What is the Chicago Plan and can it save the global economy?

An IMF study has proposed a 1930s plan that would magic away government debt and end 'boom and bust' for good

LAST UPDATED AT 13:26 ON Mon 22 Oct 2012

WITH the global economy stuck in the mire, IMF researchers have dusted off a plan proposed in the dark days of the 1930s Great Depression that could remove government debt and eliminate 'boom and bust' at a stroke - all while increasing economic output. 

The so-called Chicago Plan has been given a new lease of life following an IMF study by Jaromir Benes and Michael Kumhof that used data taken from the US economy from 1990-2006 and put it into a computer model to examine the effects of implementing the Chicago Plan. 

Their extremely positive results have piqued the interest of economists and looks set to become a cause celebre for campaigners keen to take the banks down a peg or two.

WHAT IS THE CHICAGO PLAN?
The Chicago Plan was suggested in the early 1930s by leading US economists as a means of escaping the Great Depression. It is named after the university of its chief proponent, Henry Simons, but was best summarised by Irving Fisher, a Yale economist, in 1936.
The Daily Telegraph boils the plan down to one snappy phrase: "The conjuring trick is to replace our system of private bank-created money - roughly 97 per cent of the money supply - with state-created money."
The key features of the plan are the requirement of banks to put up 100 per cent reserve backing for deposits, at the same time stripping the banks of their ability to create money out of thin air.

WHAT ARE THE ADVANTAGES OF THE CHICAGO PLAN?
The immediate advantage would be the removal, at a stroke, of the debt burden of the US – and, presumably any other advanced Western country that implemented the Chicago Plan.
The IMF study says: "Because under the Chicago Plan banks have to borrow reserves from the treasury to fully back these large liabilities, the government acquires a very large asset vis-à-vis banks, and government debt net of this asset becomes highly negative." In other words, governments would be left with a surplus, which could be used to reduce private debt by buying it back.
The other advantages are:

  • The elimination of runs on banks, because there is no question over whether a financial institution can make good on customer deposits
  • The end of the so-called cycle of 'boom and bust'. Banks will no longer control the supply of money, which means their reluctance or eagerness to lend money are no longer a factor that drives the economic cycle
  • Long-term increase in output of 10 per cent.

WILL BANKS STILL EXIST UNDER CHICAGO?
The Daily Telegraph says that the bankers will be "dethroned" under Chicago and "the City of London will have great trouble earning its keep". But that does not mean there will be no place for the banks.
The IMF study explains that private financial institutions would continue to play a key role in providing "socially useful credit that supports real physical investment activity", as well as "a state-of-the-art payments system and facilitating the efficient allocation of capital to its most productive uses".
However, banks would be prevented from enabling "the proliferation of credit created, at the almost exclusive initiative of private institutions, for the sole purpose of creating an adequate money supply that can easily be created debt-free".

DOES THE CHICAGO PLAN HAVE ANY DRAWBACKS?
Tim Congdon of International Monetary Research told The Daily Telegraph: "If you enacted this plan, it would devastate bank profits and cause a massive deflationary disaster." He says you would have to print huge amounts of money - "QE squared" - to cure it.
"People wouldn't be able to get money from banks. There would be huge damage to the efficiency of the economy," he said. · 

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