What have we achieved by studying full-reserve banking? And what remains to be done in the future? By focusing on conceptual work, economic modelling and empirical research, I try to provide an answer.
Just recently, I finished a doctoral dissertation that focused on full-reserve banking. More precisely, I studied historical experiments and proposals for full-reserve banking. Moreover, I went through a substantial part of the literature and evaluated how full-reserve banking might fulfil the normative commitments to democracy, economic stability, social equality and ecological sustainability. I also built a macroeconomic model of full-reserve banking. Thus, I believe I am in a relatively good position to assess the current state of research and its future direction.
It must, however, be stated that I am best aware of the studies conducted within the economics discipline. Fortunately, full-reserve banking has been studied across various schools of thought – covering at least neoclassical, Austrian and post-Keynesian traditions. Nonetheless, other disciplines could and should have significant contributions as well. For instance, political science and global political economy could provide valuable insights on the possible reactions of the international political and business community.
There is still an ongoing discussion about what money and debt mean and whether money can be debt-free. Personally, I have found the debate uninteresting and want to sidestep it. The reason is that everybody seems to agree on the underlying issue, but simply use different words for it. This is also why I have avoided speaking of “debt-free” money in my dissertation and rather used “separating money creation from bank lending” as a subtitle.
For many, it remains unclear what full-reserve banking even means. I tried to clarify concepts by using full-reserve banking as an umbrella term for six different types of monetary reform: sovereign money, Chicago plan, narrow banking, limited purpose banking, deposited currency and pure commodity standard. They all shared the idea that money creation should be separated from bank lending.
Besides that, however, the proposals differ significantly. For instance, sovereign money maintains that the government should be solely responsible for money creation without any self-imposed restrictions while pure commodity standard holds that the government should have absolutely no influence on the money supply as it would be fully backed by a commodity such as gold or silver.
Another important contribution to this conceptual work is provided by Dixhoorn. She also uses full-reserve banking as an umbrella term, but she has only four types – all of which coincide with my taxonomy. She excludes deposited currency and pure commodity standard from her definition.
Now, there is a need to consolidate concepts. For instance, many use full-reserve banking and Chicago plan interchangeably while others see full-reserve banking as a generic term for different types of monetary reform – including sovereign money. The discussion on monetary reform would be easier and more fruitful if concepts are unambiguous and therefore readily comparable.
Modelling international aspects
Since the Great Financial Crisis of 2008, full-reserve banking has been assessed theoretically in a number of economic models. Probably the ground-breaking step was taken by IMF researchers Benes and Kumhof when they modelled the Chicago Plan in a state-of-the-art DSGE (Dynamic-Stochastic General Equilibrium) framework. They found support for output gains, smaller business cycle fluctuations, elimination of bank runs and reduction of both public and private debt.
Thereafter, even central banks have shown some interest in evaluating the economic effects of full-reserve banking. My contribution was to model full-reserve banking in a SFC (Stock-Flow Consistent) framework for the very first time. Most of the formal models find chiefly positive results for full-reserve banking, but they all tend to focus on domestic factors.
Currently, the most pressing is to study the international aspects of full-reserve banking. After all, the success of full-reserve banking significantly depends on how the international political and business community react to such a reform. There is some evidence that at least the international political community might be tolerant of such experiments as, for instance, the IMF has taken a positive stance. It would be important to model how international investors would react as they can determine the direction of capital flows. Until now, practically no studies have been conducted, but, for instance, questionnaire surveys might reveal the attitudes and possible reactions of the international business community.
In the end, no amount of theoretical research can provide a final verdict on the consequences of full-reserve banking. Therefore, experiments and empirical research are highly needed.
Empirical research waiting for digital currency experiments
Experiments with full-reserve banking were conducted in the 19th century in the UK and US. Previously, private bank-issued notes were the common medium of payment circulating in the economy. The reforms required full backing of private notes and that effectively shifted money creation from private banks to the public sector.
It is worth noting that the full-reserve banking experiments were never actually abandoned. Governments generally maintain a monopoly over issuing cash. Banks, however, were able to gradually undermine the reforms by issuing deposits. Ever since the foundations of the monetary system have remained unchanged.
In my doctoral dissertation, I provided a rudimentary examination of macroeconomic developments around the implementation of the reforms. I found that most indicators continued their previous paths or pointed upwards. Even though it is hard to associate the positive developments directly with full-reserve banking, one can quite confidently draw the conclusion that at least it did not cause an economic catastrophe.
In terms of further empirical research, one could do a more rigorous statistical analysis of macroeconomic indicators around the full-reserve banking experiments. However, it is difficult to isolate the effect of the reform from other events. In addition, data availability and reliability impose extra challenges.
Perhaps most significant empirical research has to wait for new experiments. After Iceland discontinued to actively promote full-reserve banking in the aftermath of the Global Financial Crisis, it seems unlikely that any country would implement it in the near future.
However, central bank digital currency (what I called “deposited currency” in my dissertation) could provide a politically acceptable alternative. Implementing a voluntary or partial full-reserve banking system would provide important data on how public money might work while avoiding risks involved in the full-fledged implementation of full-reserve banking. There are strong signs that technological development and technocratic needs of central bankers will soon lead to the implementation of central bank digital currency. Scholars, stand by for empirical research!
The author is Dr.Soc.Sc. (Political Economy) and works as an Economist at the Central Organisation of Finnish Trade Unions (SAK). He is also a founder and an activist in a non-profit organisation Economic Democracy Finland that promotes full-reserve banking.