that existed alongside them. One need only read contemporary accounts of crises to verify this (e.g. https://www.alt-m.org/2015/07/29/there-was-no-place-like-canada/).

  14. Gravatar of George Selgin George Selgin
    17. March 2019 at 11:48

    On a different point, John Cochrane and others are erecting what I believe to be a complete myth about the Fed being opposed to narrow banking. In fact I don’t think the fed would do anything, and I doubt it COULD do much, to prevent any established bank fro offering narrow banking services. What it is trying to do is to prevent nonbanks, and mutual funds especially, from “tapping into” IOER. TNB exists specifically for the latter purpose, and not to offer “narrow” banking services to ordinary people. The Fed’s policy may be wrongheaded, but it has nothing to do with being anti-narrow ban per se. Of course TNB itself welcomes the myth, as it plays into its hand in its lawsuit.

    In fact there is a good argument against TNB. It’s that the Fed’s IOER rate often exceeds the risk-adjusted rate it itself earns on it’s asset portfolio. And even if it didn’t it would be earning an attractive rate only by virtue of holding longer-term assets than MMMFs are allowed to hold. TNB would effectively allow MMMFs to indirectly invest in longer-term securities, while fobbing-off the risk on taxpayers, who bear it in the shape of reduced future Fed remittances to the Treasury as i-rates increase etc. In other words, whatever the distortions connected to IOER, broadening access to it by nonbanks compounds them. I say, if the MMMFs can earn more from the Fed than from their own asset portfolios, that’s a reason to worry about IOER, rather than a reason to let nonbanks on the action!

  15. Gravatar of Why does the Fed oppose narrow banking?, by Scott Sumner – My blog Why does the Fed oppose narrow banking?, by Scott Sumner – My blog
    17. March 2019 at 13:04

    […] a lot to say on narrow banking, and I’ll have another post over at TheMoneyIllusion.  Here I’ll focus on the cross-subsidy aspects of the […]

  16. Gravatar of H_WASSHOI (Maekawa Miku-nyan lover) H_WASSHOI (Maekawa Miku-nyan lover)
    17. March 2019 at 13:46

    Occasionally,I have realized that blockchain technology just only have narrow useful space.(amount of calculation resources, security)

  17. Gravatar of rayward rayward
    18. March 2019 at 05:47

    Letting anyone deposit funds at the Fed would solve a problem that currently has no very good solutions, namely a perfectly safe and liquid investment with no transaction costs for the depositor. Today, owners of modest 401(k)s and IRAs must choose from an array of investments that have large transaction costs, cutting the returns and reducing the funds that will be available upon the owner’s retirement. Thus, allowing anyone to deposit funds at the Fed will also reduce another problem, namely underfunded retirement accounts. Banks and non-bank banks will object because they currently benefit from the large transaction costs for the small investor.

  18. Gravatar of ssumner ssumner
    18. March 2019 at 07:45

    George, Good comments. I see two issues here:

    1. Given we have private accounts at the Fed, should the privilege be limited to commercial banks? This gets into the “do two wrongs make a right” debate.

    2. Can private accounts at the Fed reduce the problems created by FDIC?

    Again, my preference is a cash only monetary base, until the Fed can show me that it’s able to competently conduct monetary policy at the zero bound.

    Your comment does suggest one answer for why the Fed’s explanation is so weak, they don’t want to admit that they are giving banks an above market rate of return on reserves.

    Rayward, I don’t follow that. My 401k is in low cost index funds.

  19. Gravatar of ssumner ssumner
    18. March 2019 at 07:49

    George, You said:

    “In fact I don’t think the fed would do anything, and I doubt it COULD do much, to prevent any established bank from offering narrow banking services.”

    And Cochrane said:

    “The Fed has also issued an advance notice of proposed rule making, basically announcing that it would, on a discretionary basis, refuse to pay interest on reserves to any narrow bank. In case anyone gets a bright idea to take a small bank that already has a master account and turn it in to a narrow bank, thereby avoiding TNB’s legal imbroglio, take note, the Fed will pull the rug out from under you.”

