The Revised Chicago Plan
Introduction
This essay is a brief precis of the IMF Working Paper “The Chicago Plan Revisited” by Jaromir Benes and Michael Kumhof in 2021, see URL=https://www.imf.org/external/pubs/ft/wp/2012/wp12202.pdf>
A balance sheet is a financial report that shows the value of a company’s assets, liabilities, and owner’s equity on a specific date, usually at the end of an accounting period, such as a quarter or a year. An asset is anything that can be sold for value. A liability is an obligation that must eventually be paid, and, hence, it is a claim on assets. The owner’s equity in a bank is often referred to as bank capital, which is what is left when all assets have been sold and all liabilities have been paid.
Here, I have divided the economy into four sectors. And I will talk in term of the U.S. situation to keep things simple. Although the Chango Plan can be implemented in any country with a Central Bank and the equivalent of a Treasury Department. The relationship of the assets, liabilities, and owner’s equity of a bank is shown by the following equation:
Bank Assets = Bank Liabilities + Bank Equity
What I present here is a rough indication of the net consolidated Balance Sheets for four sectors of the economy:
- Private enterprises and individuals. This would also include any other non-bank users of the national currency, including state and local governments.
- Commercial Banks
- The Central Bank
- The Treasury Department (Federal Government)
Consolidated Balance Sheet of Private Enterprises and Individuals
| Assets | Liabilities |
| Cash on Hand Deposit Accounts Government Securities as Investments Bonds issued by the Banks Other Financial Assets as Investments International Investments |
Bank Short Term Credit Bank Loans & Mortgages (Net) Commercial Bonds (Net) Accounts Payable International Loans & Mortgages |
| (Net) Accounts Receivable | Owners Equity |
| Other Real Assets (Land, Buildings, Tools, Machinery, Software, etc.) | Owner’s equity |
Consolidated Balance Sheet of Commercial Banks
| Assets | Liabilities |
| Cash on Hand Bank Short Term Credit Bank Loans & Mortgages Government Securities as Investments Other Financial Assets as Investments Reserve Account Balances |
Deposit Accounts Bonds issued by the Banks Loans from the Central Bank Other loans assumed by the Banks (Net) Accounts Payable |
| (Net) Accounts Receivable | Owners Equity |
| Other assets (Land, Buildings, Software, etc.) | Owners Equity |
Balance Sheet of the Central Bank
| Assets | Liabilities |
| Government Securities Loans to the Commercial Banks Commercial Securities Gold & Other Precious Metals |
Currency in Circulation Reserve Account Balances Other Liabilities (Pensions, etc.) |
| Other Assets (Shares in IMF, etc.) | Net Position |
| Other Assets (Land, Buildings, Software, etc.) | Net Position |
Balance Sheet of the Treasury Department
| Assets | Liabilities |
| Direct Government Loans Loan Guarantees Receivable |
Government Securities
Other Liabilities (Pensions, etc.) |
| Equity | |
| Other assets (Land, Buildings, Software, etc.) | Cash & Monetary Assets |
In general economic theory, a commercial bank uses liabilities to buy assets, which in turn earns income for the bank. By using liabilities, such as deposits or borrowings, to finance assets, such as loans to individuals or businesses, or to buy interest earning securities, the owners of the bank can leverage their bank capital to earn much more than would otherwise be possible using only the bank’s capital. When a Commercial Bank is considered in this light, the bank is considered a “financial intermediary”. It intermediates between the depositors who deposit their savings in the banks Deposit Accounts, and the creditors who take out loans to finance their consumption or investments.
