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

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.’

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

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.


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.

David Beckworth
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Jul 30, 2018
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Building a banking system with full public access to central bank accounts could be a big benefit for low-income families.

Morgan Ricks on Money as Infrastructure and Bank Regulations

Morgan Ricks is a law professor at Vanderbilt University where he studies financial regulation. Between 2009 and 2010 he was a senior policy advisor and financial restructuring expert at the US department of the Treasury where he focused on financial stability initiatives and capital market policy. Morgan joins the Macro Musings podcast to discuss his new paper, ‘Money as Infrastructure.’

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

David Beckworth: Morgan, welcome to the show.

Morgan Ricks:   Great to be here, David.

Beckworth: It's fun to have on. You always have very interesting if not provocative things to say about money and you bring both a legal and a financial perspective so it's fun to have you on the show. And then your new paper Money as Infrastructure, presents an argument for the regulation of banking I had never seen before. So it's very fascinating. I can't wait to get into it, but let's begin our show by first talking about something you bring up early in the paper. And that is the two paradigms of banking and its implications for regulations. What are they?

Ricks:    Yeah, so I think this'll probably be familiar and at least at some conceptual level to a lot of your listeners, at least those who have studied banking or have a macro background. So, I say that there's essentially been two competing paradigms that have really dominated understandings of banking and its regulation. The first is what I call the intermediation paradigm. And this has really been the dominant one, I think, certainly in recent decades, and it understands banks to be mostly in the business of taking funds from depositors and then lending those funds out. So this is just a classic financial intermediation function. The other paradigm, which was certainly dominant in the 19th century and I think also, and the early 20th century is what I'm calling the money paradigm. And it sees banks really is distinctively monetary institutions. And that means something more than just offering payment services.

Ricks:    It means that banks augment the money supply. And so rather than seeing banks as entities that take funds and lend them out, it sees banks really as issuers of 'funds.' And of course, that's both a familiar statement in the sense that I think every textbook on macro or on money in banking presents banks as entities that augment the money supply. We're all familiar with the classic money multiplier model that we see in the textbooks. It's not something that's unfamiliar, but I do think it's the case that the intermediation paradigm has really dominated. The way people understand banks in terms of both academic theory. The modern models of banking within economics are really dominated by the intermediation paradigm. And within regulation, I think the intermediation paradigm starting probably in the '80s, really began to take hold and take predominance within the US bank regulatory agencies. I think that had a lot of implications for how regulation has changed over recent decades.

Beckworth: And you mentioned in your article, they're not incompatible, but they do have some tension with each other before we get to those, just to flush it out a little bit more, someone who says a bank lends out reserves is taking the inner mediation perspective, right? They see it as connecting the positives and borrowers. And then another view you often hear is, well, bank makes the loans and then they go look for the reserves. So they're in the business OF making loans, which create deposits, creates the money. And that's the money view, right?

Ricks:    That's one way of putting it. I mean, I know there's in the blogosphere over the last decade and other contexts, there have been big debates about these issues and I think a lot of times they've turned into kind of semantic debates. And I want to avoid getting into semantic debate to the extent possible. But I do think what is distinctive about banks is that they augment the money supply and that bank regulation traditionally was focused on that. And that was central to how we organized our thinking about and organized the structure of bank regulation. And that's really not as true as it used to be. And I think that's because of a shift kind of subtle but important and consequential shift in thinking about what a bank is.

Beckworth: Yeah. So just a few more thoughts on this. The intermediation paradigm I think is useful when you want to think about interest rates, right? You're connecting borrowers, savers that this is where you get this whole notion of a natural interest rate. There's a desired amount of savings, desired investment. They come together and you can think of banks playing a role and that's often stressed. At least that's part of the story. The other money paradigm that was very useful because it takes money seriously. I mean, this is what you get into your article. It really focuses in on the fact that money's this one asset that's on every exchange in the marketplace. No matter what you're buying or selling money is always half of that transaction.

Ricks:    Yeah, that's right. I mean it's a distinctive type of financial asset. And I kind of catalog some of the shift from the money paradigm to the intermediation paradigm over the course of the 20th century. And I think it had in part to do with developments in the late 19th and early 20th century when bank notes, which were the predominant liability of banks, of course, in 19th century began to be supplanted by checkable deposits. And one way of thinking about that is that was just a transition of form and not one of substance. So a deposit account of course is a demandable claim putable to the bank at par that functions as money. That's what a bank note was.

Ricks:    And so one way of thinking about this is a checkable deposit account, a transaction account is just an uncertificated banknote. And of same way that lawyers or commercial lawyers will talk about uncertificated securities as opposed to certificated, there's no difference in economic substance between the two. It just has to do with the mechanics of transfer and determining ownership. But if we think about deposit accounts as uncertificated bank notes then it forces us to think a little more about bank note issuing banks. I mean, no one would've described a bank note issuing bank in the 19th century as being in the business of taking funds that were lent out. Right? And they were issuers of funds and the tangible nature of bank notes made it much more conspicuous.

Ricks:    And I think part of the reason the intermediation paradigm took hold was the shift to transaction accounts. Had a subtle but important effect on the way we think about what a bank is and maybe we shouldn't have shifted our thinking quite as fully as we did. And I describe another reason I think that this happened which was just the rise of finance as a discipline, as an academic discipline. And one of the cornerstones of modern finance is that absent taxes and other distortions, financing structure really is unimportant.

Ricks:    It doesn't affect the firm's value. And I think that is, while it's an interesting way of thinking about corporate finance is certainly true in a lot of respects, but banks are somewhat distinctive. And maybe we should be a little bit cautious about applying that kind of framework to banks. But in any case, I think those two things, the shift away from tangible bank notes as being monetary liabilities of banks. And the rise of finance as a discipline that affected the way we thought about the right side of the balance sheet in general. Those two things have really, really impacted profoundly the way people think about banking.

Ricks:    I mean, the 19th century when I'm calling the money paradigm was just universal. I mean, and I document a lot of this in the early part of the paper in the footnotes, the degree to that, that was just common knowledge and everyone thought about banks in that particular way. And now it's really receded in importance.

Beckworth: That's interesting you mentioned in your paper that the national banking system that came in during the civil war, the federal government got back into the business of money and it started chartering national banks. And one of the things that it did is it imposed a tax on state bank notes, kind of kick them out of business. But based on what you just said, one of the unintended consequences is, is state banks they later emerged issuing checks because they couldn't issue bank notes. So kind of an unintended consequence of the national banking system is this, it helped contribute in this shift in paradigms, right?

Ricks:    That's true. It was all incidentally, a similar story, amazingly played out in England before it played out in the US but the central story of bank regulatory history has been seeking to confine the issuance of 'money' whatever we call that. And this started in England just very soon after the creation of the Bank of England, England sought to restrict entry by others into banknote issuance. And it did so successfully. But in the very late 18th century in England, checkable deposits started to become a big deal. And so sidestepping of restrictions on banknote issuance is one reason for how deposit accounts came to be at the time so prevalent. And the same story as you just mentioned, played out in the US with the National Bank Act in 1864. We imposed a form of entry restriction, which was in the form of a punitive tax essentially. But it was designed to really nationalize money creation in the sense that we were going to get states out of the business of creating entities that were issuing money at all and all money was going to be issued by these sort of franchisees of the federal government.

Ricks:    And it was unsuccessful precisely. This was a classic instance of what we would now call financial regulatory arbitrage to the state banks to shifted to checkable deposit accounts.

Beckworth: I would argue they also had an ulterior motive in setting up the national banking system. One argument was, let's have a uniform currency, let's get the federal government back in. But part of that setup was you had to have federal government debt back in your notes. Why would they want that in 1864? Well, they're fighting a war and need some demand for the debt they're issuing. So I'm sure there's some public choice arguments as well as there was some people who genuinely wanted to unify the currency. But anyhow, it's interesting story you bring up in your paper, there's this continual regulatory arbitrage. More recently you talked about how banks were bleeding in the 1970s, '80s because of high inflation and fixed interest rates and money market funds emerged in that period to take deposits. So there's a continual race against the regulatory structure for money creation from different types of firms. Is that right?

Ricks:    Yeah, that's right. I mean, I see, that of course is another famous story in banking history is how the rise of money market funds was an essentially an around and around regulation of bank deposit interest rates under regulation Q. And creating things that were serving the function of deposits, but were not called deposits. Interestingly less well known is the fact that the SCC when very early in the rise of money market mutual funds was concerned that maybe these actually would be deposits for purposes of federal banking law. So federal banking law says you can't have deposit liabilities unless you have a banking charter, right? This what I called elsewhere, the first law of banking. It's the way we do entry restriction into banking is to say deposits are off limit unless you have a banking charter.

Ricks:    But that begs the question, what is a deposit exactly right? What are we restricting entry into? And amazingly, there is no definition of deposit for purposes of entry restriction in federal law. And so the SCC with the money fund industry came up said, are these entities violating 12 USC Section 378, which says you can't have deposit liabilities without a banking charter. Because of course they did not have banking charter. And the SCC wrote to the department of justice to ask for a legal opinion. And justice came back and opine this is fine because these are equity and they're not debt, which was a pretty formalistic way of answering the legal question. And of course, as we all know, money funds turned out to be susceptible to the same kinds of instability problems that deposits and of course bank notes before that were susceptible too. So it's the same funding model serving the same function. And it raises the same problems.

Beckworth: In our previous interview you stress that point a lot that the run on the shadow banking system was run on money accounts effectively. And so the question is, how do you deal with that? In fact, your view is that most financial crisis, modern financial crisis are related to run on these accounts that effectively our money.

Ricks:    Yeah, that's right. I mean, and this is sort of a Gary Gorton and others have said some more things. I would put it maybe a little more forcefully than you did. Which would be to say that the main risk that the financial sector poses to the real economy has to do with the instability of what you might call private money. Money in a slightly broader sense than just transactable things, but really short-term debt that's serving a monetary function. And so on the unraveling of private monies is one of the main sources of acute macro economic disasters certainly in US history and also I think it's true to some extent abroad. And so in so far as we're concerned about the propensity of the financial sector, shocks in the financial sector to cause acute macro economic disasters, mostly with that is about is runs on money. So that's one of the central themes of my previous work. Although in this particular piece, I'm not as focused on the instability point, which I've addressed in detail elsewhere.

Beckworth: Listen to the previous show folks and you'll get the full treatment on that.

Ricks:    Or buy the book.

Beckworth: Buy the book too. I'm sorry. Absolutely. I've got both the hard back and the paper back. Thanks to you. So one last thing I want to stress on these two paradigms. Going back to the financial intermediation paradigm and think regulation and the money paradigm is that you see them in the conduct of monetary policy, at least I do. And I you see it both in how scholars view the Great Depression and how things were done and viewed during the great recession more recently. So let's go to the Great Depression, the Great Depression and Milton Friedman saw this as a monetary phenomenon, into money supply collapse. And the fed didn't do enough.

Beckworth: It was as destruction of this assets, that transaction asset across the economy, and it would cause problems. Ben Bernanke in a very famous paper look back at the Great Depression, and he saw it as a financial intermediation problem. It was a shock that banking that caused the great recession and they had different emphasis. Friedman focuses on supply, the production supply of money. Bernanke focuses on the collapse in financial intermediation. Move forward to the great recession and you have QE as one of the tools the Fed use to address the recovery and to get us back to a full healthy economy.

Beckworth: And the way QE was set up, it was focused on the asset side of the central bank's balance sheet, which is the financial intermediation view. Where the monetarist would say, no, no focus on the liability side, where you create the monetary base, you create money. And Bernanke actually was very clear about this in the one speech he said, "Look, we're not like Japan's Q." Japan's QE was actually focused a little bit more towards creating reserves, creating money. He goes, "We're not about that. We're about tinkering, credit spreads, suggesting supply of safe assets out there." So I think-

Ricks:    Exactly I remember that speech and he used a different terminology for Japan's QE than he used for ours. I forgot the specific terminology he used, but he was precisely trying to make that exact point.

Beckworth: Well he called QE credit easing.

