Thursday, August 23, 2012

Jan Kregel — Minsky and the Narrow Banking Proposal: No Solution For Financial Reform

Before the law has even been fully implemented, the inadequacies of the regulatory approach underlying the Dodd-Frank Act are becoming more and more apparent. Financial scandal by financial scandal, the realization is hardening that there is a pressing need to search for more robust regulatory alternatives.
The real challenge for financial reform is to develop a vision for a financial structure that would simplify the system and the activities of financial institutions so that they can be regulated and supervised effectively. Some paths to such simplification, however, are not worth treading. Against the backdrop of renewed present-day interest in the Depression-era “Chicago Plan,” featuring 100 percent reserve backing for deposits, Senior Scholar Jan Kregel turns to Hyman Minsky’s consideration of a similar “narrow banking” proposal in the mid-1990s. For reasons that eventually led Minsky himself to abandon the proposal, as well as reasons developed here by Kregel that have even more pressing relevance in today’s political climate, plans for a narrow banking system are found wanting.
Levy Institute Policy Paper
Minsky and the Narrow Banking Proposal: No Solution For Financial Reform
Jan Kregel
(h/t Michael Stephens via email)

Scott Fullwiler tweets
stf18: I've always said 100% reserves misses fundamental necessity of liquidity/overdrafts to pvt sector; Jan Kregel agrees.
stf18: Kregel p6 "the real problem lies in the way that regulation governs provision of liquidity in financial system" EXACTLY 

6 comments:

Ralph Musgrave said...

That paper by Jan Kregel is complete nonsense, to judge by the preface. (I’ll read the whole paper and tear it to shreds on my own blog in a day or two.)

In the preface he claims “This narrow banking proposal would create a system in which voluntary savings decisions would completely determine investment decisions.”

Hogwash. Under narrow banking, private banks cannot “lend money into existence” as the saying goes. And no question about it, that constitutes a RESTRICTION on funds for investment. But there’s nothing to stop the law of supply and demand operating. That is, given a rise in demand for funds to borrow, interest rates would tend to rise, which would encourage savers to lend more to borrowers.

The supply of apples is not “determined” by apple producers. It’s determined by RELATIONSHIP between apple producers and those wanting to eat apples – supply and demand.

Next, Kregel claims “This would be a system marked by a chronic tendency toward deflation, making it even more reliant on demand injections from the government.” Well it’s pretty stark staring obvious that any restrictions on bank activities will be deflationary, all else equal, and that any such deflationary effect will have to be countered by some central bank / government implemented stimulus. But so what?

Implementing stimulus costs precisely NOTHING in real terms. That is (putting it crudely) having the central bank / government print and spend more money into the economy costs nothing in real terms. Or as Milton Friedman put it, “It need cost society essentially nothing in real resources to provide the individual with the current services of an additional dollar in cash balances.”

In contrast to the ZERO REAL COST of stimulus, the REAL COSTS of our current fractional reserve banking system are of CATASTROPHIC PROPORTIONS. Doesn’t Jan Kregel realise we are now in about the fifth year of a recession which has brought unemployment and misery to millions, and caused an unprecedented fall in real GDP for numerous countries?


Matt Franko said...

Ralph,

Even under the current arrangements, when a bank makes a loan the deposits are created for the principle amount of the loan only, however, the loan terms include the requirement for payment of interest in addition to the principle. Where are the balances to pay the interest supposed to come from?

Is this situation changed by your proposal?

Seems to me what is a core problem with all banking is that at loan inception, the creation of balances required to pay both the principle AND interest are not accounted for within the banking system.

Then it's up to govt via the fiscal balance to provide these required system balances and govt does not necessarily make sure that adequate balances are being created AND generally getting to those who have loan payment requirements.

Once the fiscal balance gets too small due to increased tax receipts, eventually the system malfunctions as there are not enough system balances and what balances there are, are not in the correct position to make loan payments.

System is designed to fail.

Narrow or wide banking or medium banking, it looks like this cyclical failure condition is going to be exhibited.


It might help just to have non-morons in govt...

Pass all the laws and regulations you like, if morons are in control, it's never going to work out.

Humans in govt end up being too dumb.

rsp

Leverage said...

Yes Matt, eventually it will come to that. BUT, the less power to leverage state money (create credit and other forms of money) private sector has, the less liabilities part of the population (99%) will have and hence the corporate/wealthy welfare program of interest bearing will be reduced (as well as having stronger financial position for most households). Ofc government will have to print enough to reach full output potential (in case it wants to or is desirable, which is an other question).


If morons end dominating government we are screwed either way, but that will happen with full reserve, fractional, gold standard or whatever financial-monetary system we end up with. If we stopped issuing public debt securities and calling public debt (or state debt) 'debt' things will change a lot. IMO the eurozone crisi and when/how it's solved is just a clear example of how things work and there is no other way around it, it may be the strong empirical evidence that some brains need to break their cognitive biases towards 'exogenous/endogenous' dilemma of money.

Tom Hickey said...

Matt Pass all the laws and regulations you like, if morons are in control, it's never going to work out.

And I would add, take away all the laws and regulations and the same result will happen.

The problem is the level of collective consciousness. This is why all energy should be focused on raising it, as Roger Erickson is continually pointing out. If humanity doesn't increase its adaptability rate and return on coordination we are toast as increasing complexity eats us up.

paul said...

"If humanity doesn't increase its adaptability rate and return on coordination we are toast as increasing complexity eats us up"

Eventually, failure to adapt will likely result in decreasing complexity as natural forces resulting from climate change, overpopulation, etc. will reduce the number of participants dramatically.

Tom Hickey said...

Eventually, failure to adapt will likely result in decreasing complexity as natural forces resulting from climate change, overpopulation, etc. will reduce the number of participants dramatically.

Exactly, and how dramatically depends on the level of conflict engendered.