Jul 30, 2018

Morgan Ricks on the Features and Advantages of Federal Reserve Bank Accounts

Building a banking system with full public access to central bank accounts could be a big benefit for low-income families.
David Beckworth Senior Research Fellow , Morgan Ricks

Hosted by David Beckworth of the Mercatus Center, Macro Musings is a new podcast which pulls back the curtain on the important macroeconomic issues of the past, present, and future.

Morgan Ricks is a law professor at Vanderbilt University and studies financial regulation. Between 2009 and 2010, he was a senior policy advisor and financial restructuring expert at the U.S. Department of Treasury, where he focused primarily on financial stability initiatives and capital market policy in response to the Financial Crisis. Morgan joins the Macro Musings podcast to discuss his most recent paper, ‘Central Banking for All: A Public Option for Bank Accounts.’

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to macromusings@mercatus.gmu.edu.

David Beckworth: Morgan, welcome back to the show.

Morgan Ricks:   Great to be here, David.

Beckworth: It's good to have you on. This is your third time appearing.

Ricks:    I know, I feel like a privileged guest.

Beckworth: I tell you what, well, it helps that we both live in Nashville and we're close by and we have similar interests, so that kind of draws us together. But it's great to have you on because you have a really fascinating paper on opening at the central bank's balance sheets to the public. It's also really timed well, it came out at the very week, am I right? The same week that the Swiss referendum on this was happening?

Ricks:    Yeah, that's right. And that wasn't by design. I mean, we were aware of the Swiss Vollgeld referendum that was going on, which was really about something a little more strong than our proposal that was really essentially banning fractional-reserve banking and that's not what we're proposing here.

Beckworth: Sure.

Ricks:    But in essence there are some sort of similarities between the two and it was coincidental that they came out at the same time.

Beckworth: But it was great because there were a number of conversations going on, there were many people who were for it, Martin Wolf, Financial Times, Ryan Avent, The Economist, Matthew Klein from Barron's and some other folks were for it or some against. I wrote a piece against which you proceeded in great style and fashion to torpedo, my blog posts. This is great, I learned a lot from you.

Ricks:    I don't know about that David.

Beckworth: No, it was great. In fact, we'll link to it on the SoundCloud webpage.

Ricks: Good.

Beckworth: But the point is, it was a great time to have your article step in because I feel like the conversations that were being had were mostly the blog level, the newspaper level. You came in with an academic paper, a little more serious thought put into it. You've dealt with these issues already. In our previous conversations, we've touched on this, we've talked about the narrow banking plan, the Chicago plan. So you have already thought about this extensively and you kind of stepped in and provided a well thought out paper that responds to some of the criticism.

Ricks:    That was the goal and people have said things along these... I mean, there is similarity with the old Chicago plan, which you and I've talked about before and is related also to the Vollgeld initiative. But this idea of letting the general public have access to central bank accounts, I mean, it goes back. James Tobin wrote about this in the 1980s. I mean, it was just a two page several paragraph suggestion in a broader article, so it wasn't as spelled out certainly as we made it. But this isn't something that had never been considered or thought of before, so that it sort of has been recurring idea. What we really wanted to do was take it very seriously, trace out the benefits and also trace out the costs and cover objections as well as we could.

Beckworth: It's also, I think increasingly relevant because of technology, right? Implementing today might be a lot easier than when it was written about in the past. Is that fair?

Ricks:    Yeah, I think that's right. I mean, greater electronification of payments. It was only in the early 2000s that electronic payments started to outnumber checks and now they vastly outnumber checks. I mean, ACH payments, wholesale wire payments and of course debit card and credit card payments vastly outnumber checks anymore. Checks are really sort of on the way to extinction or at least getting there. Check clearing historically was a huge burden for the logistical undertaking for the banking sector and that I think meant that it would have been very hard to have greater centralization of maintenance of bank accounts because handling all of that paper was really a vast, a huge logistical undertaking. Now, with more electronification, it just becomes a lot more feasible.

Beckworth: Great. The environment was primed for you to step forward with this paper. The technology, the interest in the Swiss reform, the 2008 crisis as well, kind of also planted some of the seeds of this discussion. So here we are with your paper, why don't you give us kind of the executive overview of it and then we'll get into the details.

Ricks:    Sure. The idea is really simple. It's why don't we... The central bank has two kinds of monetary liabilities as physical currency and as accounts. The physical currency is an open access resource. It's available to everyone, right? We all can have access to it. You said earlier opening up the central banks balance sheet to the general public, well, there's a sense in which it already is open to the general public.

Beckworth: True.

Ricks:    But what we're saying is why not also give the public the ability to hold account money or accounts at the central bank? You would just have your bank account if you wanted it. This would be for individuals and businesses and other institutions. You just have your bank account at the Fed and it will be just like any other bank account essentially except there's some important difference I'll touch on in a second. But it would have a debit card. It would allow for electronic bill payments. It would accept direct deposit. You could use your debit card at ATMs. It would just be like an ordinary bank account, but the differences would be several fold.

Ricks:    It would be more like a reserve balance that banks are able to hold. Banks this privileged ability, I say banks, but it's actually a little broader than that, some other types of financial institutions are eligible for Fed accounts, but I'm just going to say banks for simplicity. Banks have these accounts and they're really great and they're different from ordinary bank accounts. First of all, as of today, they pay nearly 2% in an interest. It's actually five basis points shy of 2% as of last week.

