At the height of the Great Depression a number of leading U.S. economists advanced a
proposal for monetary reform that became known as the Chicago Plan. It envisaged the
separation of the monetary and credit functions of the banking system, by requiring 100%
reserve backing for deposits. Irving Fisher (1936) claimed the following advantages for this
plan: (1) Much better control of a major source of business cycle fluctuations, sudden
increases and contractions of bank credit and of the supply of bank-created money.
(2) Complete elimination of bank runs. (3) Dramatic reduction of the (net) public debt.
(4) Dramatic reduction of private debt, as money creation no longer requires simultaneous
debt creation. We study these claims by embedding a comprehensive and carefully calibrated
model of the banking system in a DSGE model of the U.S. economy. We find support for all
four of Fisher's claims. Furthermore, output gains approach 10 percent, and steady state
inflation can drop to zero without posing problems for the conduct of monetary policy.
This paper revisits the Chicago Plan, a proposal for fundamental monetary reform that
was put forward by many leading U.S. economists at the height of the Great Depression.
Fisher (1936), in his brilliant summary of the Chicago Plan, claimed that it had four
major advantages, ranging from greater macroeconomic stability to much lower debt levels
throughout the economy. In this paper we are able to rigorously evaluate his claims, by
applying the recommendations of the Chicago Plan to a state-of-the-art monetary DSGE
model that contains a fully microfounded and carefully calibrated model of the current
U.S. financial system. The critical feature of this model is that the economy’s money
supply is created by banks, through debt, rather than being created debt-free by the
Our analytical and simulation results fully validate Fisher’s (1936) claims. The Chicago
Plan could significantly reduce business cycle volatility caused by rapid changes in banks’
attitudes towards credit risk, it would eliminate bank runs, and it would lead to an
instantaneous and large reduction in the levels of both government and private debt. It
would accomplish the latter by making government-issued money, which represents equity
in the commonwealth rather than debt, the central liquid asset of the economy, while
banks concentrate on their strength, the extension of credit to investment projects that
require monitoring and risk management expertise. We find that the advantages of the
capital adequacy requirements.
Chicago Plan go even beyond those claimed by Fisher. One additional advantage is large
steady state output gains due to the removal or reduction of multiple distortions,
including interest rate risk spreads, distortionary taxes, and costly monitoring of
macroeconomically unnecessary credit risks. Another advantage is the ability to drive
steady state inflation to zero in an environment where liquidity traps do not exist, and
where monetarism becomes feasible and desirable because the government does in fact
control broad monetary aggregates. This ability to generate and live with zero steady
state inflation is an important result, because it answers the somewhat confused claim of
opponents of an exclusive government monopoly on money issuance, namely that such a
monetary system would be highly inflationary.