Where are we now? The current state of research and next steps

Patrizio Lainà

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.

Conceptual consolidation

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!

Patrizio Lainà

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.

10 Replies to “Where are we now? The current state of research and next steps”

  1. Tax Coin says:

    Money Made from Tax

    Goldcoin is made from gold
    Bitcoin is made from bits

    Taxcoin is made from tax

    Tax is an existing robust algorithm

    In order to regulate the current unbalanced fiat money creation system. A system that is Biased towards those who are already wealthy. New tools are required.
    Tools that control the distribution of fiat money.

  2. Alan says:

    Money creation should not and can not be divorced from the real asset base. This means currency being based on global biophysical activity as that is the system we are created and constrained by.

  3. Sanjay Mittal says:

    My only quibble with the above article is the author’s claim that ” it remains unclear what full-reserve banking even means”. Strikes me that the various advocates of full reserve were all saying basically the same, i.e. that money creation by commercial / private banks should be banned and that that is easily done by implementing the well known “two account” system: i.e. depositors who want total safety have accounts which earn little or no interest and where all money is backed by or consists of reserves (aka base money) at the central bank). In contrast, depositors who want a significant amount of interest, i.e. who want their money to be loaned on, have to buy into mutual funds / unit trusts.

    Certainly the “heavy weight” advocates of full reserve advocate that basic model: e.g. James Tobin, Milton Freidman, Irving Fisher, Lawrence Kotlikoff, Matthew Klein, etc. But having said that, there are of course numerous possible variations on the above basic two account system. E.g. Friedman advocated that some safe account money can be invested in short term government debt. Others say that no investments at all should be made with safe account money.

  4. David Lucas says:

    Whatever form of currency we end up with, its value will still basically derive from the wealth of civilisation, and all wealth would be zero without energy.
    Economist and author Jeremy Rifkin points out that our prevailing economic theory is based on the wrong laws of physics. Adam Smith and Jean-Baptiste Saye both based their theories on Newton’s laws of motion. Smith’s ‘invisible hand’ (supply balancing demand) is a metaphor for the third law of motion (every action has an equal and opposite reaction). Saye’s theory of supply and demand reaching equilibrium until acted on by external factors is basically the first law of motion (every object will remain at rest or in uniform motion in a straight line unless compelled to change its state by the action of an external force). Trouble is the laws of thermodynamics – NOT the laws of motion are the laws that govern economics.
    So let’s have a conversation about having a currency explicitly tied to an infrastructure that guarantees us an abundance of sustainable energy with which to power all our lives and commensurate economic activity. How do we incorporate this into the definition of a currency to replace the fractional reserve Ponzi scheme?

    1. Jim Lee says:

      David Lucas, you make a powerful point. I think you are the first person I have seen, besides myself, to recognize the functional equivalence of money and energy “and all wealth would be zero without energy.”
      Have you done any further work on this concept? I’ll check out Rifkin. I’ve read some of his work, but hadn’t seen that.
      If you get this message, please feel free contact me at jleecitizen@gmail.com if you are willing to discuss it further. Thanks !!!

  5. Rory Short says:

    Humans have to make exchanges of goods and/or non-financial services in order to survive. Ideally these exchanges are voluntary. The biggest impediment to embarking on and completing such voluntary exchanges is the need for a coincidence of wants between the two exchanging parties. This impediment ceases to exist if one of the exchanging parties has in their possession a Universally Exchangeable Item [UEI]. UEIs are however not naturally occurring they have to be created by humans. What characteristic[s] will a created item need to possess in order for it to fill the UEI role? The variety of items involved in completed exchanges is infinite. Is there however a possible characteristic that is present in every completed voluntary exchange that could be put into a UEI? There is, it is the value of the exchanged items. This value is in the exchanging parties heads however so it would need to be made visible, i.e. externalised, in order for it to appear in a UEI. Humans have a long history of creating UEIs but in a clumsy way totally separated from actual exchanges. We know these UEIs as money. However the banks’ development of the credit card facility connected the creation of UEIs, i.e. new money, with exchanges because the use of a credit card to make a purchase of goods or non-financial services results in the production of new money, recorded as debt against the purchaser and the value of the new money is confirmed once the debt is settled. This is real sovereign, or democratic, money in that it is created by individuals as and when they make purchases and the additional benefit, if banks were not allowed to issue new money for any other purpose, would be an end to inflation induced by the money system.

