A Program for Monetary Reform

The Chicago Plan was introduced by University of Chicago economists in 1933 as a comprehensive plan to reform the monetary and banking system of the United States. The Great Depression had been caused in part by excessive private bank lending, so the plan proposed to eliminate the private bank money creation method of fractional reserve lending. Centralized money creation would prevent booms and busts in the money supply. Multiple bills in the United States Congress are related to the Chicago Plan. Following the Great Recession, the plan was updated in a 2012 International Monetary Fund working paper.

Background

Roaring Twenties

The Roaring Twenties, a period of economic growth in the United States, was marked by speculation and excessive lending. Under laissez-faire economic policies, loose lending practices fueled a bubble.

In this environment, stock market speculators used leverage to buy stocks on margin. Consumers had easy access to credit through installment plans and consumer loans, further fueling the growth of consumption and production.

Rapid economic expansion led to an oversupply of goods and services.

Great Depression

With the Wall Street crash of 1929, the Great Depression began. Federal Reserve Board monetary control was indirect since all twelve Federal Reserve banks could perform open market operations without Board consent. Banks with inadequate capital reserves found themselves unable to absorb potential losses from loan defaults or market fluctuations. Widespread bank runs culminated in a national banking holiday.

The Emergency Banking Act was enacted on March 9, 1933 to set reopening standards. Public demand for deposit insurance grew.

Proposal

Main provisions of the Chicago Plan

Its main provision was to require 100% reserves on deposits subject to check, so that "the creation and destruction of effective money through private lending operations would be impossible". The plan, in other words, envisaged to separate the issuing from the lending of money. This, according to its authors, would prevent the money supply from cyclically varying as bank loans were expanded or contracted. In addition, the payment system would become perfectly safe. No great monetary contraction as that of 1929–1933 could ever occur again.

Key differences with other full-reserve plans

Other proponents of full reserves, however, such as Currie and Fisher, would still have allowed commercial banks to make loans out of savings deposits, as long as these could not be made transferable by check. As Fisher put it in 1936, the banks would be free to lend money, "provided we now no longer allow them to manufacture the money that they lend".

Although the Chicago Plan is often likened to other full-reserve plans (such as Fisher's), there were some important differences between them, for example, regarding bank intermediation. The Chicago Plan would not only have subjected checking deposits to full reserves, but further eliminated fractional-reserve banking itself: banks could no longer make loans out of savings deposits and would be replaced in their lending function by equity-financed investment trusts.

An important motivation of the Chicago Plan was to prevent the nationalization of the banking sector, which, in the context of the Great Depression, was considered by some as a real possibility. This concern was shared by Fisher: "In short: nationalize money, but do not nationalize banking."

History

Origins (1933)

Frederick Soddy proposed 100% reserves for transaction deposits in his 1926 book. Frank Knight, a laissez-faire proponent at the University of Chicago, wrote in his review

The Chicago Plan was suggested by University of Chicago economists including Henry Simons, Garfield Cox, Aaron Director, Paul Douglas, Albert G. Hart, Frank Knight, Lloyd Mints and Henry Schultz.

A six-page memorandum on banking reform was given limited and confidential distribution to about forty individuals on 16 March 1933. The plan was supported by such notable economists as Frank H. Knight, Paul H. Douglas, and Henry C. Simons, as well as by Lloyd Mints, Henry Schultz, Garfield V. Cox, Aaron Director, and Albert G. Hart.

Between March and November 1933, the Chicago economists received comments from a number of individuals on their proposal, and in November 1933, another memorandum was prepared. The memorandum was expanded to thirteen pages; there was a supplementary memorandum on "Long-time Objectives of Monetary Management" (seven pages) and an appendix titled "Banking and Business Cycles" (six pages).

These memoranda generated much interest and discussion among lawmakers. However, the suggested reforms, such as the imposition of full reserves on demand deposits, were shelved and replaced by less drastic measures. The Banking Act of 1935 institutionalized federal deposit insurance and the separation of commercial and investment banking. It successfully restored the public's confidence in the banking system and ended discussion of banking reform.

Reception

The Chicago Plan was presented to President Franklin D. Roosevelt (FDR) by Henry A. Wallace within a week. FDR asked Congress for legislation in 1934 to establish a sound and adequate currency system.

This idea of full reserves on checking deposits would be advocated by other economists in the 1930s, including Lauchlin Currie of Harvard and Irving Fisher of Yale. A more recent variant of this reform idea is to be found in the "narrow banking" proposal.