Ricks:    Credit easing. That's what I was trying to remember. Yes.

Beckworth: They did more money easing and we're doing credit easing.

Ricks:    Yes, that's it.

Beckworth: And I think a lot of what they did related to that, why they paid interest in excess reserves at least initially was so they could kind of not worry about the liability side and just focus on getting the right mix of treasuries and mortgage backed securities in the economy and that will lower credit risk and get the economy going. And I find that fascinating because it's the same spirit of this paradigm that you're sharing it in terms of how we view the regulation of banks. Correct?

Ricks:    Yeah. I think that's right. And look, I'm not trying here to say the intermediation paradigm is wrong and the money paradigm is right. Or I think they can coexist and probably should coexist in our minds. I think we as a regulatory matter have given insufficient attention to the money paradigm, certainly in recent decades. But the way I think about, look, I'm no scholar with the Great Depression. I understand that the International Gold Standard had a lot to do with things. I'm sure that Bernanke is right about constriction of credit and I found that to be a really enlightening point of view. I think that's the flip side of the coin of bank panics is that when holders of low powered money, let's call it, are exchanging it for high powered money, that it stands to reason that banks need to be liquidating their portfolios and trying to meet redemptions.

Ricks:    And they are therefore going to both reduce their own new credit extensions and they're going to drive down the price of bonds because they're dumping on the market. And that means the yields are going up. And so newish ones is going to be very difficult. So I don't necessarily then we need to, at least in my own mind, I don't know that I think it's important to draw some really sharp distinction or choose between those things. But I see them as really two sides of the same coin.

Beckworth: Fair point. And again, I want to stress what I said earlier that the intermediation do you think is important. When you think about fundamental interest rate, the natural interest rate, you think about, what drives that. And that's kind of the built in or baked into the New Keynesian. New Keynesian view. They view monetary policy as differences in interest rates, difference between the Fed's target rate and the natural rate where a monetarist would focus more again on the liability side of the Fed's balance sheet. So you're right, they can complement each other. But I do think, I'll put a stronger foot forward than you on this point. Then we'll move on to your-

Ricks:    I've been reading the market monitors for years, so I know something about how this argument goes.

Beckworth: Let me just say this, that I do believe QE was partly less effective than anticipated because there wasn't enough focus on the liability side of the Fed's balance sheet. There wasn't enough focus on money. And so I think you can use them properly in the right context together, but I do think you can air to one side or the other to a fault. But with that said, let's move on to your paper, enough macro debate. Let's talk about the implications of this intermediation paradigm versus the monetary policy paradigm when it comes to regulating banks.

Ricks:    Right. So I think the important thing to understand is that the two paradigms really start from two different institutional baselines is one way of putting it and sort of one of the ways I put it in the introduction of the paper. So if you really are devoted to the intermediation paradigm, you tend to think of banking as something that sort of arises out there. It's a private activity that is then regulated and one would want that regulation under this view to be as light handed as possible, to avoid distorting private market outcomes. And so the idea under this view that say you should regulate deposit interest rates, well that's anathema to the intermediation paradigm. That's deposit interest rate should be determined by market forces. Entry restriction is disfavored if you favor the intermediation paradigm for similar reasons, right?

Ricks:    We don't want to have any limits on competition in this area. And so, and who gets access a bank account is a matter of private concern and that's not as much a matter of public concern. I think if one starts from the intermediation paradigm, which really envisages banks as private actors and we're of course regulating them because they raise problems and stability being the foremost of the problems. But we want that to be as non-intrusive as possible. The money paradigm, I think if you take it seriously and want to really think about bank regulation seriously by way of the money paradigm, you really start from a different institutional baseline. Which is not a private activity that is then regulated, but more of an intrinsically public activity that is then being outsourced.

Ricks:    So you begin to see a bank charter is sort of a franchise or outsourcing of what might be called an intrinsically public function. So the institutional baseline here is direct public provisioning. We can imagine a world just for purposes of a thought experiment, I suppose, and which we just all held our transaction accounts at the central bank. Right. And there was no private money creation. This was all a public function, just as the public monopolizes, just as the central bank monopolizes the creation of dollar bills. It could also monopolize the creation of account money as I sometimes call it.

Beckworth: So I can have a checking account at the Fed.

Ricks:    You would have a checking account at the Fed and you actually it's funny, I've been talking to various people about this including Luigi Zingales recently who was here and we had a long conversation about it. Not to get too sidetracked on this, but during the say the 1930s or for decades thereafter the idea that everyone would just hold an account at the central bank wouldn't have really made sense because all payments essentially involve physical payment media in some form or fashion. Whether it was actual delivery of federal reserve notes or whether it was a transfer of a physical check.

Ricks:    Well, now we're in a world where physical payment media are very, very small part of the overall transactional environment and are kind of going the way the Dodo bird. And in such a world, it's not hard to imagine with modern telecommunications infrastructure, with smartphone penetration being what it is, a world in which we wouldn't need to really transfer physical payment media of any sort in ordinary transactions. And that raises the prospect of everyone. I mean, realistically, somewhat of everyone just having an account at the central bank. And most of us don't interface with our banks physically that much anymore. I don't go into a bank branch very often at all and hardly even go to ATMs anymore. So suppose we all held our account just for the sake of argument at the fed and the fed was really monopolizing account money as I call it, just as it's monopolizing paper money.

Ricks:    Then ask the question, what determines the interest rates you would receive on your account? Would that be determined by 'market forces?' Well, of course it would not be determined by market forces. Any more than today and the interest on reserves, that the central bank does pay to commercial banks is determined by market forces. That's a question of monetary policy, to be determined by macroeconomic considerations that the fed is taking into account. So in the insource setting interest rate controls on your account money is a question of monetary policy and not a market question. Likewise, with respect to access say to bank accounts if the central bank were offering bank accounts, it might really favor a universal service as opposed to having everyone be necessarily paying the marginal costs of their account.

Ricks:    I mean, a lot of government services are offered below marginal costs. You could think about postal services in remote areas, for example or a variety of other services that the government offers. And I think there are good public policy reasons for those decisions. And so when you start from a money paradigm, if you're thinking of this as an outsourcing of a bank charter, essentially an outsourcing of a public function. You start by thinking about the insource setting and then asking whether anything necessarily needs to change when you outsource. And this is where things get a little bit controversial, I think in the paper, is because I argue that there's no reason in principle why you need to give up control over the payment of or the rates of interest paid on deposit accounts once you've outsourced money creation to private banks.

Ricks:    If you're starting from the money paradigm within which insourcing is the institutional baseline that you're starting with. And so I'm envisioning a world in which a regulation Q type regime, except one in which we're adjusting the right pay on deposits in accordance with monetary policy. Is something we can at least entertain as an idea. And of course that raises questions about bank profitability and other things that I deal with on the paper [crosstalk 00:25:52].

Beckworth: National crisis.

Ricks:    Yeah, national crisis, of course, in inflationary environments and so forth. But I think within the academic literature and I think in the policy world, there's pretty much universal consensus that doing away with controls on deposit interest rates was a good thing. And I'm in this paper questioning at least raising questions about whether it didn't make sense after all.

Beckworth: So you've presented this paper before, right? Did you get like oohs and gollies about it?

Ricks: Yeah. So-

Beckworth: What's been the reception? Because it is at some level pretty radical.

Ricks:    Yeah. I haven't had any takers in terms of the specific argument about deposit interest rate controls. I haven't had any takers, but I've had some really nice private... Well Luigi commented on it in a seminar and he thought some aspects certainly if the framing were interesting. He didn't really get into the deposit interest rate control argument specifically. And so I don't really know what he thought about that, but it's been pretty well received and, but also received as a provocative and sort of coming from left field in some ways.

Beckworth: A good academic writer. I retired. Great ideas. Well, I mean, the thing is what I appreciate about it, and I have some questions too, but what I like about it is this framing that takes money seriously. Going back to what we've mentioned earlier, and I just want to flesh out that the point you're making about money creation as being kind of a public good or a public provision, that goes back to the idea that money is this important asset, unlike any other asset, right. That's being used by everyone. And that therefore it's more than just selling a stock or buying a car or a house. It's very and fundamentally different. And that's why you see it in addition to the stability issues. Is that the kind of a key argument for what you're doing?

Ricks:    Yeah. I mean, it's public. In other words, money has been the creation of a functioning monetary system has been an important aspect of statecraft for a very long time. And well-functioning monies usually I think pretty much always. I mean, I'm sure George Selgin and others would pick fights with me on this, but my reading of history and my intuition tells me that you really do need the government involved in money in some form or fashion. And look, a lot of laissez-faire oriented people have agreed with that. I mean, including Milton Friedman and James Buchanan wrote a paper around the time of the crisis in which he suggested that the market can function with monetary anarchy. And I interpreted that to be an assertion of the fact that the government does have a role to play here in the monetary framework.

Ricks:    In a way that it doesn't necessarily have as much a role to play in the securities markets other than of course regulating for maybe disclosure and fraud and these kinds of general market norms that we want people to abide by. But money creation is really distinctive activity that's separate and apart from the issuance of securities in some kind of generic sense. So that's a long winded affirmative response to your question.

Beckworth: Yeah. So it's great that you're taking money seriously. So let me put on the George Selgin hat since you've mentioned him and Larry White and some of the other scholars who are classified as the free banking school. And they would point to... And I want to hear your answer to Scotland's free banking system, relatively stable. Canada up until I think great depression had a relatively stable, even in the US, the US had a... It's not really a true free banking system, but you mentioned in your paper actually there was period where standard laws you could incorporate a bank. And I know there's been work done that said some place like Michigan was horrific, that kind of the bad name that free banking has in the US is kind of like the Michigan Wildcat banks. But the State of New York had a very successful for banking system. So how would you reply to those folks who say, look, it can be done if just done right.

Ricks:    Well, with respect to the US system, which I know a lot better than Scotland and Canada. And I think George and others agree with this and I think I've seen him write about the US free banking era, which was between the demise of the second bank of the United States and the creation of the national banking system that we talked about earlier. It's sort of the mid-19th century. Free banking laws in the US we're not really laissez-faire, right? I mean, the idea was that banks, we would no longer have special legislative charters for banking. So you wouldn't have to go to the legislators smacked of cronyism and corruption. It was also a burden on legislators to have to... Even decades earlier, you needed a legislative act for even any kind of corporate charter. General incorporation acts started to be enacted around the 1820s, if I have my history right.

Ricks:    But banking was still something where was perceived as special. And so up through until say the mid-1830s in every state, you still needed a special legislative back to get a banking charter. The free banking laws were designed to turn that into more of an administrative function where we weren't going to require a special legislative act. And anyone who came in and met the requisite standards would be able to get a bank charter, but it was not laissez-faire. Right. So I think in all of the state laws you had to, it was very much like the National Bank Act that you referred to earlier. You had to post collateral in the form of bonds issued by the state in order to issue bank notes. And so that was not a laissez-faire system. It was actually in some ways a very onerous form of portfolio constraint.

Ricks:    So I don't think we can call that laissez-faire. And draw any interpretations about true laissez-faire banking from the free banking era. Scotland and Canada. And boy, it's been a little while since I looked at these closely. But Scotland for the late 18th and early 19th century had a few big banks and well, you know what, I'll probably butcher this specifics of, I tried to do. There's the Royal Bank of Scotland and the Bank of Scotland. And they were created they had some special privileges and I'm not completely sure. And they also, as I understand it, has special relationship with the Bank of England.

Ricks:    I think that George and others dispute this or have dug into the nature of this relationship. But the pushback I've seen on Scotland is that it really wasn't as laissez-faire as some people would like to suppose. But I can't give you any sort of definitive opinion on that. With respect to Canada, I think I know it a little better maybe, but there was the bank of Upper Canada and the bank of Montreal. They were both dominated from their inception by the provincial governments and they received state support in the very late 19th and early 20th centuries.

Ricks:    I don't think we can really look at those as true laissez-faire systems either. So I sort of questioned whether the extent to which those two episodes were really truly laissez-faire. And of course, they don't need to have been really purely laissez-faire for them to sustain an argument that maybe laissez-faire banking would work. But I don't think we can interpret them as real vindications either.