Ricks:    But the upper end of the federal funds target range is about what we're paying on interest on reserves. That's a very high interest rate not available certainly in other types of similar accounts. Payments between Fed accounts clear instantly, of course, in real time gross settlement, so banks don't have to wait even minutes, much less days for payments between Fed accounts to clear. Also importantly, these accounts, reserve balances are of course fully sovereign non-defaultable, you can call it government backed to the full extent of whatever the size of the balance. You can hold billions of dollars in your Fed account as particularly our larger banks do and not worry about any kind of default. Whereas with a ordinary bank accounts, of course, your deposit insurance runs out of $250,000. That's a big problem for institutions in businesses with large cash balances.

Ricks:    We would say that those features would also apply to Fed accounts when you opened it to the general public, everyone who held an account at the Fed would get the interest on reserves rate. We would have real time gross settlement, real time payments between Fed accounts and irrespective of the size of the balance you would have a fully government packed account and we with it there's a lot of benefits that would come from this.

Beckworth: It is interesting that in some sense we already have access as you mentioned to the balance sheet. I can use currency, which is a liability of the Federal Reserve, it's on their balance sheet. And this would just going to be a further opening, completing the next step of sorts. Is that right?

Ricks:    Yeah, that's right. It's hard to defend from first principles, the idea that currency itself should be this open access resource, but the account money, which is economically... it's just uncertificated currency that pays interest rate, right?

Beckworth: It's a bearer bond.

Ricks: It's an uncertificated... But it's a bear bond versus a bond held in registered form-

Beckworth: Right.

Ricks:    ... that's not certificated. But those are not distinctions really of economic substance and so the question becomes, "Wait, why do we draw this distinction in terms of access based on whether it's account money versus physical currency?" It's not easy to defend that from first principles, so we think we ought to open it up.

Beckworth: All right, well, let's get into some of the specifics of your plan. I want to begin with the workings of it. If I'm an individual, I go and I open up this account, what would I get? I'd have no transaction fees, I'd have easier access to my debit card? What are some of the changes I would see, I guess, if I had this account?

Ricks:    One of the main changes is you would see a lot higher interest on your balance. And if you have a large balance, in other words, imagine you're Walmart or you're Apple or Google and you have billions of dollars of cash on your balance sheet and cash management's a big problem. It's very challenging because they're not going to hold a bank account, even with JP Morgan at that size because of the credit risk associated with the bank fails and they're out their cash, so you get rid of that problem. You both get higher interest and again, for large balances, you get to stop worrying about having to allocate and diversify your cash balances to deal with credit risk problems. But for an individual, it's the same, right? I mean the Fed would set up a retail interface through the internet and an application for smart phones. You would get a debit card. You might also get checkbooks if we wanted to do that. Although we think there's arguments for not doing checkbooks, we'd probably charge a small fee for that.

Ricks:    But in general, these will be no fee accounts, no minimum balances and we would be turning the account money system into kind of public infrastructure. This would be more like a sidewalk or a road that everyone else is allowed to use and we don't just charge marginal cost to everyone that's making use of it.

Beckworth: To be clear, it would be open to me the individual, but also businesses that aren't financial firms.

Ricks: Yeah, that's right.

Beckworth: Like Walmart and Apple?

Ricks:    I mean anyone who... That's right. I mean, the idea is if you can get a US bank account now, you should be able to get an account at the Fed and it will be an option. Again, this isn't compulsory. We're not saying fractures or banking is over. We're not saying deposits accounts are over. We think a lot of people would have good reasons to keep their existing bank accounts, but this would be an option.

Beckworth: This also addresses the concern you've had in some of your previous work on money and this is the run issue because individual accounts would be run proof obviously. But now you'd have these corporations that in the past may have gone into the repo market or shadow markets, where we did see the bank run in 2008. They too would be now parking their cash at the central bank, is that right?

Ricks: Yeah. If they chose to do-

Beckworth: If they chose to do so.

Ricks: ... and we think that, look, the run problem is one of the main motivations certainly for the Chicago plan in the '30s, right?

Beckworth: Right.

Ricks:    They were trying to deal with the run problem. That's certainly one of the things that prodded us into thinking harder about this. We did have runs in 2008 of course on deposit substitutes, like you mentioned repo and there's other types of institutional deposits-

Beckworth: Right.

Ricks:    ... substitutes. We also had runs on bank accounts that were above the $250,000 limit. That happened at WaMu and it happened at Wacovia. I mean, they were isolated, it wasn't system wide. You may recall that the FDIC ended up insuring bank accounts, transaction accounts. They removed the cap-

Beckworth: That's right.

Ricks:    ... on insurance precisely to forestall the run. They also put an unlimited guarantee on money market fund shares as you may recall. In other words, we got rid of this cap, the cap tends to be illusory when things get really hairy. But if he held your account at the Fed, I mean, the run problem is certainly not the same and arguably goes away. I mean, this idea that you need to go redeem... runs are redemptions for higher forms of money, right?

Beckworth: Right.

Ricks:    If you're redeeming from repo, what you're getting ultimately is a credit to your JP Morgan bank account. If you're redeeming that, what you're getting is physical currency. Physical currency, you can't really redeem, right? I mean, you could go to the New York Fed and hand them your $20 bill and they would just give you a fresh new $20.

Ricks:    There's no redemption problem with the Fed, if you've can print money, that type of run is not feasible. Now, of course, people could still trade the asset on the secondary market, it can decline in value, you have inflation risk, of course. But that's just a general problem of any currency system. But Fed accounts reserve balances in a fiat money system are not technically runnable.

Beckworth: That's going to get to some of the concerns later, but I want to bring one up because it's related to this and this is the one that I mentioned in my post that you proceeded to respond to in yours. That is are we trading a bank run risk for an inflation risk? You Rick make this good point that look, we've already implicitly backed up all these liabilities. You just mentioned that cap on the FDIC is very flexible in times of crisis. We backed up money market mutual funds. I mean, even though the Fed's balance sheet isn't as big as it could be relative to the true size of the financial market, what's being backed up implicitly, what you're saying is let's make it explicit. Given that it already is and we haven't had inflation, there really wouldn't be this inflation risk moving forward into this system.