The American Bankers Association (ABA) warned against "political control of banking" and feared more radical change.

Legislative Efforts

Congress passed the Banking Act of 1933 on June 16, 1933, creating the Federal Deposit Insurance Corporation (FDIC) and separating commercial and investment banking through the Glass-Steagall Act.

Alternative proposals

In 1934, Thomas Alan Goldsborough sponsored bills HR 7157/8780 to create a Federal Monetary Authority with sole right to issue legal tender. Lauchlin Currie proposed a plan essentially identical to the Chicago Plan except for its allowance of branch banking that gained support from Treasury advisors as well as experts supporting significant monetary system changes.

1935 bill

Senator Bronson M. Cutting sponsored S 3744 based on an outline of the Chicago Plan. Rep. Wright Patman introduced a companion bill H.R. 9855. Unfortunately Cutting died on May 6, 1935.

In July 1935, Senator Gerald Nye proposed a substitute bill that incorporated elements of the Chicago Plan, including 100% reserves and a central monetary authority.

The Banking Act of 1935 passed on August 19, 1935. It did not include 100% reserves. Jacob Viner and other economists and politicians believed that this was a first step in reform.

''A Program for Monetary Reform (1939)''

As America entered the Recession of 1937–1938, this caused renewed discussion of the key elements of the Chicago plan, and in July 1939 a new proposal was drafted, titled ''A Program for Monetary Reform''.Douglas, Paul H.; Hamilton, Earl J.; Fisher, Irving; King, Willford I.; Graham, Frank D.; Whittlesey, Charles R. (July 1939)
A Program for Monetary Reform
(original scanned PDF),
transcript text here
, archived from the original (PDF) on 26 July 2011. The draft paper was attributed on its cover page to six American economists: Paul H. Douglas, Irving Fisher, Frank D. Graham, Earl J. Hamilton, Wilford I. King, and Charles R. Whittlesey. It claimed that 235 economists from 157 universities and colleges had expressed approval of the draft with 40 more had "approved it with reservations" and "43 have expressed disapproval".

The proposal was never published. A copy of the paper is in the Yale University Library. Copies of the paper, stamped on the bottom of the first and last pages "LIBRARY COLORADO STATE COLLEGE OF A. & M. A. FORT COLLINS COLORADO" were circulated at the 5th Annual American Monetary Institute Monetary Reform Conference (2009), and the images were scanned for display on the internet.

The Chicago plan was submitted to the Government, but did not become law.

Monetary Stabilization and Debt Reduction Act of 1945

Following the Recession of 1937–1938, Jerry Voorhis made the case for 100% reserves. In 1941, the US economy heated up with WWII. In 1945, Voorhis sponsored HR 3648 to establish a Monetary Authority. Jerry Voorhis was defeated in 1946 by Richard Nixon.

IMF's Chicago plan revisited (2012)

In August 2012, the proposal was given renewed attention after the International Monetary Fund (IMF) published a working paper by Jaromir Benes and Michael Kumhof. In the paper, the authors have updated the original Chicago plan proposal to fit into today's economy. They conclude that the advantages of such a system, according to the authors, are a more balanced economy without the booms and busts of the current system, the elimination of bank runs, and a drastic reduction of both public and private debt. The authors rely on economic theory and historical examples and state that inflation, according to their calculations, would be very low.

Criticisms

Asked about the paper in 2019, Christine Lagarde (managing director of the IMF when the paper was published) said that she was not convinced "that eliminating the role of private banks in the supply of 'broad' money is a good idea"."I am not convinced that eliminating the role of private banks in the supply of 'broad' money is a good idea, as there is no guarantee that governments would, on the whole, do a better job at providing financing for the real economy. Furthermore, if banks face such severe restrictions on their ability to lend, one can expect that private credit would quickly migrate to unregulated parts of the financial system, with unknown consequences.
Answers by Christine Lagarde to the questionnaire by the European Parliament
September 2019.

See also

* Islamic banking and finance
* Full-reserve banking
* Money creation
* NEED Act
* Technocracy movement

References

Bibliography

* Douglas, Paul H.; Hamilton, Earl J.; Fisher, Irving; King, Willford I.; Graham, Frank D.; Whittlesey, Charles R. (July 1939)
A Program for Monetary Reform
(original scanned PDF),
transcript text here
, archived from the original (PDF) on 26 July 2011

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Great Depression
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