Beckworth: Okay. Right now in the case of the US free banking system, you're right, it was more of a transformation to a rule of law versus the crony capitalists. Let's incorporate our friends, people we know, and I think that that's an important, even though it might be onerous on the portfolio, it creates predictability and minimizes the level of corruption. And I think what's interesting in your paper, these free bankers may roll rollover and hear this, but that you kind of spend that free banking structure, that thinking into your proposal we'll get into in a minute, right? This kind of there's a standardized kind of predictable process, right? Where they based on whatever that your design would be.

Ricks:    I suppose that's true, although, I am more favorable toward a form of entry restriction in banking. And that, I get into this a bit in part two of the paper where I wouldn't necessarily grant a bank charter to anyone who came along who met the requisite standards. I think a public convenience and necessity type of a standard is important in banking. And that's one of the parallels I draw that's a theme of the paper is that the similarities to what and the law is called regulated industries, network industries, common carriers, public utilities, those things are sort of grouped under the regulated industries umbrella, which economists tend to think of in terms of natural monopoly. And that framing and the legal structure of those industries has a lot of light that it can shed on banking.

Ricks:    And historically there was a lot of parallels between the two, including and rate regulation. Of course, the quintessential practice of public utility regulation is the regulation of rates. And I'm suggesting here that there may be a stronger rationales than a previous event supposed for regulating deposit interest rates. And so that puts you kind of in that domain of thinking about rate regulation and with respect to entry restriction, of course it's similar. Certificates of public convenience and necessity is in the legal world, what you need to acquire to enter one of the regulated industries. And those are not granted to any comer, right? There's inherently some regulatory discretion that goes into that. And I think about banking more through that lens. So I think I'm not quite as free banking as the free bankers I what I want to say.

Beckworth: Okay. Many questions come to mind, but I want to hold off on some of them until we get to your specific proposal. Instantly comes to mind among other things, certificate of needs. For example, if you want to get an MRI machine, there's all kinds of pushback as well. The other people who own MRI machines don't want the competition. And so I think you'll address that later when you get to the actual proposal. Just a thought though, your hypothetical experiment, we've actually talked about this where on the show before we've had guests on talking about. There is kind of a gradual incremental move toward having a checking account at the federal reserve or at a central bank in general.

Beckworth: There's been a progression toward that. We see that with the opening of the Fed's balance sheet to other financial firms that exist before. Even the one of I think is Chicago Mercantile Exchange or one of the big exchanges in Chicago has access to the Chicago Fed the balance sheet through that. Also we see those things happening. So I think we see some incremental movement in that direction. We can debate whether it's good or bad, but I know members of the FMC have brought this issue up in their discussions as well. Do we want to shrink the balance sheet or not? Do we want to have a smaller footprint or not? And the more we opened the balance sheet, in fact, some of the issues you could bring up later in the paper why is an interest in access to reserves working as well as they intended because some firms have access to the balance sheet and some don't.

Ricks:    That's exactly right.

Beckworth: And it's arbitrage and is a lot of problems the way that it's set up.

Ricks:    Well, and in fact, I mean you speak of expanding access but part of, when they started paying interest on reserves, and I mean, you know this very well, but in late 2008 everyone sort of thought the interest on reserves rate would serve as a floor on the Fed funds rate. It would have to, right? Who would ever lend a reserve balance for less than they could get by risklessly just holding the reserve balance. And so I think a lot of people were kind of confounded by the fact that the Fed funds rate was remaining below the excess reserves rate. And of course, the answer to that is I think everyone accepts is that, well it wasn't just commercial banks that had access to the Fed balance sheet, right? The GSEs had accounts. This relates to the point you were making earlier about the kind of slow expansion of access to accounts at the Fed and the GSEs were not eligible and are not eligible, I believe, still to receive interest on their reserve balances.

Ricks:    And so that created this sort of wedge where you saw the Fed funds rate falling below the interest on excess reserves rates. But I think Bernanke I think essentially admitted that it surprised him. And I think that it surprised a lot of people. Even at the Fed, the Fed funds rate wasn't fully supported by the interest on excess reserves rates. Of course, broader money market rates have consistently fallen significantly below the Fed funds rate. And that's why they started the reverse repo facility itself, which is in a way-

Beckworth: It's another opening.

Ricks:    ... Another opening is exactly what I was going to say, right. So we have 100 money funds or whatever, that in essence are owning, have access to the Fed's balance sheet, right? They have access to Fed liabilities. And so we haven't gotten to the point where you and I can open an account there, but maybe that's down the road.

Beckworth: I mean, the danger, and I know some of our listeners will be thinking, "Oh my goodness, are we going to turn into China's state owned banks that have kind of nonperforming loans and full of crony capitalism?" That's the fear I guess if you nationalize something that maybe requires experience and all that, but let's hold off on that discussion. One thing I wanted to mention, I failed to this last point on opening up the Fed's balance sheet is that it's been done before.

Beckworth: I had J.P. Koning on the show and he talked about the Bank of England used to be, people had their own checking accounts. It used to be a private bank, I guess then it eventually became more public. But it wasn't that long ago that if you worked at the Bank of England, you could write a check on the Bank of England, sort of blows your mind. And they finally got away with it. And J.P Koning makes it a unique argument. He believes this could still exist. He thinks if you wanted a super safe checking account, you'd open one at your central bank. And then if you wanted banks with great online service and loans and mortgages, you'd go to traditional retail banking. He thinks they could coexist. I don't know. But that's his view.

Ricks:    Well, look, if you're paying the interest on excess reserves rate on all of those accounts that are held with central bank, you're not going to have a lot of people choosing to hold their account elsewhere unless they're able to match that rate. And I'm certainly not getting that rate on my BVA account these days. So the pass through issues become more acute in that world. If you're really opening it up. And if you're not saying the interest on excess reserves, I mean, it would be hard to justify, I think opening up the Fed's balance sheet to a broader set of the public than just the commercial banks. But also saying, well, only the commercial banks are able to receive interest on their excess reserves and no one else would be. I mean, it would be, I think, really difficult to justify, even on a theoretical basis, any reason for that. So that will create a challenge.

Beckworth: Political backlash.

Ricks:    Yeah. Yeah. Well, I mean, I think it should create a political backlash probably. I mean-

Beckworth: Well it is bad optics even now, right. Large-

Ricks:    I think it's more, I think it may be more than bad optics. I mean, I know people, I know experts who want to think of this as just an optical issue that we're paying whatever it is right now, a percent and a half on our large banks balances and what are the total size of excess reserves right now? Three trillion, whatever it is. And this is a significant amount of money that checks that are being cut, essentially. And the way we do monetary policy now, of course, not until 2008 was this the case. But the way that we do monetary policy is by cutting checks to banks and it is an optical issue, but also if we're not getting really good pass through on that, which is an issue we touched on earlier. Maybe it's more than an optical issue, maybe there's an efficacy issue. Maybe there's also a, for lack of a better word, a subsidy or favoritism issue that's more than simply optical.

Ricks:    And so that's one of my concerns about the way we've chosen to do monetary policy. In theory, it works great. And in theory it's just an issue of optics that you're paying interest on these accounts because it'll all pass through an arbitrage will work perfectly. But if it doesn't work so perfectly, then I think we have reasons to be concerned about the present structure of monetary policy implementation. That's my own view. I know that's a minority view among experts.

Beckworth: Well, Marvin Goodfriend, who was one of the first scholars to advocate a floor system, he to a surprise, you mentioned Ben Bernanke and he has proposed that the Fed either take the GSEs off of its balance sheet, remove the access, or pay them full interest in excess reserves. Now that's the thing is even if they did that though, I questioned-

Ricks:    It just solves part of the optical problem, right?

Beckworth: It does. But I'm not convinced that it would still solve the fact that there would be a spread between really low money markets. Even now, you'll get a one month treasury bill it's still occasionally falls below the reverse repo rate. So there's a lot of issues with the floor system. We've mentioned George Selgin, he's been on a --

Ricks:    He's been probably the most prolific person in writing about this stuff and very interestingly.

Beckworth: And he makes two points I think are fair. One is that the floor system to make it work, to make a sustainable has a natural bias to keep. Because that rate the interest in excess reserve rate is higher than market rates. It can create a bit of a drag. It has a deflationary bias is one point, his other point is increase distortions in banks. How they operate, what happens to their balance sheets and stuff. Well let's move back to your paper though. Interesting side discussion. Your paper comes at bank regulation that the same way we do infrastructure regulations. So there's three things that you mentioned that you do when you go to the infrastructure regulation, like utilities, you look at the rate, the entry, and then also the service, right? And you say, we should do the same thing when we regulated banks. So tell us about that.

Ricks:    Well, at least arguably. Yeah, I know this is provocative. And what I'm calling infrastructure regulation here it really fell out of fashion in the '70s and this is this mode of economic regulation. Used to be applied to much more expansively to broader portions of the transportation and telecommunications sectors. Specifically transportation is a good one to think about it. I mean, we used to do this for the airlines and for motor carriers and of course for railroads. And a lot of this was sort of phased out in the late '70s and early '80s at the federal level, but it's still persists in utility regulation at the local level. And so I think there's basically three pillars to this mode of regulation which are of course rate regulation, which we talked about a bit earlier.

Ricks:    Entry restriction, which we also talked about a bit earlier. And sort of goes hand in hand with rate regulation specifically, if you're going to hold some rates higher than they would otherwise be, you have to prevent cream skimming and that often and to prevent cream skimming, you need to restrict entry into the activity. And then the third, which is also related to the other two, is this idea of universal service, which is pretty prevalent in the regulated industries. In the airlines it used to be equal fares for equal miles is the standard we missed in the post officer earlier, equal fares for irrespective of distance traveled for letters. Telecommunications used to during the era of Mabel we had similar system of cross subsidies and between long distance and local phone service.

Ricks:    And so that really requires entry restriction because it's those cross subsidies that create the opportunity often for cream skimming. So these are the three cornerstones of a mode of regulation, which I'm calling here infrastructure regulation. And I think that they have something to teach us about banking. And so with respect to this question of monetary policy and doing interest on reserves, what I'm suggesting in the paper is rather than paying interest on reserves and hoping that it gets passed through, which is happening in perfectly. Why don't we just regulate if we're going to really think about a bank charter or a bank as a franchisee of the government. In other words, we're outsourcing a public function, then we could control deposit interest rates as a matter of monetary policy and as we're going to regulate the rates that banks are paying on their deposit accounts.

Ricks:    And so that's the old regulation Q idea. And it raises issues about profitability of banks, right? Either that rate being too high for them to earn a profit or too low such that they're earning extracting rents from the public. And my suggestion in the book... Excuse me, not the book, the article is that well if the government were doing this internalizing or the insource system before we think about outsourcing, it's earning all the revenue for money creation, right? There's seigniorage that it's gaining by virtue of earning more on its assets than it's paying on its liabilities. When we outsource to banks, we shouldn't have the public giving up that seigniorage revenue. And there's a significant literature in banking that talks about banks earning seigniorage from money creation because the pecuniary yield that they pay on their liabilities is quite low because there's a money and there's property associated with their liabilities.

Ricks:    Well, my argument is that that excess yield, that earnings really is a public asset and belongs to the public. And so I'm thinking about a bank here is in a sense, sharing some of its revenues with the public. And a bank should be paying overall a fair cost on its liabilities. And the difference between the fair cost of his liabilities and whatever it's actually paying to depositors, which in my system I'm imagining that the Fed is determining that amount in the conduct of monetary policy. That difference, that wedge should float to fiscal revenue of the government. In other words, this is really we're outsourcing kind of portfolio management function, but we don't want banks to be earning excess returns by virtue of having a banking charter. And so this turns into a system where it's more of a revenue sharing model.