Ricks:    I don't see there being an inflation risk any more than the current world, I agree with that. I mean, first of all, as you just mentioned, in terms of private monies of various types, whether it's deposits or deposit substitutes, we are implicitly or explicitly-

Beckworth: Right.

Ricks:    ... backing those markets in my view. It's a contingent liability as opposed to an unbalanced liability, but those are economically... that's an accounting distinction-

Beckworth: Right.

Ricks:    ... more than that is a distinction of economic substance, both in terms of the government's overall risk bearing which a lot of people talk about in this context. You're going to enlarge the Fed's balance sheet and that's more risk. But when you're writing a put op, you writing the same put option either way. But I also think from the standpoint of inflation risk, I don't necessarily see how that changes in any material way. It seems to me the monetary authority, the Fed still does monetary policy the same way.

Beckworth: Right.

Ricks:    Whether that's through paying interest on its accounts, on its liabilities or whether that's through adjusting the quantity of its or the size of its balance sheet or some combination of those two things. The Fed keeps its mandate, whatever that mandate is, we can keep the same dual mandate we have today and move to this system and have a larger Fed balance sheet. But I don't think it necessarily raises the prospect of inflation risk, any more than QE raised the prospect of sort of runaway inflation. I mean a lot of people, as you know, we're quite concerned about that materialize.

Beckworth: And it did not materialize.

Ricks:    That's right.

Beckworth: The concern is that you'd make the Fed this too big to fail institution and your point, which I think is a very good one, is that it already is implicitly, right? That implicitly, the Fed is already backing all these institutions, all these financial firms that have liabilities that act as money, it's just not official, and yet we don't have inflation.

Ricks:    That's right. I mean, the Fed or the federal government -

Beckworth: ... government.

Ricks: ... the treasury department did the money fund guarantee.

Beckworth: Right.

Ricks:    The FDIC did the transaction account guarantee that was unlimited and of course the Fed did-

Beckworth: If anything we've had low inflation.

Ricks:    I don't see any reason… in principle to be particularly concerned about inflation risk. That's not to say there aren't costs or objections to the plan, but that's not one that I see as being a big one.

Beckworth: It's a good point because in my initial thinking, you'd be expanding the role of government in finance and you're appointed is, well, we are already there.

Ricks:    I think that's right. I mean, so a big question about this, which I'm sure we'll get into, maybe we'll get into it now, is if you are allowing... Look, you can think of this in sort of phases or transition. Let's say there was just broad migration of Fed accounts. Everyone loves it, businesses and individuals start to migrate on a very large scale. In the first instance that actually doesn't increase the size of the Fed's balance sheet, right? It's a reserve drainage from the banking system and so banks balance sheets would shrink, they would lose deposit liabilities. But they would competently lose an asset, that asset being their current reserve balance. From the Fed standpoint, reserves held by banks will become reserves held by non-banks, right?

Beckworth: Right.

Ricks:    But it's all right side action, there's nothing going on in terms of the asset portfolio, at least in the first instance. But of course, at some point if migration is big enough, that doesn't work anymore and the Fed's balance sheet is going to grow. You do have this real question, I think, about asset allocation on the part of the central bank. If it's balance sheet gets even bigger. These are questions of course we've been facing for years in the context of QE and not just in the US but of course abroad. In our system there would almost certainly be, I mean, again, if it were very popular, there would be a permanently large central bank balance sheet, probably larger, almost certainly larger than is today if there's really large migration. You do have to think very seriously about what your asset allocation strategy is, particularly if you don't think there are enough treasuries accommodate this large balance sheet. That's a real problem. We deal with it in the paper, but we don't want to minimize it.

Beckworth: Let's go ahead and touch on the migration process. In your paper, you mentioned three steps?

Ricks:    Yeah.

Beckworth: Walk us through how we would transition from the current system to the Fed account system.

Ricks:    I mentioned the first step. The first step is you have some people start migrating and from the Fed's perspective and from the banking systems perspective, it's not a huge deal as long as you have huge excess reserves in the banking system. So we end up not enlarging the Fed's balance sheet in this first phase, but we're just draining some reserves from the banks and not a big deal either for the Fed or for the bank. They may lose some interest on any reserves and they lose some deposit accounts right there. From a business standpoint, it might not work to the bank's advantage, but it's not mechanically a difficult thing. When you get to a situation where the banking system is reserved, constrained, if you have more migration, it presents a liquidity problem for banks in a fracture reserve system.

Ricks:    Almost certainly, again, if there was large migration and particularly if it happened over a reasonably brief, compressed period of time, the Fed would need to extend discount window loans to replace the loss funding of the banks. In this circumstance, the Fed's balance sheet now is growing, right? It has all the assets that had before, but now when more bank accounts migrate to Fed accounts, the Fed is going to lend to the banks that are losing deposits. And so the new Fed accounts are mashed by loans to banks on the left side of the bank balance sheet of the Fed. We can think of that as credit risk to the Fed, right? It's now lending to banks and they could default on the other hand and so far as these deposits were already implicitly or explicitly insured by the federal government, and a lot of them are explicitly insured, of course by the FDIC.

Beckworth: Right.

Ricks:    The government as a whole is not taking any more risk here. In so far as that's true that, that they were already insured.

Beckworth: Sure.

Ricks:    You're lending to the banks, but the liability of the FDIC is declining because they're losing some deposits that they're insuring and so you're just transferring risk. It's an inter-governmental transfer of risk. We think the degree to which the government is taking on more risk here is easily overstated. But this does raise the question, so suppose the Fed's balance sheet really balloons, say it doubles, say it triples, I mean, we could kind of go all the way to double digit trillions and think about the implications of that. The Fed's going to have these very large loans outstanding to banks and we have to ask the question over time, is that the asset portfolio the Fed wants?