  6. Graham Paterson says:

    I would like to suggest that there are basically four fundamental parameters that need to be acknowledged in any discussion about “money”.

    1. In today’s world, it is an obvious fact that “money” has become an essential tool for the survival of virtually everyone. Nobody can survive without access to money in our modern world.

    2. The single and only purpose for having a “money” system is to provide the most practical and convenient medium of exchange essential for the daily functioning of every nation.

    3. That no fiat currency has any intrinsic value, as it only represents a measure of the value of any goods or services that are available for trading. Only the buyer and seller determine the value of anything. If the value is agreed a trade will happen, if no agreement can be reached, no trade will occur.

    4. It is in the interests of every nation to have one single medium of exchange which can be universally accepted within the nation because it will come with a Government guarantee that it is not a false medium and any attempts to counterfeit the medium will be punished. Consequently, it is logical that a nation’s Government should have the sole public responsibility to determine what shall be the nation’s legal tender and to manage that legal tender in the best interests of the nation.
    It would seem logical that the above fundamentals are axiomatic for every independent nation that must have monetary sovereignty.
    So, why is the stupid concept accepted that a nation’s money supply can only be created as interest – bearing debt? The Government of a monetary sovereign nation can create as much interest-free money a nation needs to balance its productive capacity with its consumption capacity in accordance with its population levels.
    There is absolutely no need for any monetary sovereign nation to go into debt.
    Why doesn’t the Government sell access to the interest-free money to the private banks and have them pass that interest-free money onto their private sector customers after a proper due diligent analysis of the request to borrow? The banks could charge a competitive admin fee over the period of the loan to include the original cost of purchasing the credit access. The private banks could also add a competitive profit margin to placate their shareholders but the banks would be prohibited from charging any interest and especially from compounding any of their charges.
    The Government, on the other hand, would reap sufficient revenue from an access charge of 1% to 2% from the sale of the credit to eliminate every form of taxation now imposed and stifling the economy.
    In truth, all political power lies in the hands of the people and it is the people who have given their Government the authority to create the essential medium of exchange the nation must have in order to function.
    Who needs a central bank?

  7. Jim Lee says:

    Hello Graham Paterson. I very much appreciate your contribution.

    You say, “The Government of a monetary sovereign nation can create as much interest-free money a nation needs to balance its productive capacity with its consumption capacity in accordance with its population levels.” I wholeheartedly agree.

    My maxim (which is roughly the inverse of your statement) has long been that. “There is no necessary reason for a sovereign nation ever to go into debt in its own currency.” While mine is equally true, in a way, I prefer your statement in that it essentially defines HOW MUCH sovereign money should be created.

    I have just one caveat. There must also be enough (extra) money created to INVEST in increasing the nation’s productive capacity (all of which I lump under the heading of “Infrastructure) and to drive down the cost of consumption of basic human necessities to the absolute minimum (ultimately, globally).

    You also say, “In truth, all political power lies in the hands of the people and it is the people who have given their Government the authority to create the essential medium of exchange the nation must have in order to function.” Again, I wholeheartedly agree.

    In fact, I have concluded that only the effective exercise of the WILL of “We the People” can bring about the change to Sovereign Money (SM). If we are ever to see it realized, the critical tasks are to educate, empower, and engage Citizens.

    I wonder if you have explored the proper and best uses of SM. That is the area that I am currently studying. If you would like to discuss any of this further, you can contact me by email at jleecitizen@gmail.com.


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