Ricks:    And this puts you classically within the world of regulated industries and public utilities where the whole point is to set, in that case, you're setting a product rate that consumers are paying, but it's the same principle. You're setting that rate to allow the firm to earn a fair return on capital. And that's what rate making is about. And it's functionally the same in the system I'm describing here. And one of the side point I'll make about this is less this seem like something we could never rely on regulators to do. We're already in a sense of doing it because deposit insurance premium that banks pay to the FDIC since '91 have been risk-based, meaning keyed to the risk of the institution. And the idea is the FDIC is going to charge a fair premium for the put option that it's writing.

Ricks:    And so that valuation exercise is the same exact valuation exercise that I'm describing here. The difference is that in the world I'm describing, the fed would decide on deposit interest rates, commercial bank deposit interest rates, and the wedge between that rate and the fair cost of funds for the bank would flow to the government as fiscal revenue. Be essentially a quarterly fee, like a deposit insurance fee. But rather than just sitting in a fund that would be a component of government revenue, it'd be seigniorage essentially. So that was a little bit maybe longer than you want. But that's important. That's a way of thinking about the relation between traditional economic regulation and the way I'm thinking about how if we take the money paradigm really seriously. And think about a bank as an outsourcing of a public function. There's a real deep connection between the two that I think hasn't been really fully thought through.

Beckworth: So a bank would remit most of its earnings back to the federal government. I mean, how would it pay for operations, for maintenance, all those things?

Ricks:    I wouldn't say most, I mean and so the idea, I mean one way of thinking about this is suppose a bank were to replace all its money claim funding. I'm just going to use the term money claims. That can be deposit counts, but it can also be other types of really short-term debt that serve a monetary function. Well, there's a significant economic literature that shows on and money market yields are lower than you would expect based on an extrapolation of longer term treasury yields and Jeremy Stein and others called this a moneyness property, the short end of the curve, you just have deviate. It starts to be really cheap from the perspective of the issuer.

Ricks:    And that wedge between a fair longer term rate and the short term rate that they're actually paying. We can think of as an excess return from money creation. In other words, that is a seigniorage that they're earning in the same way that the federal seigniorage by earning more on its asset yields and it's able to then it needs to pay on its monetary liabilities. And so to the extent there is a wedge between those two, I'm saying that portion goes. They're piggy backing off of the public money system and that's really, that's a form of rent extraction from the public is one way of thinking about that. And that would in my world that wedge would flow back to the government as seigniorage.

Ricks:    And if you think about it and then imagine that the Fed's now controlling the deposit rate. So controlling that short term rate, well in the insource system from the perspective of just the central bank were doing all itself or when an increases that rate seigniorage goes down, all else equal, right? Because it's, it's paying more on its liabilities and that means it's remitting less to treasury. Well, in the world I'm describing where we've outsourced it, it's the same thing. If the Fed raises the administer deposit rate for commercial banks that they're able to pay on their liabilities, then that wedge gets smaller between the 'fair rate' and the administered rate. And so it reduces seigniorage in other words, it's the same as insourcing. We haven't really changed anything. We're just outsourcing something that the fed would otherwise be doing.

Ricks:    And so I do think that there's room for a revenue sharing arrangement here. And just to be clear, I mean, the deposit insurance fund over time it fills up right? And it gets fully funded. The deposit, the federal the FDIC. And what happened in I think it was about a decade before the recent crisis they really stopped charging deposit insurance fees because they were all full, right? The deposit insurance fund was fully funded. Well, that to me is just a pure subsidy. You're still insuring this thing and but you're not charging anything for it. You're writing essentially a free put option. And in my world we would've kept charging those fees and just remitted it to the treasury department as revenue, as fiscal revenue. So the functions involved of charging a quarterly fee that's based on risk is something we're already doing. We've been doing it since '91. I'm just saying that it really should flow to fiscal revenue.

Beckworth: Okay. So it's a very provocative but interesting proposal. I want to go back and talk about maybe an assumption about this. When you think of utilities and regulating utilities, because we often think they're natural monopolies, right? So the idea behind a natural monopoly is you need one big producer to produce at a scale where average costs have gone down to the minimum point. We can't have three companies running sewers into our neighborhood, it's too cost prohibitive. But if you have just one, even though it's better on cost terms, it's a monopoly and it has monopoly power. So government intervenes and says, "Okay, we're going to help you set the rate." And that's the argument, right?

Ricks:    Yes.

Beckworth: Okay. So that makes a lot of sense for a national monopoly. My question is, does money fit that definition, is money in my mind is more of a network good, which also has set of issues but a different set of issues. Right?

Ricks:    Yeah. I think you're right. You may have noticed I didn't use the phrase natural monopoly in the paper with respect to the system and I'm sort of ambivalent about that. I mean, the concept of natural monopolies, you put as sort of a technical concept about declining average cost over the relevant range of production. I don't know if that's a useful way of thinking about money itself or the monetary system or even whether we should think of those as two separate things. And I know there's been a longstanding debate within economics about whether we use this word natural monopoly in relation to money. And I seem to remember Larry White having written about that in one of his books at some length.

Ricks:    Similarly, this question about money is a public good, I don't really say that either. Because again, we're talking about a technical economic concept having to do with a non-rivalry and excludability. And my hope is that I really don't need to take a position on either of those two questions for the article to work. But it's a natural question to ask whether money is a natural monopoly because I'm analogizing-

Beckworth: Right. I mean, isn't that the whole motivation that we take an industry where we have the set of regulations because it's a natural monopoly now applying it to money?

Ricks:    Yeah. Well, let me put it this way. It's a system resource and maybe as you put a network good, I think we may be saying the same thing.

Beckworth: Yeah. Same thing.

Ricks:    I mean people network actually nowadays are network effects and that also has a very specific technical meaning and I think money certainly meets that technical meaning and that we sort of all converge on it and it's more useful to me to use a certain money if you're also using it. And so money does meet that definition. But I think that other sort of network or system type goods that are really require a resource to be heavily horizontally coordinated across, even if there are separate providers, they need to coordinate horizontally. And this has been true historically, certainly of a lot of transportation industries where there's a lot a need for heavy horizontal coordination and of course telecommunications being another. And you need a lot of interconnection in these industries if you're going to have multiple providers. These are industries in which I think economic regulation has a role to play or infrastructure regulation may have a role to play, even if we're not going to attach a technical, natural monopoly definition to the industry.

Ricks:    So of course money itself is it's a network system or a system type resource. And there's a huge amount of horizontal interconnection amongst banks. I mean from the histories of clearing houses one of the reasons we don't have payments in the US is because we have such a fragmented banking system. So greater fragmentation actually in some ways impedes the functioning of the system and therefore greater consolidation sort of makes things work better. I think this is also may have relevance to the question of monetary policy efficacy. But it is a network type good. And I think it's sort of close. It's in the sort of general range of those other network type goods to which historically we have some times applied this motive regulation. So that is an evasive answer to your question.

Beckworth: So I think of network goods, for example, Facebook or social media, right? The more someone uses it, the better it is for me. Where we'd say technically increasing returns to scale, the more it's produced and used, the better it is for us in consumption. And I know there's been talk about regulating Facebook because it's so powerful. But I have really, I acknowledge my ignorance here on air. I'm kind of vague on what is the standard approach to regulating network effects if we just leave them alone or what?

Ricks:    I mean, so this has become I think even in just the last 18 months. And of course this is not what this particular paper is about, but this has become a topic and not just because of the election related to stuff. I think there's a lot of questions about what's happening to local media markets for instance, and the extreme degree of economic power, the acquisition by the tech giants of other companies that might be their competitors or releasing free versions of other products to drive potential competitors out of existence when they won't sell themselves to you.

Ricks:    My own view on that question is that there is a growing movement towards trying to think about what ways of regulating the tech giants. And I'm not sure how that's going to play out. I mean one thing that's been used in other types of platform industries before is sometimes we've said you can't have both the pipes and the content. And that's been a historical principle, at least at times in US history in certain markets. And that would raise questions about say Amazon, whether it would be in a position to have a platform through which things are sold and also selling its own products through that platform. And so you can think about historical principles of regulation and their applicability. But these are extremely hard problems. I think they're going to be very contentious over the next decade or so.

Beckworth: That's probably the one thought I have, common thought to this proposal. It's very interesting to be very, very contentious I'm sure in terms of debating.

Ricks:    That's true. And I don't think, look to be honest, I think, and I'm writing this up in a separate paper now this goes back to something we were talking about earlier. I actually don't think this particular mode that I'm talking about is likely to be successful in the sense that I don't think you could get there through a direct pathway. But I do think that one could build a constituency for opening up access to the central bank for us all to hold accounts there. If people moved on a broad scale to holding their bank account with the Fed, you actually get somewhere close to this, ironically in the sense that suppose we all did, right? Suppose everyone just moved massively to holding their transaction account at the Fed. And again, the fact that we don't need physical payment media much anymore means it's actually-

Beckworth: It's feasible.

Ricks:    Yeah, it's technologically feasible. This is just debits and credits the stuff that the Fed's doing to the tune of many trillions of dollars a day through fed wire anyway. So we're just talking about adding on to something it's already doing. What would happen to the banks, right? If they lost their deposits? Well, they'd have to replace that funding from somewhere and at least in the first incident would probably be a discount window loan from the Fed, right. To replace its lost deposit so it doesn't have a liquidity crisis. Well, if you imagine going kind of all the way in that direction, everyone holding their account in the Fed and the Fed having a much larger balance sheet obviously but the assets then consist to a significant degree of loans to banks that were made to replace the lost deposits. Then guess what you're sort of in the world I'm describing in the sense that from the perspective of seigniorage for instance, right? So the Fed is going to be charging a discount window rate, hopefully a fair cost of capital that's going to exceed the rate that it's paying to depositors' presumably.

Ricks:    And the difference between those two, the wedge will accrue as seigniorage. So you see the seigniorage that would otherwise accrue to banks now are accruing to the public, which is one of the points of the system I'm describing here. You also have the rate regulation I'm describing, right? Of course, everyone's holding their account in the central bank, the central bank is determining the rate that's paid on those accounts. And it's determining that in accordance with monetary policy. Well, that's the system of rate regulation that I'm describing here as well. So I think you couldn't get here directly. I think the way that would happen in practice is if we truly did open up access to central bank account. This relates to the topic we were touching on earlier.

Beckworth: Now let's touch on that. So there's been a similar proposal, maybe similar in spirit, some dimension that is full reserve banking.

Ricks:    How does this relate to that idea? Well, it's sort of modernized version of the old Chicago plan as they call it. So for your listeners who haven't been exposed to that, so the old Chicago plan associated with Henry Simons in Chicago and Irving Fisher of Yale really started became a big thing in the 1930s during and after the depression. Although I understand there were some precursors, even in the 1920s intellectually, but in any case, Henry Simons and Irving Fisher thought, well bank runs our problem and we understand that problem. We get rid of them if banks are just holding cash, right? Say physical currency or base money essentially is their only asset. So a bank is essentially a warehouse of currency and just holds base money and then you're just sort of, you hold an account with the bank but it's really just a pass through of the central banks of sovereign issued money.

Ricks:    And so if you think about what I'm describing here, if we really all had an account at central bank, we're just getting rid of the middleman. It's the same thing is instead of having this intermediate warehouse of base money that's then with which you were holding an account of base money. Just hold your account with the issuer of base money. Right? So you're in the same place. I think the reason they thought about it in terms of having full reserve banks back then was precisely because of all the physical payment media that were used in payments that needed to be handled. There was a huge logistical undertaking, right? So you couldn't imagine a world like we do now where card swipes and, or electronic payments and bill pay, that wasn't part of the whole thing.

Ricks:    And so the Fed, the central bank wasn't going to manage the huge logistical undertaking of handling every single bit of paper. So that was what they were thinking. They weren't saying it this way. That's why they envisioned. But in the modern world because we're not using physical payment media all that much anymore. It's not hard to imagine dispensing with the middleman and I think that's an interesting way of thinking about this, right? It's a new way of doing a Chicago plan.

Ricks:    And, but it raises really serious questions, not about the right side of the balance sheet, but about the left side and the size of the asset portfolio and what it consists of. Right. I mean, if we all held our account at the central bank and the central bank are multiples of the time, the size it is now, what exactly is it holding on the left side? And how much does that matter? And I think we could debate that. I mean, one answer would be, well, just let it buy treasuries, but there's no assurance that there will always be enough treasuries outstanding to accommodate the desired money supply, particularly if we're talking about significantly expanding.