Ricks:    The answer is may be not, it depends on the available supply of other credit assets that might have more desirable properties for the Fed. If the treasury supply is sort of practically unlimited and the Fed just wants to own treasuries and we think owning liquid high quality bonds is the best portfolio for the Fed in our view, assuming there's enough treasuries outstanding, it could over time gradually migrate away from discount window loans. The banks would then have to adjust their own funding structure to deal with that problem. But you could imagine a situation where it's all treasuries on the left side of the Fed's balance sheet and it just has a much larger balance sheet. Now, that presupposes again, that there's just enough of that and a historical problem that we've had and that we faced more than once in US monetary history is, when you tie the money supply to the supply of government bonds-

Beckworth: Right.

Ricks:    ... then the supply government bonds becomes a cap on the supply of money, so you're entangling this fiscal and monetary function and so the Fed might have to diversify, right? I mean, imagine a longterm balanced budget, if the federal government ran…

Beckworth: Well, this is the critique in narrow banking, right?

Ricks:    Yes, that's right. I've made this critique for and-

Beckworth: Back.

Ricks:    ... before and if you had a longterm balanced budget on the fiscal side of the house, eventually you're not going to have any treasuries to invest in. You got to find something else. You can't say a priori, what the asset portfolio looks like, right? It depends on what's available that suits your investment parameters. But the broader point here is the Fed may very well over time decide to diminish, transfer away from discount window loans and towards other assets.

Beckworth:  Now, one objection might be, well the Fed has just bought up all the treasuries, all the safe assets off the market. But I'm guessing your reply is, that's not a big deal in this scenario because the Fed is now the primary deposit holder so there are no... they don't have the same safety issue that we had before.

Ricks:    I suppose that's right or I might put it a little differently. The Fed will have bought up safe assets but it has done so in the process of issuing and even safer assets.

Beckworth: Oh, okay.

Ricks:    I mean, if we think there's something really special about treasuries as a safe asset, then that's a different argument. But the right side of the Fed's balance sheet is really, truly non-defaultable, right?

Beckworth: Right.

Ricks:    There's no auction risk, there's no risk of any type, so it's bought safe assets in the process of issuing the safest assets. But look, it does have implications for the Fed's role in the treasury market and when the bond market's more general. I mean, one thing we've seen with the ECBs is extending into other asset classes and corporate bonds. I mean, there are some arguments and there's some analysis that suggests that it's been distortive of bond prices of issuers in the corporate bond market. That the issuers whose bonds are being bought by the ECB are enjoying a lower cost of funds than they would be otherwise relative to their peers who are not being bought and that's distortive. That's the kind of credit allocation you don't want the central bank doing if you can avoid it. This is a real problem that's hard to escape from.

Beckworth: Well, this is where I would throw in George Selgin's flexible open market operations where he would set up a term auction facility where anyone, not just your treasury, but anyone could bid for the funds based on their need. He actually thinks it's better to have it open like the ECB does to multiple counterparties. Any thoughts on that? Or quite not to your s-

Ricks:    Well, I'm not sufficiently up to date on all of George's voluminous writings.

Beckworth: It's hard to.

Ricks:    He and I have had an exchange on Twitter about Fed accounts. There's a sense that, look, we're getting rid of illegal privilege of banks if we do this.

Beckworth: Right.

Ricks:    We think we should be skeptical of legal privileges, particularly when they accrue to sort of elite financial interests. These things are great and these accounts are great and so there's a sense in which I think they should appeal to a more, let's say fair mentality, that if we're going to have a central bank and it's going to have account balances, at the very least they should be open to everyone. But George is not very sympathetic to their proposal, at least so far.

Beckworth: He's not sympathetic to the Fed account idea, but he is very sympathetic to opening up the Fed's balance sheet more broadly.

Ricks:    Yes.

Beckworth: Which may be surprising to some observers. Let's go over the three phases again. Deposits get transmitted under the Fed's balance sheet. The Fed in the second phase then accommodates any liquidity needs by issuing discount loans. Then finally, longterm it tries to diversify or just as portfolio so that it's doing what's best for the public for itself, for inflation, price stability.

Ricks:    Right.

Beckworth: How does financial intermediation work in this environment? Banks are still making loans, and this is one of my critiques, but you responded to, but for our listeners tell us, would there still be financial intermediation based on local economic conditions?

Ricks:    I think it's a really important point and thing to understand. A bank charter gives the banking system a legal monopoly on maintaining deposit liabilities. That's the legal privilege a bank charter can base it-

Beckworth: Does not-

Ricks:    ... convey the legal privilege of making loans, right? We don't restrict entry into that business. It's important understand that lending markets are competitive markets that anyone can enter. In the world we're describing, let's just imagine, I mean, maybe it's easy to do this sort of through hypothetical of what we're talking about. Let's say that the Fed's balance sheet goes to 12 trillion, 14 trillion something like that, but let's just say it's all treasury. Let's say they transferred, we've finished phase three and there were enough treasuries and they decided to just invest in treasuries. What happens in terms of local credit allocation there? Let's assume for the sake of argument the extreme case where everyone migrated to the Fed, no one's holding a deposit account or a deposit substitute of any kind. They're just not attractive anymore. Everyone wants the Fed account.

Ricks:    What happens to lending markets? The answer is, well, they're competitive markets, right? Loans will continue to be made, but they will not be financed directly with money issuance, right, with liabilities that are money or money deposit or deposit substitutes. Keep in mind, the credit markets in the US are vast, they're huge. They're much larger than any monetary aggregate you care to site, right?