    So are you saying Cochrane is factually wrong on this point?

  20. Gravatar of Matthew Waters Matthew Waters
    18. March 2019 at 09:23

    George Selgin,

    To be clear, I really don’t like LOLR and deposit insurance. Unlimited liability is a different ballgame and it would certainly be strong insulation against free banking failures.

    For limited liability, the Canada and Scotland biggest chartered banks had some pseudo-official alignment. Unlimited limited liability banks would have failures, just as limited liability non-banks fail all the time.

    On TNB, narrow banking would effectively shorten maturity of the Fed/Treasury consolidated balance sheet. I don’t think that’s a bad thing though. T-bills close to maturity already have a premium due to their liquidity. If IOR was more opened up, the Fed would reduce IOR and increase its balance sheet. If short-term interest rates are stochastic, reserves should on average have lower rates than longer-term Treasuries.

  21. Gravatar of Matthew Waters Matthew Waters
    18. March 2019 at 09:59

    The ANPR applies to any bank which becomes a “PTIE,” which could include existing banks. An existing small bank will almost certainly not take TNB’s model though. TNB has no federal regulation since it neither has FDIC insurance or Fed membership. The lack of Dodd-Frank regulations dramatically reduces its regulatory burden. An existing small bank would need to end its current banking relationships and stop offering FDIC insured deposits.

    IMO, uninsured deposits of large OCC banks and large security dealers have nearly explicit government backing. Still, large cash balances by institutions do not have an explicitly backed deposit account available. ON RRP is only available to primary dealers, banks, GSEs or 2a-7 funds. Large banks and MMMFs are currently very unlikely to default, but 2007-08 shows the danger of assuming no default. Narrow banks are far better than the implicit backing of security dealers and the Dodd-Frank leviathan.

    The Fed has two more substantive concerns:

    1. Large wires to narrow banks would could require significant new reserves.
    2. Narrow banks further reduce the money multiplier, requiring more QE.

    For #1, banks can get near 100 cents of margin on Treasuries and Agency MBS from the discount window. Isn’t sudden withdrawals the whole point of the discount window?

    However, even I will admit #2 is a substantive concern, given today’s politics. The Fed increasing its balance sheet by, say, $1 trillion is not truly a big deal. But politically, I can understand the Fed’s fear.

  22. Gravatar of George Selgin George Selgin
    18. March 2019 at 12:12

    Scott, I am indeed saying that JC has his facts wrong. What he says that the Fed is “basically” saying isn’t what it actually has said. Here is the relevant Fed announcement:

    https://www.federalreserve.gov/newsevents/pressreleases/bcreg20190306a.htm

    The Fed has, first of all, not made any new rule yet. It has merely announced a possible rule for which it is seeking public comment. Second, the possible rule on which it seeks public comment is one that would deny interest on reserves not to any “narrow bank,” but to any “narrowly focused depository institutions” meaning “‘Pass‑Through Investment Entities’ or ‘PTIEs'” that “could attract a very large quantity of deposits from institutional investors, yet at the same time avoid the costs borne by other depository institutions.” The reference here is clearly to non-banks.

    John, as I have said, is making or perpetuating a myth of the Fed as crusader against Chicago-style narrow banking. The Fed’s case against TNB may indeed be week, but that myth is preventing disinterested persons from assessing it correctly.

  23. Gravatar of George Selgin George Selgin
    18. March 2019 at 12:13

    Kindly read “weak” for “week” in my last line above.

  24. Gravatar of George Selgin George Selgin
    18. March 2019 at 12:17

    Matthew Watters writes that “The ANPR applies to any bank which becomes a “PTIE,” which could include existing banks.” For reasons I explain above, I think this incorrect. The language of the Fed’s request clearly suggests that by PTIE it has in mind not any ordinary bank but an “entity” established by and for the sake of nonbank FIs.