Beckworth: That's a great point.

Ricks:    And that's a problem we ran into repeatedly in actual monetary history. Right? I mean, you referred earlier to the fact that in the national bank system of late 19th century bank notes had to be secured by treasuries. Well, the problem they ran into is they didn't post-war and they started, yeah, the deficits go down and they start paying a little bit of the debt and suddenly you don't have enough bonds anymore to accommodate the desired money supply. And less we think that's just a relic of history '99, 2000 before the recession, the early 2000s you may recall this that we had fiscal surpluses, the debt was being paid down.

Ricks:    The Fed was convening our internal meetings of the Fed board to try to figure out what they were going to do if there just weren't enough treasuries outstanding to accommodate their balance sheet size was then was 600 billion or whatever it was. I mean, there was a real danger, there wouldn't be $600 billion worth of treasuries to buy. And so they were thinking and strategizing around what they would do. And so it's not written in stone there's always going to be enough of whatever your sovereign asset is. And then you need to think about outsourcing. I think you really want to avoid, in my view an organ of the federal government being involved in direct credit allocation, I think there's too much risk of the appearance or reality of politically motivated favoritism.

Ricks:    And one way, again thinking about a bank charter is we're outsourcing. That's the real thing we want to outsource is the credit allocation. We're going to issue the money supply in exchange for financial assets because we think that's a good way of doing it. But we don't want to be picking the financial assets that we're buying if we can avoid it. And so in the world I'm describing, you need to, this is what the problem of forwards or banking in the old Chicago plan is, I've always seen, I've written about this before. Is they always sort of have assumed that there's enough treasuries to accommodate the central bank, essentially issuing the whole money supply. And then they've said, well, if there aren't, and Milton Freeman addressed this, because of course he supported this at least as of around 1960 and his program for monetary stability, he came out in favor of the Chicago plan.

Ricks:    They've always said, well, I guess if you start to run out of treasury, you just got to cut taxes, you need more debt so you spend more or cut taxes.

Beckworth: Seigniorage is that abundant

Ricks:    Yeah. I call this fiscal monetary entanglement, right? I mean, if you're going to say both, that we're not going to have any private sector money creation. And also that all public money creation by the central bank is going to consist of... Is going to be issued in exchange for treasury securities. You got to make sure you have enough treasuries and you end up in these kinds of contortions.

Beckworth: That is interesting.

Ricks:    ... Of figuring out how to issue more.

Beckworth: As a full reserve banking became popular for a bit. I know there still was some observers, but it really became popular back in 2008, 2009 After that crisis. Was that Larry Kotlikoff?

Ricks:    Yeah. He wrote a book about it.

Beckworth: He wrote a book about that. What's also fascinating is that some Austrian economists, not all of them, there's a branch that I think that Rothbardian Austrians, they believe in full reserve banking. And it's interesting to think this through, these Austrians who free market. What they're implicitly asking is for enough government debt to back. Now they might go for a goal, I guess, maybe they'd have called it back but the more traditional full reserve banking story assumes there's enough treasury debt, which means this fiscal policy become entangled with monetary policy-

Ricks:    I mean, you could imagine a world where Congress tries to inflict political damage on the president by not creating more securities. And then their hands are tied.

Ricks:    And then we have a monetary tightening by virtue of the fact that we don't have enough treasury securities. So you've got to think of widening the asset portfolio of the central bank. I think realistically in this world, or at least leaving it to discretion to widen its asset portfolio. Of course, a lot of foreign central banks. So, here too with QE. But others have gone even further in terms of what they're willing to buy. And that does create I think that creates problems. I think you really want to try to outsource that somehow.

Beckworth: And that's a part of your plan.

Ricks:    Yeah. I mean, look, in this paper, I'm not suggesting everyone have their account in central bank, although in effect, it's sort of a similar place. But I am suggesting, look one of the reasons we want to outsource in the first place and a main reason we want to outsource in the first place is the asset side piece here where we don't want credit allocation happening from the central bank if we can avoid it. And so chartering a bank is a way of harnessing private incentives to invest well, to get the local expertise and knowledge, relationship-

Beckworth: So you're still utilizing that.

Ricks:    Yeah, you're trying to harness incentives, you're trying to harness private incentives for profit. And-

Beckworth: So you hang onto that. I see what you're really trying to do here is to get better pass through of the policy rate to the deposit rate and minimize any distortion between the two.

Ricks:    That's right. I mean that's both a monetary policy efficacy point, but there's also this seigniorage bit that there may be a little maybe came through a little less clearly in the paper, but-

Beckworth: But as a public good, you want the public sharing the seigniorage. So that's-

Ricks:    Yeah.

Beckworth: So, well one other point on your proposal we haven't touched on, I want to do before we run out of time and that is the accessibility, the reach, the amount of service. So you highlight in your paper a number of challenges that many people don't have access to the official financial system that you mentioned how credit cards really are set up in a way that favor those who do have higher income. People who are responsible, are better educated. You would give an example of if you have a credit card and you pay off your balances because you have the discipline, the income, you earn points. If you're someone who's poor and collects big balances, you get all these fees. So it's really hard in many other examples you've given, but it's hard to be a part of the official financial system, part of the banking system and your proposal would try to fix that, right?

Ricks:    Yeah, I think so. I mean this is the third part of the paper is about what I'm calling universal service, which I'm saying is sort of the third prong of traditional economic regulation. And it's not universal access to credit. Credit I'm still sort of viewing here as a function of the private market crisis place. But access to an account, a money account or access to account money is another way of putting it. It's something that we could think about as being an area in which the federal government might have a role to play. And if we're outsourcing, again, this issuance of account money to chartered banks we might impose conditions on them in terms of access and not excluding people on the basis of some bounce checks in the past or not imposing fees. We're excluding people based on small balances. I mean, we saw BVAs is reducing its degree of low cost checking. So we have 8% of US households that are unbanked in the sense that they just don't have a transaction account with a bank.

Ricks:    And we have another 20% of US households are under-banked in the sense that they do have a bank account but they still rely on check-cashing, expensive money orders and alternative payments arrangements in order to meet a lot of their payment needs. And the bank is just, isn't working that well for the lower end of the income spectrum in the US, they're tending to move a lot more toward prepaid cards especially in the past kind of 10 years. And that's really, really taken on a big role in terms of how the lower end of the income and wealth spectrum is interfacing with the payment system. And a prepaid card, it's funny, we think of money being 'loaded' onto the card and being spent off the card. But in fact, what it is, it's a card that's linked to a bank account.

Ricks:    It's a pooled bank account that's managed by the program manager. But the way the FDIC sees it is that the card holder is the owner of a bank account and they pass through deposit insurance to the individual card holder because they say the money is not on the card. The money consists of the bank account that's managed on a pool basis and in which the card holder has a demarcated interest. And so we talk about them being unbanked. There's a sense in which card holders prepaid cardholders actually are part of the bank, but they're banked in a really expensive a way. The fees are very high. There is a lot of inconvenient aspects of prepaid cards. Customer service is really not great. They've also shown problems that are operational problems in terms of unavailability of funds. And so the lower end of the income spectrum, the less well-off Americans don't have really full access to the mainstream payment system in the way that you or I do.

Ricks:    And we could conceivably I'm saying here, if we adopted the money paradigm, if we took it more seriously and think of this as outsourcing of a public function. It makes us maybe more open to the idea of imposing universal service mandates on banks to serve really everyone. And let's have this be more like the interstate highway system or other public functions where they're really equal access components of our infrastructure. We could think of the monetary system as an infrastructural good. The title of the paper's Money as Infrastructure though. So that's what I'm thrusting at here. So that's what part three is about.

Beckworth: Well, in closing, I want to bring up bitcoin. Bitcoin has a long, long ways to go before it's actually really used as if transaction asset as money. It's mostly used as speculative asset, particularly in the West, Europe, the United States. But what happens one day if it does become widely used, how does that affect your system?

Ricks:    Well my system doesn't have any direct implications for cryptocurrencies at all. I'm talking about dollar denominated money creation or the sovereign monetary unit and money that is denominated in that unit is what I'm concerned about. So I think there's plenty of room for experimentation. I for one, I'm pretty skeptical that it's going to take on a scale to seriously rival the dollar in terms of ordinary payments that are being made in the US economy. But I could be wrong and if it works out and if we could do it in a way that isn't too unstable and isn't too costly from a resource perspective then that's great. But so the system I'm describing would have no direct implications for cryptocurrencies.

Beckworth: So Morgan Ricks is open to currency competition. Huh?

Ricks:    Absolutely.

Beckworth: Well, great. On that positive note, we will end. Our guest today has been Morgan Ricks. Morgan, thank you for coming on the show again.

Ricks:    Thanks, great to be here.

David Beckworth
Calendar Date: 
Apr 16, 2018
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Our perception of banking has shifted, has our policy kept up with the times?

Morgan Ricks on “The Money Problem,” Financial Regulation, and Shadow Banking

Morgan Ricks is a law professor at Vanderbilt University, former senior policy advisor and financial restructuring expert at the US Department of Treasury where he focused primarily on financial stability issues and capital market policy in response to the financial crisis. Morgan joins David on the podcast to discuss the ideas expressed in his book, “The Money Problem: Rethinking Financial Regulation,” and the implications it has for economic policy.

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

David Beckworth: Morgan, welcome to the show.

Morgan Ricks: Thanks for having me.

Beckworth: I'm glad to have you on. I've read your book and as you know I wrote a review of it, it's a really fascinating book and I encourage all the listeners to get a hold of a copy. Now I want to begin because this book is really chock full of interesting ideas and finance and monetary economics. A great review of the literature and there're some new things I didn't know I learned in reading your book as well. So, how did you get into this book? What experience was behind it? And what motivated you to do it?

Ricks: Yeah, I got interested during the financial crisis in this set of issues. A lot of people I watched with a mix of horror and fascination and in 2007 and 2008 as the financial system really melted down and I was at the time sitting on a trading desk at Citadel, a big Chicago hedge fund and as the crisis unfolded in particular in the later stages, I decided to make a move into public policy. And so in early 2009, I joined the Geithner Treasury on a small team there that was focused on... They were called the Crisis Response Team originally. So, it was run by a guy named Lee Sacks and a guy named Matt K. Baker and they hired me as the first team member and then we built out a team and so we were focused there in 2009 on financial stabilization policy and then we started to turn our attention to... In the later part of 2009 more to thinking about financial reform.

Ricks: There was a separate team within Treasury that was spearheading the drafting efforts for Dodd-Frank, we started to get more involved with that and that was when I started down the path that led to this book. I suppose it was probably around 2010 that I... maybe the early part of 2010 that things started to click in the sense that I had a thesis that I was really driving toward, but it took a number of years for it to reach fruition into this book.

Beckworth: You wrote some papers before the book, they were the early seed of the book, is that right?

Ricks: Yeah, that's right. In fact, I wrote... Even when I was in Treasury, in late 2009, early 2010, I wrote an internal memo that when I look back on it was a really crude precursor to some of the ideas of the book and we circulated it around Treasury and Geithner took a look at it and told me it was wacky. And then we basically threw it in the trash. So, when I left Treasury I kind of resurrected that set of ideas and I think he was right it was a wacky set of ideas then but it needed a lot more development and so I wrote a few academic papers in 2010 and 2011. By 2012, I realized that the topic needed for me to do it the right way it needed to be in a book form.

Beckworth: Okay, so has Tim Geithner come back and read your book and changed his mind?

Ricks: I haven't heard anything from him on it yet.

Beckworth: Okay.

Ricks: I did send him an email when it was out, but I'm not aware of whether he's read it.

Beckworth: We'll take his silence as an approval of the book. Okay. Let's begin with a quick summary of your book. There's a lot to go through but if you could summarize the arguments upfront and then we'll kind of walk our way through them piece by piece. What is it that you see as the key problem, the key cause of the crisis and what should be done about it?