Beckworth: Right.

Ricks:    We have $40 trillion of bonds outstanding, give or take. That doesn't even count the loan markets, so credit portfolios can be financed, in the case of if it's tradable bonds or finance with a demand equity of mutual funds, right, which is not a deposit substitute, as long as it's not a money market fund. They could be financed with term debt, with bonds issued into the capital markets, which is what finance companies do. The idea is, look, if the Feds bought all these treasuries, there will be all of these funds issued, down there in the courtesy of issuing all these funds and if the best use of those funds is lending throughout the economy to consumers and businesses, then we have to have some faith in financial markets to get them there. We don't think lending is sort of joined at the hip somehow as an activity with issuing money, right? Those things are distinct and you can finance a-

Beckworth:         Sure.

Ricks: ... portfolio of loans or bonds with other types of claims that are not money claims.

Beckworth: The financial intermediation will continue. Markets will still do their thing, connecting borrowers and savers in the most efficient manner and presumably safer because you don't have the runs problem anymore and so your world would be a better place, I guess is what you're trying to-

Ricks:    Well, we think so. I mean, we think there's a lot of benefits. One thing we haven't touched on yet is we think it could bring the unbanked on to-

Beckworth: Talk about that. How would this help the unbanked?

Ricks:    Well, I mean, if you don't have... One of the big deterrents, I mean, there's a lot of reasons that we have a large unbanked population in the US. About 7% of US households are unbanked, which is way out of line with the rest of the developed world, right? Bank account penetration in Canada is 99% and the reason is they have a universal service mandate on their banks. Their banks just can't turn people away except for national security or sort of money laundering suspicion reas- right? There's some law enforcement, national security issues but in general, they can't turn you away because you're not a profitable customer.

Ricks:    In the US we don't have anything like that. A lot of people are deterred from bank accounts by minimum balances and account fees, right? B of A announced earlier this year, I believe it was, that they weren't going to have any free checking anymore. If you had a low balance, you were going to start to be charged $15 a month, I think it is, and that's a big deterrent to low income families. There's also some cultural things so that there are people who just don't trust banks and I'm not sure we would solve that problem necessarily, unless they trust the federal government more. I don't know what the overlap is between people who distrust banks and distrust the federal government, it may be high, I'm not sure. But in any case, these accounts, we think of it as this is really sort of a public infrastructure, like the court system, like law enforcement, like roads and sidewalks and where we really want to not necessarily charge everyone the cost of use to access the system.

Ricks:    There's maybe loosely speaking a public good. We're not going to get in an argument about whether money is a public good in a technical sense, but certainly in a sort of loose sense, I think we can think of it that way. If you don't have minimum balances, you don't have account fees and you have debit cards that are easily reloadable, we hope and reloadable in the sense that you can reload your bank account.

Beckworth: Right.

Ricks:    Debit cards, people think of as money being loaded on the card. In fact, the money is a bank account that's-

Beckworth: Right.

Ricks:    ... run on a pool basis by the program manager. But this is a confusion about how prepaid cards work. But prepaid cards have been very popular in the unbanked community and we think this could be a good alternative to them, those cards have had some problems and very high fees, they're very expensive and also have had some operational problems in terms of shutting down for periods of time where people can't access their funds. We think if marketed properly, you could make real inroads, get people in the mainstream banking system by holding a Fed account, which would have all the benefits of prepaid cards except without fees, hopefully without these operational problems. I mean, I can't guarantee there would never be an operational problem at this bank or any other bank. The idea would be to bring a lot of the unbanked onto this system.

Beckworth: It really is expensive being poor in America, right? I mean, some of the stuff that you have in your paper, some of the other stuff I've read, just online banking, it's expected that you'll have an account where your employer can deposit funds or online banking paying your bills.

Ricks:    That's right. It is expensive before, it's expensive to be poor and expensive to be excluded from the banking system. If you don't have a bank account, if you can't get direct deposit, you're probably going to use a check cashing outlet. They charge-

Beckworth: Which cost-

Ricks:    ... a couple-

Beckworth: ... money.

Ricks:    ... or 3% off the top. It's not just the monetary cost, it's the inconvenience, right?

Beckworth: Time.

Ricks:    These are people with families, but they've-

Beckworth: Right.

Ricks:    ... got to stop by the check cashier on the way home from work when they get their paycheck. And paying bills, same deal. I mean, you're probably aware of people standing in line at Comcast or wherever else-

Beckworth: Right.

Ricks:    ... the phone company to pay a bill-

Beckworth: In cash.

Ricks:    ... because they don't have the ability to do a sort of online bill pay, which we all take for granted as being this easy thing. Even if they are sending a bill, paying it by mail, if they don't have a bank account, they can't write a check, they're going to have to go buy a non-bank money order at a convenience store to pay bills. All this stuff is expensive, there're fees every time on every one of these transactions and the convenience cost is very high. The unbanked pay a high cost for being in that situation and we think that's something that could be at least partially regulated.

Beckworth: Now, this also relates to some of the proposals for banking through the postal system. My sense is this would be a better version of that, a more efficient version of that. Can you skip to that?

Ricks:    We could think of it that way, or we could even think of this as a way of implementing postal banking for the poor. There's several kind of permutations of how they work, but in most cases, the idea is that the post office would team up with a bank and the post office would be essentially the interface. But what you would really hold is a bank account in a private sector. But our view is if you're going to do that, you might as well have it be a Fed account, so you could implement postal banking through this model. We think it would be good and in fact we say in the paper that to the extent you need a retail interface, an actual physical-

Beckworth: Right.