  25. Gravatar of Matthew Waters Matthew Waters
    18. March 2019 at 13:35

    Re-reading the APNR, it seems somewhat unclear. Of course the only “PTIE” they have in mind is TNB. They make a big deal of the fact that TNB has no federal regulator and thus none of the capital requirements. TNB is only bound by Connecticut statute and regulation.

    AFAIK, very few state banks currently exist which are neither FDIC nor Fed members. I know State Street has a Massachusetts charter and does not offer FDIC insurance, but it is a Fed member bank. If one of the few state banks with no Federal oversight at all do try to adopt TNB’s model, it looks like they would become TNB.

    Any federal oversight currently ruins the business case for a narrow bank because capital has to be held even against reserves. TNB with 4% capital, as opposed to 0.1% capital, makes ROE 40 times smaller.

  26. Gravatar of Matthew Waters Matthew Waters
    18. March 2019 at 13:35

    That should say “become a PTIE” at end of second paragraph.

  27. Gravatar of Lorenzo from Oz Lorenzo from Oz
    18. March 2019 at 15:15

    Ralph Musgrave: central banks allow the issuing of bonds: they are a way to access loan funds. Both the two oldest central banks, the Bank of England and Sveriges Riksbank were to access loan funds for government spending. You can do it other ways (the Serene Republic started issuing bonds in late C12th) but central banks turned out to be a more efficient way of managing it.

  28. Gravatar of George Selgin George Selgin
    18. March 2019 at 18:14

    Matthew Waters: “If one of the few state banks with no Federal oversight at all do try to adopt TNB’s model, it looks like they would become a PTIE.”

    Perhaps. But of course that leaves about 11,000 banks that might offer narrow banking services in the conventional sense of the term.

    That doesn’t mean any would want to, of course. The plain fact is that there’s no reason for them to try. Apart from capital requirements most demand deposits enjoy either explicit insurance coverage or implicit (TBTF) insurance. So, no market. And all the more reason for the Fed to say to banks, “go for it!” The concern to keep non-banks from tapping into IOER, rather than any opposition to “narrow banking” in the conventional sense of the term, is what is behind the ANPR, which was crafted, as much as possible, to apply only to TNB and very similar efforts, and not to ordinary banks.

  29. Gravatar of Michael Rulle Michael Rulle
    19. March 2019 at 09:02

    Not sure why “narrow banking” is good—–sounds like it takes the safest assets outside the remainder of the financial system—and when the latter fails again—-won’t there still be a hue and cry to bail them out? But as someone who is perpetually confused as to the basic purpose of the Fed—–unlike most of your readers—–I find it (shocking?, amazing?, confusing?) that an expert as talented as you (no sarcasm!) has a view that even the appropriate determination of what base money should be is open for debate—and if I read you correctly you believe it should be currency. It makes me think that what the Fed does is either much simpler than it appears to me (because we currently do not have just currency as base and somehow we survive) as perhaps almost any internally consistent method can function.

    And while I always thought QE was just a method for the Fed, inadvertently, to train markets to NOT provide liquidity—and therefore bad—-I realize I do not know what to think—-since the economy just keeps on moving on.

    Further, the Fed was going to unwind—and now it is not! It is as if nothing matters—-like it is a magic show. You also make the point that the reason the Fed was put in place ended up not working c.1930s. So did that mean it could have been viewed as an experiment which failed? (I really always thought JP Morgan, from his 1907 experience, pushed hard for it so no one else what have to suffer thru what he did—even as it appears he was successful–and he wanted to replace his ad hoc actions by a central authority).

    So if base money can be “anything” we define it to be–or at least many things (M1-MX?), and we can invent QE out of thin air and then change our strategy overnight—-and we can still fail spectacularly (30s and 2000’s)—while we have history like 1907—when we did not fail spectacularly—then why is monetary policy an area where “central planning” is good?

    I still do not understand why we need a Fed.

  30. Gravatar of Matthias Goergens Matthias Goergens
    19. March 2019 at 19:04

    Scott, I agree. And more general, you want to keep nGDP on a stable trajectory. Lowering the barriers to private sector money creation just makes that job easier.