2008 Financial Crisis

Ricks: Yeah. So the book at its core is really a pretty old fashioned idea. So my core argument is that financial instability is mostly about private sector money creation. And I say this is old fashioned because I think if you had said that to, say, Milton Friedman, would have said it was self-evident. But most experts today at least in the field of financial regulation, don't tend to see it this way and the actual path of financial regulatory reform has been mostly occupied with other things. So, I'm arguing that we should consider doing things very differently. And one of the big conceptual hurdles and a major theme of the book is that, the nature of money and what constitutes money has evolved very rapidly in recent decades. So, it used to be when we thought about private sector money creation and the textbook description of money creation its deposits, where before that it was of course circulating bank notes that banks issued.

Ricks: But now, as Gary Gordon and others have described in detail, we have what's come to be known as the shadow banking system. That term gets used in a lot of different ways and some of those ways I think are less or more useful than others. I use it to refer in a pretty narrow sense to a very specific business model that involves issuing a lot of short term debt that's rolled over continuously. And so part of the argument in the book is that we have this rapid growth in various forms of private money in recent decades and that in a very real sense, these instruments are monetary in the sense of their deposit substitutes. The holders of these instrument think of them as cash and refer to them as cash or cash equivalents. And so in a very real sense shadow banking creates money and I documented the book that these markets are huge and they're pervasive. And I argue among other things that they are unstable and that this instability presents a uniquely grave threat to the broader economy.

Ricks: So like I said, in a sense that's all kind of old fashioned, although actually each of those components is quite controversial. Much of the book is concerned with what does it mean to say these instruments are monetary? That's a controversial topic. Is this funding model really unstable and what does it mean to say it's unstable? That turns out to be controversial. And is this instability really dangerous to the broader economy that's also unstable? And so the first part of the book is concerned with all those questions and then the second or third parts of the book are, "Okay, if I'm right about that, what do we do about it?" And here I'm also pretty old fashioned. So, I really like our US system of insured depository institutions insured banking that we've had since 1933 as amended a few times since then. And we can get into the details later if you want to, but the most controversial part of the book is my argument that we really haven't given sufficient attention to entry restriction into money creation. So, entry restriction has been around as a key part of banking law, really since the emergence of fractional reserve banking.

Ricks: And in the US and England at least, we pretty much always restricted entry into the creation of monetary instruments understood as banknotes or later deposits. My argument is that, well, the nature of money has changed the nature of our entry restriction needs to change. So, I'm advocating or suggesting at least that we think about imposing a generalized prohibition on private sector money creation outside the charter banking system, which means prohibiting a very specific funding model. And I argue not only is this feasible, it's actually a lot more feasible than a lot of other things we're trying to do in financial regulation. In fact, if we did this I arguably could stop trying to do a bunch of other things. So, that's really what the books about. You could say it's a book about shadow banking or about short term wholesale funding or about private money creation. Those to me are all ways of saying essentially the same thing.

Beckworth: Okay, the first part of that message that you have in your book is about money, what is money? You give a chapter titled taking money seriously and that really resonated with me, because like many people I too was under the impression or took the view that when we think of money it's M1, M2 and then the recession comes along Gary Gordon as you mentioned opened my eyes that we got to take all forms of money seriously. So, the M2 measure would be more of retail money assets and what you're pointing towards these institutional money assets. They're also very important. And you mentioned in your book that textbooks, principles of macro textbooks, money and banking textbooks. You mentioned some of the better known ones. They still look at money kind of the old fashioned way. Is that right?

What is Money?

Ricks: Yeah, I think that's right. And it's understandable certainly from a pedagogical perspective to describe deposit creation and to limit your view to deposit specifically but the problem is that we now have all these deposit substitutes that are really as you point out institutional money. So, I'm talking about things like overnight repurchase agreements and asset back commercial paper as well as euro dollars as well as securities lending, collateral obligations, variable rate demand notes and auction rate securities. There's a whole proliferation of these types of instruments that are really serving from their holders perspective as monetary assets, right? It's part of their cash reserve. They're not thinking of this as an investment security, they're thinking of it as a form of cash. And so I think we haven't certainly from a textbook perspective, the textbooks haven't caught up to institutional reality here. But there's a conceptual hurdle to get over which is what do we mean when we say that these instruments have monetary attributes.

Beckworth: Yeah. I'm still waiting for this first textbook to do that. I started teaching my undergrads soon after the crisis emerged in effort Gordon's work, what is money? We got to think of it more broadly than normal. So that's why your book is really refreshing to see that that chapter is really clear. And in fact, I plan to use in future classes that I teach when this money question comes up. Now, you are clear to distinguish between what you call near money assets or cash equivalents and the ultimate medium of exchange, which is actual currency or the dollar. But you point out that these near money equivalents, they still satisfy money demand. So, they're effectively functioning as a transaction asset, at least a potential one. Now, how do you define them in terms of maturity because you make a point in the book, there are safe assets in general, such as long term treasuries, short term treasuries and you draw a line in the sand in terms of what really is a near money asset.

Ricks: Yeah. So, this idea of safe assets has become really prominent in the literature in recent years and that term gets used in different ways, but I think usually it's used as a synonym for AAA credit assets, which would include say a 10 year Treasury bond. So, I argue that that is an excessively capacious understanding of what constitutes money and that moneyness really is something that arises at the short end of the yield curve. And the distinction is sort of obvious. High quality short term debt both has very little credit risk, but also very little interest rate risk and so it fluctuates very little in value in relation to the medium of exchange and therefore serves essentially as a substitute for the medium of exchange. I choose a year cut off, there's no magic to a year. It is the traditional dividing line between the money market and the capital market. I think that term money market isn't a misnomer and some people have argued that it is a misnomer we shouldn't refer to short term debt as money. But the one year maturity cut off is pretty traditional within the financial markets.

Ricks: It's also financial regulators and their new liquidity regulations have selected the one year maturity cut off as being significant. So, I'm not alone in that. Others have chosen different cut offs. So, the accountants for purposes of accounting, the relevant maturity cut off or something to be a cash equivalent is three months. So, a longer term security would have to be classified as an investment security for accounting purposes but if the maturity is three months or less it's classifiable along with deposits on your balance sheet. Why do I pick a year part? Yes, it's the traditional financial market cut off, but more importantly Jeremy Stein at Harvard along with Sam Hansen and Robin Greenwood, those are three economists at Harvard, have done a lot of work on analyzing the Treasury yield curve and they document that yields get really puzzlingly low on treasuries at the short end of the curve and their focus is on six months and less.

Ricks: But they show that there's this kind of moneyness premium, they refer to it as a moneyness premium or a convenience yield, in the sense that short term Treasury yields are a lot lower than one would predict based on an extrapolation of the longer term yield curve. So creditors or holders of these claims are paying extra for them in a sense. And they must be getting something out of that and Jeremy and his colleagues, his co-authors described that as moneyness. And they document that phenomenon and show it kind of at the six month and less maturity. I'm picking a year because it's traditional and because it's a bit outside of that six months. There's no magic to a year but I think it's kind of about right.

Beckworth: Well, that's where Treasury bills end, right, at a year?

Ricks: Yeah, that's right. And I would... It's funny when you look more detail at the way various way this issue gets treated in various domains. So, securities lawyers use a nine month maturity cut off. If it's in within nine months, you're generally exempt from certain registration requirements under the securities laws. Keynes, if you go back and read the general theory, he suggests the maturity cut off of three months. He says within three months, we can treat it as money outside of three months we can treat it as a bond. So, there's some range in here between zero and a year, that's probably about right.

Beckworth: I've read your book and I read that chapter on taking money seriously. It was fascinating because I've been working on an informed measure of the money supply. So the Center for Financial Stability, they have constructed some Divisia measures at the money supply and they're broader than the traditional simple some M2 you'd get from the Federal Reserve. And the informed measure includes some of these assets you've mentioned and they also include Treasury bills with a stop at Treasury bill. So, their definition is entirely consistent with yours. And I've done some work with a co-author Josh Henrickson, where we empirically look at what happens when they're just shocked to M2, verses M3, M4 and also M1 these different measures. And if you include the Great Recession period, the only one that produces reasonable results in terms of standard monetary theory, so responses in the price level, short term effects and real output, enforce the only one that gives the best measure. So, I thought it's striking that you're making the case for this definition of where money gets cut off and empirically seems to be supported by this Divisia M4 measure.

Beckworth: And I would encourage people to take a look at it. If you go to the Center for Financial Stability's website, they actually have graphs, you can download that data. And what's fascinating is you see a clear break in the series during the crisis. So, if you look at M2, you might think, "Oh, everything's fine," but M4 clearly has a collapse. And it's grow back past its peak, but never fully has recovered back up to the trend growth path. There's kind of a permanent reduction GDP, there has been this permanent reduction in the growth path. So, it speaks I think a lot to the point you're making in your chapter. I think that's why it resonated so much with what I was thinking.

Ricks: Yeah, I did come across the Divisia stuff in my research and ended up for some reason not really pursuing it, but I'll have to take another look.

Beckworth: Yeah. Well, it's consistent what you're doing. But let's move on in your book to the part where you talk about money creation and you get into how money is actually created. So, why don't we talk about that and then maybe segue into what problem is there when the private sector makes... You make an argument that there was a market failure in the money creation business. So, tell us about that.

How Money is Created

Ricks: Yeah. Well, in some ways this will all be quite familiar. So, the funding model, that issue here, whether it's deposits or whether it's these cash equivalents, it always consists of rolling a lot of the stuff over continuously and using these instruments to fund longer term financial assets, using also kind of fractional reserve of cash to meet redemptions in the ordinary course. And so it's a law of large numbers business model. That's the standard textbook treatment. I do think that there's a coordination game involved here. So this is for those... I know a lot of your listeners are economists and are very familiar with modern banking theory.

Ricks: For those who aren't, there's a very famous contribution to the banking literature by Diamond and Dybvig from the early 1980s, where they argued that banking involves a coordination game with a good equilibrium and a bad equilibrium and that runs on banking institutions have a self-fulfilling dimension. Not everyone accepts that banks do have a self-fulfilling dimension, but I think they do. I think that the way to the evidence points in that direction. And because there's a bad equilibrium and there's a self-fulfilling dimension, we can think of that as being a classic market failure.

Beckworth: Okay. And you suggest that there's no market solution to this, is that right?

Ricks: Well, I don't think there is. I'm open to the idea there might be but it doesn't seem to have materialized at least not on a broad scale.

Beckworth: Now, I have to turn around there. What about the idea of a suspension clause?

Ricks: A suspension clause in the instrument, so a contractual agreement?

Beckworth: Yeah, that says ahead of time. Look, if this bank run does occur, we're going to suspend convertibility between deposits and physical cash.

Ricks: Yeah. I am-

Beckworth: Is that workable? I guess.

Ricks: I'm aware there's a literature on that, that I looked at some time ago and then there may be some historical precedent for it in Scotland and in England, maybe in the United States, I don't really recall. So, I'm open to the idea that could work. I think one of the things that Gordon has argued and he Hugh Rockoff I think has a version of this argument in relation to the Depression is that suspension undermines the monetary nature of these instruments. So, Gordon says when suspension of comfortability happens, he's not referring to contractual suspension, he was referring to government imposed suspensions, but that once suspensions of convertibility have happened historically these claims on bank ceased to be money in any meaningful sense. And Rockoff had a paper that I looked at some time ago that argued that the quality of the money stock decline and the great depression as a consequence of suspensions. So, you're likely to see these claims ceased to trade at par, they'll cease to serve a meaningful monetary function for their holders. It's not obvious to me that a suspension clause would deal effectively with the knock on consequences of run.

Ricks: So, if an institution didn't want to suspend it, it would seek to liquidate its asset portfolio in order to prevent redemptions, which it might want to do for reputational reasons. And if that happens on a broad scale, you end up with disruptions in the financial markets. I think not withstanding a suspension clause but I'm open to the argument that could be workable.