Ricks:    ... interface for the Fed account system, the post office is a natural way to do that. We think these are philosophically very much in the same place as it relates to the problem of the un and under banked, right, which is what postal banking is designed for. But keep in mind, we have sort of broader ambitions here. We want this to be a business account too.

Beckworth: Sure. It's not just for the-

Ricks: We want Apple to hold its account here.

Beckworth: ... unbanked.

Ricks:    Most postal proposals have a limit on account size. They could solve or substantially mitigate the un and underbanked problem, but we have a host of other things that we think we can also solve if we did it through the Fed, which as we've already talked about the financial stability problem. And there's other things we haven't really touched on so much yet, payment speed and efficiency, monetary policy transmission and the earning of senior age or other benefits that we think for Fed accounts that wouldn't come from postal banking. This seems to us to be better.

Beckworth: Well, one of the critiques that you hear about postal banking, in fact, Peter Conti-Brown had a piece recently, the Brookings, is the concern on the lending side.

Ricks: Right.

Beckworth: So the deposit side, which I think is where your proposal comes in, makes a lot of sense. But then do you want the government getting the business and making loans to poor, being the enforcer if they don't pay their bills? I mean, if you did your Fed account and let's say you could get it to the postal service, would this be an issue or not?

Ricks:    We don't contemplate as part of this if there's any small dollar lending component to... In fact, I don't know if I mentioned this, but we don't contemplate overdrafts being allowed at all for Fed accounts, which is a mode of extending credit of course. We were trying to have this really be just a non overdraftable bank account, which doesn't in and of itself present any meaningful credit risk to the Fed. Postal Banking proposals, again, I said there's several permutations of them. I mean, some of them contemplate small dollar lending really being at the core of what they do and so far as credit access is a big for segments of the population as it is. That's not a problem that Fed account really meaningfully deals with.

Beckworth: Right.

Ricks:    I mean, we would improve payment speed and one reason for using payday loans is the delay between getting paychecks and having them clear into your bank account. We think we could help a little bit at the margin on those things and Aaron Klein at Brookings has written a lot about the payment speed and how it disadvantages the lower income population. We think we could help at the margin on the credit side, but that's not really what this is driving at.

Beckworth: Sure. Well, let's speak to that. Let's speak to the real time payment issue. Tell us about what it's like in America compared to the rest of the world and why we have this system.

Ricks:    Japan's had real time retail payments since the 70s and the UK is more recent, I think in the last decade or so they've had essentially real time retail payments from between bank accounts at different banks. In the US it still takes, even wire transfers are end of day and not real time. We have a pretty slow payment clearing process in the US. It's largely a function... this is also something else that, well, Aaron Klein at Brookings is one of the better people to read on this topic. But part of it's due to banking system fragmentation. We just have 6,000 or 7,000 separate banks that are stitched together. Each one has its own ledger and then they're stitched together through the Fed itself and through various correspondent arrangements between each other. Of course, this is a network system resource and we're debiting and crediting balances, but the more fragmented the ledger is, the harder it is to get it all coordinated and have it be fast. What we found-

Beckworth: That's interesting.

Ricks:    ... what's been found internationally is that other countries have been able to get to much faster payments than we are in part because they have more concentrated banking systems. But our thought here is that look, payments again between Fed accounts, between reserve accounts at the Fed have been real time since the '70s in the US and that's because it's a simple instruction to the Fed to debit one account-

Beckworth: Sure.

Ricks:    ... and credit another account, right?

Beckworth: Sure.

Ricks:    Those are very simple transactions within a single integrated ledger and our idea is, well, if we bring more onto this ledger, more people in business onto this ledger, then in so far as they're making payments between each other, those could also and should be real time. That's the basic idea.

Beckworth: Turn us back into the unbanked, one could imagine a world where they're using their smart phones because even poor people have smart phones-

Ricks: That's right.

Beckworth: ... like the MPs Kenya having real time settlements, real time payments and making them a part of their system.

Ricks:    That's right. Smartphone penetration is very high in the US and elsewhere and of course we would envision having a Fed account app that you could use. There's FinTech companies like Venmo and so forth that offer in network payments that are very fast and efficient but you all have to be... they only work within network, right?

Beckworth: Right.

Ricks:    So you all have to have a Venmo account for that to work. There's a network effect that happens with that, but we'd like for Fed accounts to offer the same.

Beckworth: Let's move on to monetary policy, how would this system affect the conduct of the Fed's activities?

Ricks:    Well, so I alluded earlier to the fact that I think the Fed can keep doing things the same way if it wants to, but we think you would actually get better monetary policy transmission if you enlarged access to Fed accounts. Right now the Fed pays interest of course to banks on their reserves just since 2008, is sort of the way we do monetary policy or at least the way we administer our Fed funds target is through paying interest on reserves and pass through has not been great on this, both to the Fed funds rate and more importantly to broader market-

Beckworth: Right.

Ricks:    ... to broader money market rates and the Fed has really struggled with this. They created this new reverse repo facility some years ago to try to open up the Fed's balance sheet, right, to a broader set of counterparts.

Beckworth: On the margin.

Ricks: So pay interest to money funds is-

Beckworth: Right.

Ricks:    ... basically what's going on now. We want to broaden out our set of counterparties in order to get better transmission on interest rates. What we found is that broader access to Fed liabilities, interest paying federal liabilities improves the conduct of monetary policy, improves the pass through monetary policy. We don't see any reason why that logic shouldn't continue if you further open it to non-bank businesses, non-financial businesses and into individuals, if the Fed is paying us administered rate it's interest on accounts directly to everyone, that you no longer have to worry about imperfect pass through because you're no longer seeking to pass interest exclusively through the banking system.

Ricks:    You're getting directly to individuals and businesses and affecting their decisions on spending and saving and so forth. We see this as a way of improving interest rate pass through and you ought at least in principle to get better efficacy of monetary policy in our view.