    The central bank would just target nGDP level (or even price level) and not worry too much. They would just notice that a more flexible private financial sector would make their job so much easier. And would also correct a bit for targeting the ‘wrong’ variable.

    (Eg the classical gold standard sort-of targeted the gold price. Something pretty useless by itself. But the private sector under free banking managed to effectively erect an nGDP level targeting system on top. Similarly, the Fed could probably target the price level trajectory (or equivalently long-running averages of inflation), and the private sector could adapt to mostly stabilise nGDP. I think that’s what mostly happened in Australia and Israel in recent decades?)

  31. Gravatar of Matthias Goergens Matthias Goergens
    19. March 2019 at 19:11

    Michael Rulle, you are not alone in your scepticism. Check out any of George Selgin’s papers and posts. Our host Scott Sumner also has at least some sympathies in that direction. Have a look at his ‘Midas Paradox’.

  32. Gravatar of Negation of Ideology Negation of Ideology
    20. March 2019 at 02:50

    Excellent post – more posts on the Chicago Plan and narrow banking, please. Also another post on the circularity problem (esp with the Fed targeting TIPS spreads or NGDP futures) would be greatly appreciated.

    Great comments by ChrisA and Ralph.

    Michael Rulle – Interesting post, but the question I have to ask is “Compared to what?”. The whole “central planning” charge assumes there can be a neutral monetary policy, which is a physical impossibly as long as the government exists at all. If the government is going to collect taxes, pay employees, award damages in lawsuits, charge tolls on public roads, etc., it needs to use something for money. It either uses a security it issues itself, or borrows it from someone else and pays the issuer interest. Whatever it uses is centrally planned. If you favor the central plan to be the Treasury buying and selling a commodity at a government controlled price that’s fine, but it’s still a central plan. If you favor private banks issuing money, with the government picking and choosing which notes to accept for public purposes, that’s a central plan.

    I’ve long favored the Chicago Plan (100% reserves) coupled with NGDPLT targeting by the Fed as the best of these central plans because it seems to me to involve the least government interference in relative prices, and it seems to me to be the cheapest (or most profitable) for the government to run. But I don’t claim that it is not a central plan.

  33. Gravatar of ssumner ssumner
    20. March 2019 at 15:34

    Thanks George, I’m not qualified to opine on this, but it seems odd that the Fed would allow a tiny existing bank to suddenly become a huge narrow bank. John seems to read the proposed regulation that way. Perhaps that’s not the Fed’s intent, it’s unclear to me.

    BTW, As you know, I strongly oppose the payment of IOR at rates above other market short term rates, and hence I oppose the policy that makes this “arbitrage” possible.

    Matthias, You said:

    “But the private sector under free banking managed to effectively erect an nGDP level targeting system on top.”

    That’s being pretty generous.

  34. Gravatar of mario rossi mario rossi
    21. March 2019 at 06:00

    I am very skeptical that a cashless society would incur higher transactions costs. The idea that cash is costless is simply an illusion. Printing, storing and trasporting cash are all expensive. One way or another, society is paying for that cost. When I see an armored truck collecting or depositing money, I don’t think costless… Counting and recounting physical banknotes and coins takes time. All these are real costs.

    I see no reason to believe a cashless society would make life harder for poor people, since they already likely pay large transactions costs anyway.

    Privacy is an entirely different matter, and a cashless society is a significant worry on that side. But actual costs I find very difficult to imagine…

  35. Gravatar of ssumner ssumner
    24. March 2019 at 08:18

    Mario, What about poor people who have no access to banks?

  36. Gravatar of George Selgin George Selgin
    24. March 2019 at 13:22

    Scott, you say, “it seems odd that the Fed would allow a tiny existing bank to suddenly become a huge narrow bank. John seems to read the proposed regulation that way. Perhaps that’s not the Fed’s intent, it’s unclear to me.”

    I’m mot sure what “big” has to do with it. My point is that the Fed would not try to stop an ordinary bank, whether big or small, with ordinary retail (not MMMF) clients, from going “narrow.” At least, that’s my understanding of the Fed’s statement.

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