Beckworth: Yeah. Well, it is hard to think through what would it have meant for the bank run of 2007/2008. I'm not sure I know that answer. How would they have had a suspension clause in place in the shadow banking system? Well, let's move on a bit to your discussion on banking, you have a chapter banking in theory and reality. And you go through the standard models for why banking exists and as a consequence why maybe money exists. And you mentioned too, you mentioned the commitment device model for banking as well as the information asymmetry model for banking. And you argue that they both have interesting things to say but they're incomplete. They don't really get at the heart of what is money. The role banks have in creating money. So, can you speak to that?

Commitment Device Model of Banking

Ricks: Yeah. So, there's a number of theories about why this funding model exists, why does certain institutions use demandable debt or very short term debt funding? And one of them is this commitment device model that's associated with Charlie Calomiris and others and it's really interesting. In their model, this funding model is used as a kind of way of solving an agency problem. It's essentially a way of keeping the management team honest and preventing them from absconding with the firm's assets. I find this interesting, but it's really essentially a non-monetary model of banking, in the sense that... And they're explicit about this in their paper, they say that liquidity demand is absent in their model. And it can be maybe seen as a byproduct of this solution to this agency problem. So, the monetary function of banking kind of arrives incidentally or as a byproduct here. As an intuitive matter, I'm not sure how plausible that is.

Beckworth: And that seems completely backwards.

Ricks: To me it does. If you think of banks first and foremost as monetary institutions, it's weird to think of that as being a byproduct of a solution to an agency problem. The other question about those models as a reason I think is, how do they connect up the right side and the left side of the balance sheet. So, this funding model is really heavily associated with financial asset portfolios, credit portfolios in particular and explaining why that particular asset profile raises these agency problems or which short term debt is a good solution, that connection has never been obvious to me. So while I find this models interesting, they don't for me at least get me very far.

Beckworth: No, I agree with you on that commitment device mode. I do want to point out an interesting, maybe an example where it seems to shed some light. But again, it doesn't get at this question of what is money and how the banks play a role in it? And that is the tequila crisis in Mexico 1994, ‘95 I think Calomiris has written about that where... My understanding, I may be wrong, but my understanding was that the government of Mexico basically guaranteed all bank deposits and then once the crisis hit, people realize they didn't have the resources to do that and so they said, "Oh, goodness," so they actually started looking at balance sheets, the health of banks and this kind of discipline story kicks in and what you found is that banks that were sound deposits flowed to them out of banks that weren't sound and the good banks survived the bad ones did not.

Beckworth: But I think your bigger point is that it really doesn't answer this money question. So, let's move to the next one. The information asymmetry model. I think probably a lot of our listeners have heard of this from Gary Gordon. What are your thoughts on that?

Information Asymmetry Model of Banking

Ricks: So, I think for me this was a really powerful set of ideas and the basic idea here is that the financial markets produce certain kinds of claims for which research is not really rewarded that much. The point of them is to be insensitive to information and this allows investors I think in the original version of their model, the idea is that there were informed traders and noise traders and the noise traders would be taken advantage of by the informed traders. And so the noise traders will prefer to hold instruments with respect to which the production of information is not rewarded and that way that could be not taken advantage of. I find this to be really powerful. I think it's a really interesting way of thinking about things like securitization, the production of safe assets, which we referred to earlier, AAA bonds. In other words, it's a way of understanding capital structure generally. At least for me, I find it helpful to think about that way.

Ricks: I'm not sure it gets... For me, at least it doesn't necessarily get to what's distinctive about banking, because information insensitivity I think can apply to long term debt as much as it can to short term debt. And yet, as we just talked about a moment ago, this moneyness property really seems to be a distinctive attribute of the short end of the curve. And I'm not sure that the information asymmetry models give us a good way of thinking about that. And so while I think they're powerful, they don't fully illuminate the banking business model to me.

Beckworth: Okay. So, moving on from those you also talked about in this chapter that the right definition of what a panic is. And you focus particularly on this idea of short term runnable debt panic. And you stress like an equity crisis in 1987 or maybe 2001 doesn't really measure up because it's focused on equity. So, tell us more about this idea. You this mentioned earlier, the primary threat that comes from the financial system is our bank runs. Is that right?

Why FinReg Policy Should Focus on Bank Runs

Ricks: That's what I think. Bank runs understood to include shadow bank runs. Right? So, what's the unraveling of this of type of funding model that we've been talking about it is what in my view, we should be far and away most concerned about when we do financial stability regulation and financial stability policy. So, for me, here I'll sound just like Gary Gordon and Bernanke has made a similar point. Bernanke says... He defines a panic in one of his speeches as widespread withdrawals of short term funding to a set of financial institutions. And that's all I mean by a panic. It's a run on the bank, it's not sales in the secondary market per se. So, an equity market disruption is not in and of itself, a panic. A panic is widespread redemptions of the financial sector short term debt. So, that's pretty much... I think that's pretty standard and old fashioned. Anna Schwartz has this paper that I haven't looked at in a while, but I think it was called “Real and Pseudo Financial Crises.”

Ricks: And what she equates runs on banks with real crises and she says all this other stuff burst bubbles and corrections in the stock market and whatnot, she refers to as pseudo crises and I agree with her definition, except that I'm not sure she would treat a shadow bank run as a... Or shadow banking panic as real crisis whereas I would.

Beckworth: So, your explanation for the Great Recession, at least what triggered it is a massive bank run on the shadow banking system. And you discuss in your book some of the other ideas given for the Great Recession, everything from the debt-fueled housing boom collapse, to Austrian theory, to the Monetarist discussion, but that's your understanding of what happened is primarily a financial crisis driven by this bank run, is that right?

Ricks: Yeah, that's what I think the main thing was. And that's not to say that there weren't multiple elements. And so, one of the things that's really interested me since the crisis is the sheer diversity of explanations for what it was that happened by experts. And there's a lot of diversity, but I think... My view is not really unorthodox, it may in fact be the dominant view. I think it's pretty clearly the view of Ben Bernanke as expressed in his recent book, which is that the financial crisis proper was a major source of damage to a major source of the Great Recession.

Beckworth: So your claim is that it was a bank run that caused the crisis. And so the follow up question is why we had so long of a slump or slow recovery. Rockoff and Reinhart would say, well, empirically, whenever you have a recession associated with bank runs or severe financial crisis, they just take time. They take time to unwind all the imbalances and to get balance sheets back in order. Do you have an explanation for why a banking crisis that caused the recession would take so long to recover?

Ricks: Yeah, I'm not sure I have a satisfactory one. This is a topic on which I would certainly defer to macro economists who have thought about this for a long time and studied in detail. A number of prominent economists argue that this debt overhang is a big part of the story. So, over-leverages household balance sheets or over-leveraged balance sheets in general throughout the economy create a drag that's an impediment to recovery. I think there's... I don't see any reason why there wouldn't be some truth to it. As I read through this, the literature here I was sort of intrigued by the idea that maybe the economy just doesn't have any automatic tendency to revert back to pre-crisis trend. So, this kind of multiple equilibrium notion that is present in Keynes and that others after him. I found James Tobin to be really interesting on this question of whether the economy has natural adjustment mechanisms to return it back to the pre-crisis path. I'm not sure that's the right answer, but it seems to me to be a plausible explanation for the lack of return to the pre-crisis trajectory.

Beckworth: Yeah, it was interesting reading your book, you brought out the multiple equilibrium story. Basically, there's multiple equilibrium. We could be in a better one, we're stuck in the low growth equilibrium. You mentioned Keynes, Tobin, I'd also throw in there maybe a current version of that is Roger Farmer from UCLA. He's a big advocate of that right now.

Ricks: Yeah, I read his book, which is an accessible version of his theories and I'm kind of fascinated by it. I think I sighed him in a footnote there in that section. But I just want to emphasize for me, that's more of a review of literature and theories I don't necessarily have any strong attachment to it and I don't know that I am qualified to have a strong opinion on the question of failure to recover, why we fail to recover from sharp acute macroeconomic disasters that are caused by the financial system. I'm not really qualified to answer. What I do think is important though and what I do believe, is that the financial crisis itself was a major driver of the recession.

Beckworth: It was the spark, right?

Ricks: Yeah, I think... I don't know. You could call... What was the spark, you might say the spark was a bubble in housing prices, you can take the chain of causation back as far as you want to. So, I don't like to think of it as a spark, I think of the panic itself as kind of the dagger in the gut, right? That's what really was the source of the damage. Another way of thinking about it is where would the economy have gone and the absence of the panic if everything else had played out the same way in terms of the conduct of monetary policy, in terms of the path of asset prices, including housing prices and household balance sheets, et cetera. And so I suppose my argument is that in the absence of the shadow banking panic, we would have had a much milder recession.

Beckworth: I don't know the answer this question, but I wonder what happened in Australia to its shadow banking system if they had it to a large extent, because they also had the big expansion of household debt, housing prices exploded and they never had the Great Recession. They were fortunate in that they had the ability to low interest rates before hitting zero lower bound. They also had support from fiscal policy. So, it would be interesting to see what happened there. So, I think that did good counterfactual, I suspect they must not have had the same type of bank run that we did.

Ricks: So I'm not as familiar with the Australia experience. Well, one thing that I find is interesting to look at or thought provoking in the US experience, is to think about the timing of the macro contraction. Housing prices started to fall in late 2006. They started to fall really in earnest in the early part of 2007 and by the time the Lehman event, which is when the severe panic struck, that story of housing price correction was already about two thirds played out and we were still at that point in a very mild recession, right? The peak to trough contraction was about 20%. We were about 20% of the way from peak to trough in terms of a macro contraction. And then there's this massive acceleration and the pace of contraction that happens immediately after the acute phase of the financial crisis. And so to me, the timing of these events is suggestive of an independent role for the panic in terms of causing a contraction.

Beckworth: Yeah, I agree with the point you make about housing already been almost completely done at least two thirds of it, you mentioned done. And by the time things really turned sour in 2008, housing had been contracting for a while if you look at the housing sector data, employment, income and all the sectors related to housing had been going down and the rest of the economy actually had been fairing not so bad. Actually you see some employment growth even through early 2008 outside of the housing related sector. So, we were weathering that recession well enough. So, I guess your point is, had this bank run not occurred, this may have just been an ordinary garden variety recession, not the Great Recession. And my views, I have a slightly different view at that point and I think the Fed may have made things worse, so I won't go there. I will mention this though, in terms of going back to your observation about the slow recovery, the multiple equilibrium story of Keynes, Tobin, Roger Farmer, it's a story of a coordination failure, right? That for whatever reasons, there's increased liquidity, people are highly risk averse, no one wants to be the first one to put their foot forward and maybe invest in a new plan, create jobs.

Beckworth: And so the question comes, well, what is something that can coordinate all of these actors and catalyze them to get going and in my mind, from that macroeconomic policy comes in, maybe temporarily raising the inflation rate, so people don't want to hold on to these liquid assets as much, some kind of spark that's going to take the efforts of a coordinated macro policy response, which I think we did not have or have enough of after 2009.

Ricks: Yeah, I don't disagree with that although again, I can't imagine that people really care what I think about-

Beckworth: As you said, there's a diversity of views and-

Ricks: ... but I do think irrespective of how we answer that question, there is reason enough to think that we'd all be better off if we get aboard avoid these kind of severe shocks to begin with.

Beckworth: Oh, absolutely.

Ricks: That's really my key point in that chapter.

Beckworth: And I think where we definitely agree is on this observation that you can't have a huge collapse in the money supply as measured by M4 and expect nothing to happen. When you have a huge drop like that in the money supply, something is going to happen. So, I think that's a reality that we all have to deal with. Let's look at potential solutions now and let's talk about a few others before we get to yours. Let's talk about one of the ones that has seemed to become more popular and that's narrow banking. So, what is narrow banking and what are the challenges you see with it?

What is Narrow Banking?

