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Sunday, July 15, 2018

Dr. Warren Coats - Shrinking the Fed Balance Sheet and The Chicago Plan

Dr. Warren Coats, former head of the SDR Divsion at the IMF, sent out this message by email today (7-14-18).


"This coming week Chairman Powell will testify on the Hill re the Fed’s new operating strategy and whether to shrink its balance sheet. It is a good time to raise the prospects of introducing the Chicago Plan (100% required reserves). I set out the case for doing so in the following article: A Proposal for the Fed's Balance Sheet"

Below are a few excerpts from the article just released.

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"To save financial institutions from the collapse that threatened them after the bankruptcy of Lehman Brothers in September 2008, the Federal Reserve purchased government securities and Mortgage Backed Securities (MBS) sufficient to increase the size of its asset holdings from $0.9 trillion to $4.5 trillion by the end of 2014.  These large open market purchases were not meant to increase the money supply, the traditional purpose of such operations, which after a sharp drop followed by a sharp increase in the growth rate of broad money (M2) has grown at its historical average rate of around 6% per year. Rather they were to support the market prices of government debt and hard to price MBS in the face of market panic (at least initially).

The Fed accomplished this trick (large increase in the Fed’s asset holding with only modest increases in the money supply) by paying banks to keep the proceeds of their sales of securities to the Fed in deposits with the Fed, so called “reserves,” in excess of what is required, so called “excess reserves.”    . . . . .


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My added comments: Dr. Coats points out in this article that bank lending based on the issuance of equity by the bank would shift the risk of defaults to stock holders and away from regular depositors.

"Adopting the Chicago Plan would prevent banks from on lending our checkable deposits.  At the moment they are not doing that anyway. This raises the question of where banks would get the funds (our savings) to on lend in their financial intermediary role?  In an extreme version of the Chicago Plan (100% required reserves against all deposits and deposit like bank liabilities) all bank lending would be financed by equity rather than debt.

. . . . . . 

Equity rather than debt financed bank intermediation is a more stable structure as a result of shifting the risk of loses (loan defaults) from banks to the ultimate public investors.  The Federal Deposit Insurance Company would stop insuring 100% reserved deposits and its bank resolution functions would be moved to the Office of the Comptroller of the Currency (OCC) in the U.S. Department of the Treasury."




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