However, this view of the Bank is not entirely accurate. It tends to suggest that the Bank waits for Deposits to arrive before lending them out as loans to creditors. In actual fact, however, the commercial banks first create the loans and then credit the borrower’s bank Deposit Account with the amount of the loan. The Commercial Bank’s balance sheet remains balanced. But the emphasis, and consequence, is that Commercial Banks are relatively unconstrained in how many loans they can create. If a commercial bank needs or wants a greater amount of income, the bank can just create a larger volume of loans. The bank can therefore largely control their level of income at will. In order to make lots of money on their shareholder’s equity, commercial banks create interest paying loans. The more loans they create, the greater their interest income, and the greater the return on the shareholders equity. So it is in the interests of the commercial banks’ owners and managers to create as great a volume of interest paying loans as possible. And it is in the interests of the commercial banks’ owners and managers to maximize the difference between the interest they charge on the loans they create, and the interest they must pay on the deposits they receive. Now in general, the interest that banks charge on the loans they create varies directly with the perceived risks of the creditor defaulting on the loan. On average then, it is in the interest of the commercial banks’ owners and managers to maximize the risks they are willing to tolerate (so as to maximize the interest they can charge on the loans they grant), consistent with the risks of default on their total portfolio of loans.
In the modern economy, almost all money takes the form of bank deposits. But just how those bank deposits are created is often misunderstood by both the general public (who have never been told), the media (it is just to complex a subject to fit into a “10 second sound bite”), and by the politicians (whose job it is to oversee banking operations). The reality of how money is created today differs from the description found in many economics textbooks:
- Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits.
- In normal times, the central bank does not fix the amount of money in circulation, nor is central bank money ‘multiplied up’ into more loans and deposits.
On the other hand, one of the major services of a commercial bank is to supply cash on demand, whether it is a depositor withdrawing money or writing a check, or a bank customer drawing on a line of credit. Both the amount and timing of cash withdrawals by customers are not very predictable. Hence, a bank must maintain a certain level of cash and other reserves compared to its Deposit Accounts liabilities to maintain solvency. Now the amount of actual cash that a Bank holds is an insignificant proportion of the Deposit Accounts liability. Most money transactions against the Deposit Accounts happen electronically, and most of the rest happen through checks.
Although commercial banks create money through lending, they therefore cannot do so freely without limit. There are some constraints the commercial banks must live within. Commercial banks are limited in how much they can lend if they are to remain profitable in a competitive banking system. Prudential investing acts as a constraint because a bank manager does not want to have more depositors coming in to demand their deposits back, than the bank has cash ion reserve to deal with this. Otherwise, what you get is a “run on the bank”. It is the intent of Deposit Insurance programs to assure the general public that there can never be a disastrous run on the bank where the depositors lose their money. This approach has proven useful for small runs on local banks. But the 2008 Financial Crisis proved that for a major run on the whole commercial banking system, it was simply not enough. Federal governments across the world had to step in and “bail-out” the commercial banking system to the aggregate tune of several trillion dollars.
Government regulation is also supposed to act as a constraint on banks’ activities. The regulators supposed purpose being to maintain the resilience of the financial system. But again, the 21008 Financial Crisis put paid to that idea. Banking regulations in the years since have been enacted to “ensure this never happens again”. But we’ve all heard that before, haven’t we.
What happened in the 2008 Financial Crisis can be traced to consequences of this commercial bank control of the creation of money. Up until the meltdown of 2008, the housing industry had shown a long history of rising house prices. So writing a mortgage loan against the purchase of a house seemed to be a risk free loan for the bank. Since the underlying asset (the house) is “sure” in increase in value, the bank can always get its money back. The result is that many banks created a lot of mortgage loans. Some bright financial guru figured out how to package those mortgage loans into interest paying securities that other banks and financial institutions might buy. Hence the incentive for all parties to write and then resell more and more mortgage loans. And as with any economic resource, the more you exploit the market demand, the lower the quality at the margin. When the housing bubble burst in 2007-2008, some financial institutions were writing mortgage loans to people who should never have qualified.
When housing prices collapsed, a lot of these junk mortgages became not worth the paper they were written on. Hence for a lot of banking institutions, the Asset side of their balance sheets collapsed. All of a sudden, the liabilities represented by the Deposits, and by the Bonds they had issued were worth a lot more than the assets they could realistically expect to realize. They were bankrupt.
But of course, because their Deposit Accounts were the basis of the Money supply needed by the whole economy, the government couldn’t let all of them fail. That would shrink the supply of money available to the economy so extensively that the economy would grind to a halt. Hence the label of “Too Big to Fail”. All because the banks let their lending practices get out of hand.