Ricks: So, people use that term in slightly different ways, but when I talk about narrow banking I am referring to taking your chartered banking institutions and requiring them to hold extremely safe assets. So, in the original and purest version of narrow banking, which is 100% reserve banking, which of course was advocated by Irving Fisher and Henry Simons and later by Milton Friedman. The idea is that a bank could hold nothing but base money. And so a bank essentially become just a pass through vehicle, private sector money creation then just goes away and money creation is a public monopoly. And then so of course, under the later versions of narrow banking, they liberalized it somewhat. So, I think the idea as Bob Layton and others described it in the late 80s, was to have banks be allowed to own Treasury bills at least. So, the basic idea is let's do massive restrictions on portfolios to the very, very safest stuff. So that set of ideas has been around for a long time and it's always run up I think against two problems.

Ricks: And the first problem is what I'm sure we'll talk about a little while, which is this problem of regulatory arbitrage or how do you prevent deposit substitutes from arising outside of your chartered banking system and essentially recreating the problem that you were trying to solve? And that's a problem that... It's interesting Henry Simons became... He was one of the guys who really spearheaded 100% reserve banking and was a leading thinker, an advocate of this in the 1930s, but he sort of ended up souring on it or becoming disillusioned because he didn't think you could solve this regulatory arbitrage problem. Irving Fisher thought he could solve and Milton Friedman thought there was a solution by paying interest to the 100% reserve banks. But essentially, this has always been a problem that proponents have had to confront. I actually think this problem is solvable in the sense I'm advocating entry restriction into creating monetary instruments. So, I clearly think it's possible to do it as a regulatory matter, but what I think is the big problem with narrow banking is the second problem, which is what I've called fiscal monetary entanglement.

Ricks: So, if you're going to restrict the banking system, to say Treasury bills and you need to make sure you have enough Treasury bills to accommodate the desired money supply. We're assuming for this purpose that we solve the regulatory arbitrage problem, where we don't have private sector money creation happening outside the banking system. Well, then at that point the banking system and the Federal Reserve are your only money creators. And if you're restricting them to holdings of treasuries and you got to make sure you have enough treasuries outstanding to accommodate the economy's need for transaction balances. So, to put it another way, a narrow banking system would not be consistent with a long term balanced fiscal budget because there wouldn't be any treasuries outstanding and so you couldn't have you a functioning banking system in the absence of those treasuries.

Ricks: So, it requires a certain structure of government debt. I happen to think there are good reasons to just divorce these two things and to have a monetary system that's compatible with a variety of fiscal environments, including a balanced budget. As far-fetched as a balanced budget may seem today, it wasn't that long ago in 2000 the Fed was very concerned about the rapid pay down of the government debt. They were concerned that they were going to run out of enough government debt even to accommodate the base money supply. Just the Fed's balance sheet. And they were giving serious consideration to what other assets they would have to buy if there weren't enough treasuries outstanding. So to me, there are good reasons to want to divorce, have a separation between fiscal and monetary and you can't do that under narrow banking.

Beckworth: Yeah, that was fascinating. I hadn't considered that point you've made, that if you go to 100% reserve back and you're going to be entangled in fiscal monetary policy. And I guess what's interesting is a lot of people who advocate that are more free market leaning types and I wonder if they think through the implications of that.

Ricks: Well, it's interesting, they all do in one way or another. Actually, Simons I don't know if he did, but Irving Fisher has this great passage where he basically says, "What if some fine day you bought all the Treasury debt and its outstanding? You bought it all and you still need more. What are you going to do now?" And his solution was, well, you just cut taxes. And in other words create more debt to accommodate your money balances. And Milton Friedman has this passage that he puts in a footnote of his program for monetary stability where he essentially goes through the same thing and he says he's not really satisfied with any of the potential solutions. He said you could either have the central bank start buying things other than treasuries or you can produce more debt to finance deficits. And he says neither of those answers is particularly appealing, but then he doesn't pursue the idea very much. Bob Layton addresses this point briefly toward the end of his book. So, narrow banking proponents have at least acknowledge the point but I don't think they've ever addressed it satisfactorily.

Ricks: This is a... It's not really just a hypothetical problem and as I mentioned we faced this issue in 2000. At least perceived it to be happening until of course we had the recession and tax cuts that resulted in an upward trajectory of government debt again and we stopped having to worry about it. But even in the late 19 century, one of the big flaws of the national banking system was that it required that national bank notes be collateralized by US Treasury bonds. Well, there just weren't enough Treasury bonds to satisfy money demand. And so the idea of creating a uniform national currency ran up against this problem of requiring that it'd be secured by Treasury debt. So, it's actually a recurring problem in monetary history.

Beckworth: Yeah, I was going to mention that episode. It's fascinating. They actually changed the law I believe to accommodate more money supply growth, because there wasn't enough national debt. Let's move on to capital requirements and probably our listeners are familiar with this one. This one's received a lot of coverage, but you make an argument that they can actually... Well, to some extent they're good, they can also be counterproductive. Why?

Capital Requirements: the Good and the Bad

Ricks: Well, it's actually for similar reason the narrow banking. So let's suppose we have a world where we have one set of money creation firms, let's suppose we solve this regulatory arbitrage problem so there's no money creation outside of our charter banking system. Once you impose capital requirements on the system, you're crowding out money creation by the system right? For any given asset portfolio of the banking system an increase in the amount of capital financing results and assume that the only types of financing available are capital or equity financing on the one hand and what I call money claim or monetary financing on the other hand, every dollar of capital financing or equity financing results holding assets constant results in a reduction of your monetary liabilities. So, you can't... If you're if you want the system to help you create money or to engage in money creation, you've got to have capital requirements that are lenient enough to accommodate the desired money supply. So, I'm not against capital requirements, I think you actually need them, but we can't make them arbitrarily high.

Ricks: The other thing about capital requirements there's two other brief points I'll make about capital requirements, which first is if you've decided to panic for the problem, which is what I argue in the book, capital requirements are a very indirect way of dealing with that problem. And there are a way that's hard to generalize and apply and generalize fashion across the financial system. So, I think that's one of the difficulties of capital regulation. Another difficulty is the capital regulation in a world with derivatives is just irreducibly complex. I think this point doesn't get enough attention in the literature on capital, there seems to be an assumption that we can make capital regulation simple. You have a set of assets, you take a percentage of that, you require that the equity capital, but of course losses can arise from instruments that are not reflected as assets on the balance sheet, particularly in a world with derivatives. And it's just extremely hard to calibrate capital regulation in a world with derivatives. So, I'm not against capital regulation, but I think we rely on it way too heavily to do too much heavy lifting and modern financial stability regulation.

Beckworth: Well, the third proposal is taking that idea capital requirements to the limit, you have complete equity finance banking. So, you talked about... You call it floating price money. Once you mentioned that briefly and then what challenges do you see with that?

Ricks: Yeah, this kind of idea has been floated over the years a number of times, why don't banks just look more like mutual funds and the claims on banks would fluctuate in price. There seems to be demand in the economy for assets that have a stable value in nominal terms. And I think that as money demand and I don't think we can assume it away. So, I'm not that attracted to the idea that we should just get rid of these fixed value claims.

Beckworth: Yeah, I absolutely agree to that view. I'm going to read from your book here, what John Cochrane, you mentioned John Cochrane. He has a proposal along these lines. He says with today's technology you can buy a cup of coffee by swiping a card or tapping a cell phone. So in $2.50 cents of an S&P 500 fund in crediting the coffee seller $2.50 cents mortgage backed security fun. Quarterly liquidity no longer requires people hold a large inventory fixed value pay demand, enhance run prone securities. Of course, the flip side of that is... And then David Andolfatto who I had on the show before we talked about this issue a little bit too, he has a great analogy.

Beckworth: He says basically your ATM becomes a Las Vegas slot machine and who wants that? When I go by ATM, I don't want to... One day I have $1,000 in my account, next day I got $800 in the account. I think you're absolutely right there is this... For whatever reason we have this demand for fixed value nominal short term securities. Maybe it's a sticky price world we live in that we want... And historically, that's what's evolved. If you go back to the free banking episodes, what naturally emerged was this demand for if fixed value short term debt, not equity backed financing.

Ricks: Yeah, I essentially take for granted that there's demand for that stuff. And our monetary system, we should be thinking about how to accommodate that demand.

Beckworth: All right, let's move to your solution now. We have about 10 minutes left. So, let's talk about your solution, how you are going to solve all the problems of the financial world.

Ideal Policy Solution as a Containment Strategy

Ricks: Well, I don't know about all of them, but I do think that this is a problem that we can make a lot of progress on. And so as I alluded to at the beginning, I like the insured banking system that we've had for a long time. It's not perfect. We certainly haven't managed it perfectly, but the basic structure of it is that we're going to have this chartered set of financial institutions that are in the business of having monetary liabilities. We confine their asset portfolios to the safer end of the credit spectrum. We don't say it has to be treasuries but we do say you can't hold stocks, you got to have a diversified portfolio, you can't hold junk bonds and what have you. We require some equity financing as a loss of the option layer and then we wrap the monetary liabilities with a federal guarantee for which we charge a fee.

Ricks: And that basic structure to me has a really sound internal logic and I like it, but as I mentioned earlier the controversial part of... So, I would build on the logic of existing system but the controversial part of this is building on the logic of entry restriction. So, we currently say as a matter of federal law 12 USC section 3782, you're not allowed to have deposit liabilities unless you have a banking charter. So, that's how entry restriction works. It's a generalized prohibition on everyone who's not a bank. So, a banking charter confers an exemption from that probation. And so my suggestion in the book is that money is changed all this other stuff, what we've learned is that we need a much more functional definition of what constitutes a monetary instrument, not just a deposit. The term deposit is defined in the law and circular fashion. A deposit is defined as a claim on a bank and a bank is defined as an entity that has deposit liability.

Ricks: So, it's perfectly circular. We need a functional definition of what constitutes a monetary instrument, which in practice always means various kinds of very short term debt issued by the financial sector. And so my suggestion in the book is that we should think much harder about restricting entry into this funding model. The strategy when I say restricting entry, saying the only chartered banks are entitled to use large quantities or short term debt rolled over continuously to finance a portfolio of financial assets. And so that will be a generalized provision. It presents a lot of questions, right? How do you enforce it? How do you specify what constitutes a monetary instrument in a way that can't be easily gamed or arbitrage by the financial system? And I have a whole chapter essentially, mostly devoted to that very question.

Ricks: I actually wrote down an appendix to one of the chapters, the entry restriction provision. In other words, I wrote statutory text and said this is how I would do it, here are the problems that presents and I think it's a lot more feasible than a lot of other things we're trying to do. But to me, that's the first step of financial regulation. Is entry restriction into money creation and in the absence of doing that, our financial regulatory problems are going to remain intractable.

Beckworth: Well, you mentioned in the piece in your book that the shadow banking system effectively already is backed by the government. It was during the crisis, you mentioned the large scale interventions done by the government. Let me just quote page 99 of your book, you put “the scale of these policy measures were staggering, at as peak the Federal Reserve extended about one trillion of liquidity through an arsenal of emergency lending programs. The FDIC issued over one trillion in guarantees, the Treasury Department supplied 0.3 trillion in equity capital infusions and three trillion dollars of rescues of the money market mutual funds.” So, there effectively is something in place and I think what you're arguing is let's make it cleaner, official, more efficient. Is that right?

Ricks: Yeah, this is to take a phrase from geopolitics, I'm advocating a containment strategy for moral hazard. We're backing this stuff, whether we want to or not, we have to back it. The fact that we're backing it creates all sorts of bad incentive effects and the too big to fail problem is one manifestation of this problem. And so I'd like to say, only a certain set of institutions are allowed to have this funding model and they're required to live under a very carefully circumscribed institutional environment. And we aren't going to back their monetary liabilities, we're not going to pretend that we're not going to. This is an insurance type of a system where we're saying the money supply is in fact sovereign. There's no constructive ambiguity at work. But I do think this is a containment strategy in the sense that we would at least arguably be able to withdraw implicit support for much of the rest of the financial system.

Beckworth: All right. Well, our guest today has been Morgan Ricks. Morgan, thank you for being on the show.

Ricks: Thank you David.

David Beckworth
Calendar Date: 
Sep 26, 2016
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Why the threat of bank runs should be the primary focus of financial regulatory policy.