Posted by: Dirk | August 6, 2015

Milton Friedman called ‘for a 100% reserve requirement for demand deposits to avoid the endogenous creation of money’

In a recent paper by Sylvie Rivot titled Rule-based frameworks in historical perspective: Keynes’ and Friedman’s monetary policies versus contemporary policy-rules (link to paper) I found this very interesting paragraph:

The precise target imposed upon monetary authorities depends on the particular institutional setting in which the rule applies. Friedman’s point is that the complex and fractional reserve system might impede the central bank’s ability to control the total stock of money. As early as 1948 and in 1959, he calls for a 100% reserve requirement for demand deposits to avoid the endogenous creation of money, a procedure whereby ‘the total of money and of high-powered money would then be the same’ (Friedman 1959). The instability of the total stock of money due to changes in the forms in which the public holds money (i.e. currency or deposits) would be eliminated. Open-market operations would be the key instrument used to achieve this target. Later Friedman (1984) abandoned the 100% proposal and then advocated contemporary reserve accounting instead of lagged accounting, whatever the type of deposit.

This is very interesting because there are contemporary movements that have the same ideas. History of economic thought is a very important field because many debates of the past provide a good starting point or at least some perspective for contemporary debates. In footnote 35, Sylvie Rivot present the view of Keynes on the issue of reserves management – or control of the monetary supply, as Friedman would put it:

He does not believe that ‘the rules of wise behaviour by a central bank could be laid down – having regard to the immense complexity of its problems and their varying character in varying circumstances – by Act of Parliament’ (Keynes [1930] 1971, p. 234). Quite the contrary: ‘it would be much better to leave the management of the reserves of the central bank to its own unfettered discretion than to attempt to lay down by law what it should do or within what limits it should act’ (Keynes [1930] 1971, p. 243).


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