Setup
The Chicago Plan was a collection of banking reforms suggested by University of Chicago economists in the wake of the Great Depression. The plan was supported by such notable economists as Irving Fisher, Frank H. Knight, Lloyd W. Mints, Henry Schultz, Henry C. Simons, Garfield V. Cox, Aaron Director, Paul H. Douglas, and Albert G. Hart.
The Chicago Plan Revisited is an International Monetary Fund (IMF) report from 2012 by Jaromir Benes and Michael Kumhof. The focus of the study is the so-called Chicago plan of the 1930s which the authors have updated to fit into today’s economy.
The basic idea is that banks should be required to have full coverage for money they lend; this is called 100% reserve banking, instead of currently prevalent system of fractional reserve banking. Under this proposal, banks would no longer be allowed to create new money in the form of credit in connection with their lending activities. Instead, the central bank should be solely responsible for all the creation of all forms of money, not just paper money and coins.
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 both economic theory and historical examples, and state that inflation, according to their calculations, would be very low.
To outline how this would work, I will start a simplified version of the consolidated balance sheets shown in the Introduction. I have simplified things by dropping out those items that represent insignificant amounts, and items that will not impact the following discussion.
Simplified Consolidated Balance Sheet of Private Enterprises and Individuals
| Assets | Liabilities |
| Cash Deposit Accounts Bonds issued by the Banks |
Bank Short Term Credit Bank Loans & Mortgages (Net) Commercial Securities |
| Owners Equity | |
| Owner’s equity |
Simplified Consolidated Balance Sheet of Commercial Banks
| Assets | Liabilities |
| Bank Short Term Credit Bank Loans & Mortgages Government Securities Commercial Securities Reserve Account Balances |
Deposit Accounts Bonds issued by the Banks Loans from the Central Bank |
| Owners Equity | |
| Owners Equity |
Simplified Balance Sheet of the Central Bank
| Assets | Liabilities |
| Government Securities Loans to the Commercial Banks |
Currency in Circulation (Cash) Reserve Account Balances |
| Net Position | |
| Net Position |
Simplified Balance Sheet of the Treasury Department
| Assets | Liabilities |
| Government Securities | |
| Equity | |
| Real Assets (Land, Buildings, Tools, Machinery, Software, etc.) | Cash & Monetary Assets |
Step 1
On the Day of Conversion (hereafter “C-Day”) the Treasury Department – not the Central Bank (the FED) – issues (electronically) to all the commercial banks, sufficient Treasury Reserve Notes to completely cover their deposit accounts. To pay for these reserves, the banks will issue (electronically) to the Treasury a special series of Special Bank Conversion Bonds. This will keep the Commercial Banks’ balance sheets and the Treasury Department’s balance sheet in balance. Assets will still equal Liabilities.
Simplified Consolidated Balance Sheet of Commercial Banks
| Assets | Liabilities |
| Treasury Reserve Notes Bank Short Term Credit Bank Loans & Mortgages Government Securities Commercial Securities Reserve Account Balances |
Deposit Accounts Bonds issued by the Banks Loans from the Central Bank Special Bank Conversion Bonds |
| Owners Equity | |
| Owners Equity |
Simplified Balance Sheet of the Treasury Department
| Assets | Liabilities |
| Special Bank Conversion Bonds | Government Securities Treasury Reserve Notes |
| Equity | |
| Real Assets (Land, Buildings, Tools, Machinery, Software, etc.) | Cash & Monetary Assets |
Step 2
Each commercial bank will split into two legally separate corporations – a Deposit Bank and an Investment Bank. The Deposit Bank will accept Deposit Accounts, and maintain the transaction clearing function, perhaps charging a small fee to account holders for that service. Deposit Banks will be prohibited from creating loans. Short term credit will be defined by something like a 30 or 90 day due limit – intended to cover short term transaction delays, like a credit card and such like. The Investment Bank will be prohibited from accepting Deposit Accounts, providing short-term credit, or offering money-like services.