Beckworth: I'm just wondering here, people who call for negative interest rates, like Miles Kimball and others, would their policies be more feasible in this system?

Ricks:    I'm not sure about that. This is not a plan, for instance, to get rid of physical currency. We do think that this would push in that direction, but it's not one of our goals here. This is not a sort of Ken Rogoff, Curse of Cash type of argument and so as long as physical currency exists and is available, you have at least some limit presumably on the ability to pay negative rates. I know people have some sort of creative ways of thinking about getting around that problem. But it's not obvious to me that we get... and so far as there's still a trillion to 2 trillion of physical currency out there.

Beckworth: Sure. Well, let me put it this way. I still see this on two dimension and it's getting easier maybe in the direction, all the way. But first, as you mentioned just a minute ago, the Fed would have more control of our short term rates, greater pass throughs. If they wanted to lower rates, it would be felt by everyone, right? It wouldn't be just stuck with primary dealers and a few banks, would be the first thing.

Ricks:    Right.

Beckworth: The second thing though is in Mile Kimball's proposal is in times of recession, to establish a floating exchange rate between currency and electronic money.

Ricks:    Oh.

Beckworth: It would be easier to implement, at least in principle in my mind, I may be wrong. Cash would come with the discount. You go and you pay for something with cash, you would find that your electronic money went further than your cash did and you could... it'd be easier to implement that type of program, I guess, if the Fed had this massive control over money.

Ricks:    I suppose that's right. Although I'm confused, my head is spinning even just thinking about how that would work, but-

Beckworth: It may not be popular, it'd be very unpopular. In fact, I could predict that. But just in principle, I could see a Miles Kimball proposal making more sense.

Ricks:    That's interesting. Sure.

Beckworth: But also just in general, targeting... I know this is very unfashionable, the old monetarism seems it'd be a lot easier in a model like this.

Ricks:    Some people have suggested that this implies that we must be moving toward old monetarism and money supply targeting as a way of... the old Friedman rule or something that's... I just don't see it that way, right? I think you could still do everything the same, what you could do-

Beckworth: Follow Taylor rules.

Ricks:    ... you could do nominal GDP level targeting with this system, right?

Beckworth: Right.

Ricks:    We're just moving from more private to more sovereign money, but there's nothing in-

Beckworth: Right. It's not inherently old monetarist.

Ricks:    It's not inherently old monetarist, but it certainly seems that way to people. I think that wasn't in our heads at all as we wrote it.

Beckworth: Sure. But as a thought experiment, you could see Milton Friedman rolling over in his grave getting excited like, "Oh, oh."

Ricks:    Well, so, of course, he at least early in his career was a former reserve banking proponent and in fact, Fordham reissued his program for monetary stability in the early '90s, and he wrote a new preface to it, where to my surprise when I read that when I was writing my book a few years ago, he said he still supported Federal Reserve banking. He would support it if he thought it was politically possible, but it wasn't. He never strayed from his-

Beckworth: Really?

Ricks:    Federal Reserve banking, look, it's the sovereign taking over the money supply, right? It's a very statist thing and I think, I'm not a free monologist, but it seems to me there's a part of Friedman that never really strayed from being at least something of a statist about money, if not about anything else.

Beckworth: Well, he loves his monetarism and his money. Have there been any experiments, any cases that come close to Fed accounts that you know of historically?

Ricks:    Not that I'm aware of. Although-

Beckworth: So we're breaking ground here?

Ricks:    Yeah. Maybe I'll embarrass myself by learning that this has been tried elsewhere and failed miserably, but we're not aware of any central bank really offering accounts to the-

Beckworth: Well, great. You have this seminal article, who will be citing you in a-

Ricks:    I don't have a seminal. Like I said, I do think we've taken this further than others have, but even recently, discussions over so called central bank digital currencies have been something, particularly in Europe, it's been a big conversation amongst economists and central bank economists and central bankers. In some cases when you read that literature, what they mean by digital currency would be met by just the pub being able to maintain accounts at the central bank, so depending on your definition of…  Some of them, they say a central bank digital currency is maintained on a distributed ledger, for instance and that's different from what we're talking.

Beckworth: I see.

Ricks:    But there's a lot of confusion in that frustrating sort of lack of consistency-

Beckworth: Sure.

Ricks:    ... about what is even meant by a central bank digital currency. But at least, at some theoretical level, it's sympathetic to or maybe even another way of doing a Fed account program. You could call this central bank digital currency if you want. I mean, what is a reserve balance, right? It's a digital ledger entry on the central bank's balance sheets, so maybe that's-

Beckworth: That's it.

Ricks:    ... digital currency.

Beckworth: Well, the one example that I can think of that would come close to this, and I may be off and all our British listeners will correct me, I'm sure, but the Bank of England at some point in the past allowed people to have accounts there. I know initially it was a private bank and slowly it became more of a public one. But JP Koning who has a great blog and he was on the show previously talked about this. Was a few decades ago, I believe, maybe even within the past decade where they've eventually phased out check clearing privileges for bank accounts for its employees.

Beckworth: The last vestige of this was if you worked at the Bank of England, you could have an account at the bank of England.

Ricks:    Hats right. You know Paul Tucker, who is a very senior official at the-

Beckworth: Yes.

Ricks:    ... Bank of England for many years, told me the same thing about employees of they are having the ability to maintain accounts, so that's right. There is at least one precedent of sort of retail access.

Beckworth: Right. But it's still not quite the same as what you would have because this is again, a different day and age, more technology, different setup in some ways.

Ricks:    Right.

