Monday, 7 December 2015

James Tobin advocated full reserve banking.

James Tobin wrote a work entitled  “The Case for Preserving Regulatory Distinctions”. The following is a longish extract.

I believe, therefore, that the monetary and depository system should  be restructured to reduce the reliance now placed on deposit insurance  to protect the monetary payments system. I have two proposals. One  is to provide a kind of deposit money so safe that it does not have  to be insured. The second is to make in advance a sharp distinction  between insured and uninsured liabilities, and to stick to it. This involves  separating "commercial banks," which accept insured  deposits, from "investment banks," which do not.    

To diminish the reliance of the payments system on deposit insurance,  I have proposed making available to the public what I call  ' 'deposited currency. " Currency-today virtually exclusively Federal  Reserve notes-and coin are the basic money and legal tender of the  United States. They are generally acceptable in transactions without  question. But they have obvious inconveniences-insecurity against  loss or theft, indivisibilties of denomination-that limit their use except  in small transactions (or in illegal or tax-evading transactions.)  These disadvantages, along with zero nominal interest, lead to the  substitution of bank deposits for currency. But deposits suffer from  their own insecurity, unless guaranteed by the government; and the  guarantees of deposit insurance are subject to the abuses discussed  above.   

I think the government should make available to the public a  medium with the convenience of deposits and the safety of currency,  essentially currency on deposit, transferable in any amount by  check or other order. This could be done in one or more or the following  ways:     

(a) The Federal Reserve banks themselves could offer such deposits,  a species of "Federal Funds." Presumably they would establish conveniently  located agencies in private banks or post offices. The Federal  Reserve banks would pay for the services of the agents. Potential  agents could bid for the contracts. Transactions between holders of  deposited currency accounts, or between them and, directly or indirectly,  other Federal Funds accounts would be cleared through the  Federal Reserve. Wire transfers, as well as checks, would be possible.  Giro-type payment orders to other accounts in the system could  be made. Overdrafts would not be allowed. Computer capabilities  should soon make it possible to withdraw conventional currency at  any office or agency, and even to order payments to third parties  by card or telephone. Interest at a rate sufficiently below the rates  on Treasury securities to cover costs could be paid, and some costs  could be charged to accountholders.     

(b) Banks and other depository institutions could offer the same  type of account, or indeed be required to do so. The deposited funds  would be segregated from the other liabilities of the institution, and  invested entirely in eligible assets dedicated solely to those liabilities.  These would be Federal Funds or Treasury obligations of no more  than three months maturity. As in case (a), interest might be paid  on Federal Funds in such segregated portfolios.     


  1. Excellent post.
    The above Tobin paper was written in 1987.
    He made similar proposals for "deposited money" in 1985 in a paper entitled “Financial Innovation and Deregulation in Perspective", section IV.

    Is Tobin's option (a) the same as Positive Money's proposals? There appear to be some similarities and differences.

    Tobin's option (b) is Full reserve banking similar to the earlier proposals of the Chicago plan and Fisher.

    Tobin (1985) regarded option (b) as the "more likely alternative, given current sentiment for privatization". This accords with your comment made elsewhere that option (a) would be "unnecessarily beaurocratic".

    An important point is that the Chicago Plan and Tobin's proposal (b) do not include any of the the highly controversial and unnecessary extra features of the later proposals by Friedman (control of the money supply), Kotlokoff ("Limited Purpose" banking with a "Federal Financial Authority" to verify all loans) and Positive Money (a new "expert" Committee at the Central Bank to determine the fiscal deficit).
    It is unfortunate that proposals for Full Reserve banking are often discredited or regarded as "cranky" because of such inessential extra features.

    1. Thanks for all the information there.

      Re Tobin’s option (a), that’s the equivalent of Positive Money’s safe accounts. The only difference I can see is that Tobin says the Fed would “pay for the services of the agents” (i.e. banks offering safe accounts), whereas I think PM says individuals with safe accounts would foot the bill.

      I’m with PM there. If anyone wants furniture shifting from A to B, they should pay. Same goes for shifting or storing money. But that’s hardly a revolutionary suggestion: I pay about £12/month for my High Street bank current account and get interest amounting to a few pence/month.

      Tobin’s (b) is exactly the same as Milton Friedman’s version of full reserve in that “safe money” is invested in short term government debt. That would help reduce the cost for individuals with safe accounts, or it might even mean they get some interest.

      Re Friedman, he didn’t far as I know actually mix up his extreme monetarist views with his full reserve views. That makes sense. I.e. his monetarist views are just one possible way of organising stimulus, and Friedman’s monetarist idea (have the same small annual increase in the money supply regardless of circumstances) is just as valid or invalid under a full reserve system as under a conventional bank system.

      Re Kotlikoff, like you, I’m skeptical about some of the details of his proposals (Federal Financial Authority verifying loans, etc). But the basic principle of his proposal is the same as Positive Money and Friedman.

      Re Positive Money’s expert committee, I have no big objections to that. In fact we already have an “expert committee” deciding on stimulus: the central bank committees that decide on interest rate adjustments, QE, etc. So PM’s suggestion there isn't all that revolutionary.

      However, those sort of expert committees are not actually an essential ingredient in a full reserve system, nor are they an essential ingredient of the EXISTING system. That is, there are those who think Gordon Brown should never have given the BoE independence. That is, they think POLITICIANS, not the BoE should have the ultimate say on stimulus.

      I can’t get very worked up about that “politicians versus independent central bank” argument. One can go for either option under both full reserve and the existing system. However (like most people I suspect) I prefer an independent committee / central bank.

  2. Much of the scepticism regarding Full Reserve banking proposals stems from historical associations with monetarism.

    In particular, Friedman's interest in Full Reserve banking was primarily motivated by his belief that economic stability would best be achieved by control of the money supply according to fixed rules. Friedman's proposals were a development of the earlier monetarist leanings of the Chicago school, notably Simons and Fisher. See:

    Friedman understood that his plan would be impossible if banks could create money by making loans. This is why he believed "The adoption of 100 per cent reserves is essential". He made this the first element of his 1948 proposal, namely:
    "A reform of the monetary and banking system to eliminate both the private creation or destruction of money and discretionary control of the quantity of money by central bank authority. The private creation of money can perhaps best be eliminated by adopting the 100 per cent reserve proposal, thereby separating the depositary from the lending function of the banking system."
    Friedman "A Monetary and Fiscal Framework for Economic Stability" American Economic Review June 1948.


Post a comment.