Simplified Consolidated Balance Sheet of Commercial Deposit Banks
| Assets | Liabilities |
| Treasury Reserve Notes Bank Short Term Credit Reserve Account Balances |
Deposit Accounts Loans from the Central Bank |
| Owners Equity | |
| Owners Equity |
Simplified Consolidated Balance Sheet of Commercial Investment Banks
| Assets | Liabilities |
| Bank Loans & Mortgages Government Securities Commercial Securities |
Bonds issued by the Banks Special Bank Conversion Bonds |
| Owners Equity | |
| Owners Equity |
For the Deposit Bank, the new Treasury Reserve Notes will exactly equal the Deposit Account balance. Any changes to the Deposit balance because of inter-bank funds transfer, or depositor activities will be matched by a change to the Treasury Reserve Note balance that the commercial bank will maintain at the Treasury Department. This is a separate account from the accounts that commercial banks maintain at the Central Bank (the FED).
Stockholder’s Equity plus the other ignored categories of Liabilities will cover the operating costs and assets of the business. Regulations will strictly limit the fees that a Deposit Bank may charge for their service. This operation is going to be looked at as a “utility” service, not a major profit center.
Notice that in the Investment Bank, all those outstanding loans and mortgages are now funded by Bank bonds and shareholder’s equity, not Deposits.
Step 3
Now the equivalent Assets and Liabilities can be cancelled. Keeping in mind that the Central Bank and the Government are one and the same in the final analysis.
Simplified Consolidated Balance Sheet of Commercial Deposit Banks
| Assets | Liabilities |
| Treasury Reserve Notes Bank Short Term Credit Reserve Account Balances |
Deposit Accounts Loans from the Central Bank (—-) |
| Owners Equity | |
| Owners Equity |
(Where “(—-)” means “greatly reduces”.
Simplified Consolidated Balance Sheet of Commercial Investment Banks
| Assets | Liabilities |
| Bank Loans & Mortgages Government Securities Commercial Securities |
Bonds issued by the Banks Special Bank Conversion Bonds (—-) |
| Owners Equity | |
| Owners Equity |
Simplified Balance Sheet of the Central Bank
| Assets | Liabilities |
| Government Securities Loans to the Commercial Banks |
Currency in Circulation (Cash) Reserve Account Balances |
| Net Position | |
| Net Position |
Simplified Balance Sheet of the Treasury Department
| Assets | Liabilities |
| Special Bank Conversion Bonds | Government Securities (—-) Treasury Reserve Notes |
| Equity | |
| Real Assets (Land, Buildings, Tools, Machinery, Software, etc.) | Cash & Monetary Assets |
The Government Notes held in Reserve are assets owned by the Treasury Department. As are Government Securities that banks have purchased as investments. These can be cancelled – either immediately, electronically, or as they come due. The result is a massive decrease in the outstanding Federal Debt balance. Of course, not all Government issued debt is held by Commercial Banks. A lot is held by overseas investors. So there will still be left a large balance of Government Securities held as assets by the Treasury Department.
Step 4
The next step is for the Treasury Department to issue to all citizens a “Citizen Dividend” in the total amount of the Special Bank Conversion Bonds purchased in Step 1. This will be a special certificate, issued to each citizen equally, an amount of money that can be applied only to reduce outstanding personal debt. (Obviously, there will arise a market for these certificates so that people without sufficient debt can sell their certificate to others who do have sufficient debt.) The result will be a dramatic reduction in private debt balances.