Beckworth: All right, so we've talked about the Fed accounts, all the promises it has, there's more, I encourage the listeners to go look at the article, but in the time we have left, tell me any concerns that you have. As you see this plan being implemented, let's say Congress passes a bill that authorizes Fed accounts, what roadblocks, what hiccups, what challenges are there in making this real?

Ricks:    Well, of course, there's political obstacles, right?

Beckworth: Yeah.

Ricks:    You would need legislation to do this. The Fed isn't currently authorized to open up its balance sheet in the way we've described, so it goes without saying there would be political obstacles to this. I imagine the banking system would not necessarily be in favor of it. On the other hand, I think retailers, for instance, I think Walmart and Amazon would love this because this is a way of reducing interchange fees, which isn't something we've talked about, but it's in the paper.

Beckworth:Sure.

Ricks:    People can check that out. The legislation would actually be quite simple. This wouldn't have to be... this could be done in a few pages of authorizing the Fed to maintain accounts for all US persons that meet its eligibility requirements and to pay interest on those accounts, is actually just from a legislation tech standpoint, this is not a hard thing to draft up. But once you get over the political obstacles, which would of course be a real challenge, I do think look, you have implementation challenges. The Fed is not accustomed to dealing with the retail customers and whenever you're making some change of that type, there's the potential for not doing it well or screwing it up.

Ricks:    We can all think about the Obamacare rollout, which didn't go quite as planned at least originally. They got their act together as I understand it, but there's always a risk of just operationally not doing it well. I think this is way easier than that. I mean, there's thousands of banks that offer bank accounts now and offer a web based interface. There are standard ways of doing this, but in any case, of course, that's a problem. I think more serious problems arise when you start thinking about things like cybersecurity, when you start thinking about potential privacy and civil liberties concerns, and these are issues we address in some detail in the paper, but we don't want to minimize them.

Ricks:    Cybersecurity is a real issue for banks today and for the Fed and the Fed maintains expert cybersecurity capabilities at the system level. But that wouldn't stop individuals from compromising their own accounts and losing their passwords and hackers and opportunistic fraudsters can go after them. The Fed would have to deal with this problem just like banks do today, would have to insure account holders against losses and that could be expensive, particularly if it ends up not being as good at this as other banks. We don't have any reason to think it couldn't do this quite well and other federal government agencies that have retail interfaces have really good, including the IRS, has great cybersecurity defenses. They obviously have very sensitive information on Americans that some people, I can think of one set of tax returns in particular that a lot of people would have liked to have gotten at over the past couple of years. But it's not an easy thing to do.

Ricks:    But we don't want to minimize that problem and that's just an inescapable problem of the modern world in some ways. On the privacy side and civil liberties, I think there's legitimate concern about an organ of the federal government just having more information about people. Your transaction records and so far as you're transacting in and out of your Fed account, right?

Beckworth: Sure.

Ricks:    If they should see some of the payments that you're making and that is cause for concern. I think we address this at some detail in the paper and I think while that's legitimate, we shouldn't overstate this, right? First of all, your bank account today is not protected by the Fourth Amendment. There's a doctrine called the third party doctrine that you've given the information to banks, so you don't get constitutional protection and privacy protection on your bank account records.

Ricks:    By the same token, federal government agencies including the Fed, are covered by the privacy act, which was passed in the 1970s, which prohibits unauthorized disclosure by federal government agencies of personal information, prevents law enforcement access without a particular judicial or other administrative process. In some cases we put much higher bars even in the privacy, so the IRS specifically has... it's very difficult for law enforcement to get at IRS records. It's a crime for a member of the IRS or an employee of the IRS to disclose information or even access information that they're not authorized to. They have very strict protocols internally about accessing information and while the IRS certainly has not been beyond reproach in its practices over the years, one area where it's done, I think, a quite good job over a long period of time is protecting private information against disclosure. We think that IRS can kind of be a model of protecting your... but we don't want to minimize this concern, it's a real thing.

Beckworth: So it could be implemented fairly easily in terms of legislation, it would just getting past the political obstacles and some of these concerns that you've mentioned. Privacy and-

Ricks:    I think the look, the politics as with any reform proposal are serious, the legislation in this case, this would not be Dodd-Frank, 850 pages of texts. This is something you do on a few pages and so there's not a huge legislative drafting task ahead of us. If we wanted to do this, it would be quite simple, but it would require an act of Congress.

Beckworth: All right. One last concern before the show ends and that is shadow banking.

Ricks:    Right.

Beckworth: How do we prevent shadow banking from this popping up somewhere else? You create the incentive for these accounts to merge or migrate to the Fed, on the margin, in the shadow why would we not still see money creation?

Ricks:    That's a great... I mean, so I define shadow banking in terms of money creation and just very specific funding model of lots of dollar denominated debt that's rolled over continuously, is what I mean by shadow banking. Our hope would be that this would crowd out a meaningful amount of that activity because it would be attractive. It would offer an attractive yield and it would be perfectly safe. The idea is this would shrink the repo market, shrink the Euro dollar market and other markets. Jeremy Stein, formerly a Fed governor with a couple of his Harvard colleagues wrote an article that they presented the Kansas city Fed, I think it was two summers ago now, where they talk about maintaining a large Federal Reserve balance sheet as a financial stability tool to crowd out shadow banking money substitutes.

Ricks:    That's what we're saying. This could be a way of doing that. Now how effective would it actually be is a legitimate question. I've proposed in other work that we should be a lot more muscular about limiting who's able to create 'dollar denominated money' and actually restricting entry into that activity. But we don't address any of that in this paper.

Beckworth: All right, with that our time is up, our guest today has been Morgan Ricks. Morgan, thank you for coming on the show.

Ricks: Thank you, David. Great to be here.

Support Mercatus

Your support allows us to continue bridging the gap between academic ideas and real-world policy solutions.Donate