Simplified Consolidated Balance Sheet of Private Enterprises and Individuals
| Assets | Liabilities |
| Cash Deposit Accounts Bonds issued by the Banks Citizen Dividend Certificates |
Bank Short Term Credit Bank Loans & Mortgages (Net) Commercial Securities |
| Owners Equity | |
| Owner’s equity |
Simplified Consolidated Balance Sheet of Commercial Deposit Banks
| Assets | Liabilities |
| Treasury Reserve Notes Bank Short Term Credit |
Deposit Accounts Loans from the Central Bank |
| Owners Equity | |
| Owners Equity |
Simplified Consolidated Balance Sheet of Commercial Investment Banks
| Assets | Liabilities |
| Bank Loans & Mortgages Commercial Securities |
Bonds issued by the Banks Special Bank Conversion Bonds |
| Owners Equity | |
| Owners Equity |
Simplified Balance Sheet of the Central Bank
| Assets | Liabilities |
| Loans to the Deposit Banks | Currency in Circulation (Cash) |
| Net Position | |
| Net Position |
Simplified Balance Sheet of the Treasury Department
| Assets | Liabilities |
| Special Bank Conversion Bonds | Government Securities Treasury Reserve Notes Citizen Dividend Certificates |
| Equity | |
| Real Assets (Land, Buildings, Tools, Machinery, Software, etc.) | Cash & Monetary Assets |
Step 5
The final step is for the citizens to redeem their Citizen Dividend Certificates to pay down their bank loans & mortgages. Once these have worked their way onto the Balance Sheet of the Investment Banks (who held the loans & mortgages), they can be used to buy back the Special Bank Conversion Bonds from the government.
At the same time the Central Bank can be folded into the Treasury Department, because it is no longer needed as a separate entity. Control of the money supply is directly controlled by the Treasury Department. When the Treasury Department wishes to spend money to acquire goods or services for the government, it just writes a cheque. If it needs to remove money from circulation, in order to keep a check on inflation, it just sells more government securities. All money is now created by the government. Interest rates are managed by the Treasury Department by controlling the price at which it sells Government Securities.
In addition, of course, the Deposit Insurance bureaucracy can be eliminated.
Simplified Consolidated Balance Sheet of Private Enterprises and Individuals
| Assets | Liabilities |
| Cash Deposit Accounts Bonds issued by the Banks |
Bank Short Term Credit (—-) Bank Loans & Mortgages (—-) (Net) Commercial Securities |
| Owners Equity | |
| Owner’s equity |
Simplified Consolidated Balance Sheet of Commercial Deposit Banks
| Assets | Liabilities |
| Treasury Reserve Notes Bank Short Term Credit (—-) |
Deposit Accounts Loans from the Central Bank (—-) |
| Owners Equity | |
| Owners Equity |
Simplified Consolidated Balance Sheet of Commercial Investment Banks
| Assets | Liabilities |
| Bank Loans & Mortgages (—-) Commercial Securities Citizen Dividend Certificates |
Bonds issued by the Banks Special Bank Conversion Bonds |
| Owners Equity | |
| Owners Equity |
Simplified Balance Sheet of the Treasury Department
| Assets | Liabilities |
| Special Bank Conversion Bonds Loans to the Deposit Banks |
Currency in Circulation (Cash) Government Securities (—-) Treasury Reserve Notes Citizen Dividend Certificates |
| Equity | |
| Real Assets (Land, Buildings, Tools, Machinery, Software, etc.) | Cash & Monetary Assets |
Benefits
As explained in the initially cited paper “The Chicago Plan Revisited” –
“Fisher [Fisher, I., “100% Money and the Public Debt”, Economic Forum, Spring Number, April-June 1936, 406-420.] claimed four major advantages for this plan. First, preventing banks from creating their own funds during credit booms, and then destroying these funds during subsequent contractions, would allow for a much better control of credit cycles, which were perceived to be the major source of business cycle fluctuations. Second, 100% reserve backing would completely eliminate bank runs. Third, allowing the government to issue money directly at zero interest, rather than borrowing that same money from banks at interest, would lead to a reduction in the interest burden on government finances and to a dramatic reduction of (net) government debt, given that irredeemable government-issued money represents equity in the commonwealth rather than debt. Fourth, given that money creation would no longer require the simultaneous creation of mostly private debts on bank balance sheets, the economy could see a dramatic reduction not only of government debt but also of private debt levels.”
When the Treasury Department writes cheques for goods and services, it increases the cash and monetary assets in circulation. As you can see from the above Balance Sheets, the stock of reserves, or money, newly issued by the government is not a debt of the government. The reason is that fiat money is not redeemable, in that holders of money cannot claim repayment in something other than money. Money is therefore properly treated as government equity rather than government debt. Furthermore, in a growing economy the government will never have a need to voluntarily retire money to maintain price stability, as the economy’s monetary needs increase period after period.