On the Monetary and Financial Stability
under A Public Money System
Modeling the American Monetary Act Simplified
Kaoru Yamaguchi *
Doshisha University
Kyoto 602-8580, Japan
E-mail: kaoyamag@mail.doshisha.ac.jp
Abstract
Our economies are currently facing systemic failures of financial and
debt crises. To overcome these, an alternative public money system is
proposed by the American Monetary Act. This paper is the third one
that examines the feasibility of the public money system. First and second
papers have focused on the liquidation of government debt. This paper
explores monetary and financial stability under the public money system
in comparison with the current debt money system, by constructing a
simplified macroeconomic model. It demonstrates through simulation that
monetary and financial instability is built into the current debt money
system and “booms and depressions” become inescapable. On the other
hand, monetary and financial stability is shown to be accomplished under
the public money system.
1 The Chicago Plan Revisited
This is the third paper that examines the feasibility of the American Monetary
Act proposed by the American Monetary Institute’. The Act endeavors to
restore the proposal of the Chicago Plan or 100% Money Plan by repealing the
Federal Reserve Act of 1913. Specifically, it tries to incorporate the following
three features. For details see [7] and [9, 10].
Governmental control over the issue of money
“The paper is submitted to the 30th International Conference of the System Dynamics
Society, St. Gallen zerland, July 22 - 26, 2012.
ts full text is available at http://www.monetary.org/wp-content /uploads/2011/09/32-
page-brochure.pdf. On Sept. 21, 2011, a bill based on the American Moni
introduced to the US House of Representatives by the congressman Dennis Kucinich.
called H.R. 2990, National Emergency Employment Defense Act of 2011 (NEED Act). Its
text is available at http://www.govtrack.us/congress/billtext.xpd?bill=h112-2990
e Abolishment of credit creation with full (100%) reserve ratio
Constant flow of money into circulation to sus
welfare
ain economic growth and
the above condition:
The macroeconomic system which me alled a public
money system in [8], while the current system is called a debt money system.
The first paper [7] investigated how accumulating government debts could
be liquidated under the above two different macroeconomic systems. What was
found is that the liquidation of government debt under the current macro
stem of debt money is very costly; that is, it triggers economic re-
cessions, while the liquidation process under a public money system can be
accomplished without causing recessions and inflations. The second paper [8]
expanded the analysis to the open macroeconomies and found that government
liquidation can be attained without causing economic recession, unemployment
and inflation in both domestic and foreign economies. These two papers have
focused on the liquidation of government debts, because national debts are the
most imminent issues many OECD economies are now facing.
Having solved the liquidation issue of national debts, I’ve strongly felt that
something essential might have been missing in these researches. This reflection
has led me to revisit the original Chicago Plan. What is the Chicago Plan, then
? Following the Great Depression in 1929, a mimeograph called A PROGRAM
FOR MONETARY REFORM had been circulated among American economists
in July, 1939, by Paul H. Douglas, Irving Fisher, Frank D. Graham, Earl J.
Hamilton, Willford I. King, and Charles R. Whittlesey. This circulation was
well responded as follows; “Up to the date of writing (July, 1939) 235 economists
from 157 universities and colleges have expressed their general approval of this
“Program”; 40 more have approved it with reservations; 43 have expressed di
approval. The remainder have not yet replied [1, p.3].” The proposals made in
the mimeograph, together with some writings of above economists on monetary
reform such as [2], are collectively called the Chicago Plan, as I understand it.
The Chicago Plan has indeed fully predicted the fixing power of national
debts under the 100% reserve system, as being demonstrated in our public
stem, as the following statement of section 17 demonstrates:
nomic
money §
(17a) Under the present fractional reserve system, the only way to
provide the nation with circulating medium for its growing needs
is to add continually to our Government’s huge bonded debt. Un-
der the 100% reserve system the needed increase in the circulation
medium can be accomplished without increasing the interest bearing
debt of the Government {1, pp.39,40].
(17b) As already noted, a by-product of the 100% reserve system
would be that it would enable the Government gradually to reduce
its debt, through purchases of Government bonds by the Monetary
Authority as new money was needed to take care of expanding busi-
ness (1, p.41].
In other words, what is attained in my two papers is, in this way, clearly
predicted in the Chicago Plan. Yet, it turns out to be “a by-product of the
100% reserve system.”
What is “a main-product”, then, that we hi od in our previous anal-
yses? Revisit of the Chicago Plan this time convinced me that its main concern
was the monetary instability under the fractional reserve system as the following
ion 9 indicates:
sec'
(9) Fractional reserves give our thousands of commercial banks the
power to increase or decrease the volume of our circulating medium
by i ing or decreasing bank loans and investments. The banks
thus exercise what has always, and justly, been considered a prerog-
ative of sovereign power. As each bank exc this power inde-
pendently without any centralized control, the resulting changes in
the volume of the circulating medium are largely haphazard. This
ions [1,
situation is a most important factor in booms and depr
p19].
Furthermore, Irving Fisher, a great monetary economist in those day
5, Wi
‘ions
tive in establishing a monetary reform to stabilize the economy out of re
such as the Great Depression. His own plan is known as “100% Money Plan”
T have come to believe that the plan, ”properly worked out and
applied, is incomparably the best proposal ever offered for speedily
; for it would
and permanently solving the problem of depressions
remove the chief cause of both booms and depressions, namely the
instability of demand deposits, tied as they are now, to bank loans.”
[2, p-8]
The purpose of this third paper is, therefore, to examine the main-product of
the Chicago Plan; that is, how monetary and financial stability can be attained
under the public money system that incorporates 100% reserve system or the
Chicago Plan.
Having inherited the academic tradition of the Chicago Plan, Milton Fried-
man, Nobel laureate proponent of free market economy, also supported the plan
as follows;
One major reform that I recommended in the third lecture to
achieve that objective was 100% reserve banking, a proposal that
had been made by a group of economists at the University of Chicago
during the 1930s and that was strongly supported by the greatest of
Irving Fisher. The proposal is “to require any
institution which accepts deposits transferable by check to have one
dollar in high-powered money [i.e., currency plus deposits at Federal
Reserve Banks] for every dollar in deposit liabilities, ... that is, to
have 100% reserves.” [3, p-X]
It means that the central problem is not to construct a highly sen-
y introduced
American economi:
sitive instrument that can continuously offset instabili
by other factors, but rather to prevent monetary arrangements from
themselves becoming a primary source of instability [3, p.23].
In other words, monetary and financial stability has been the most important
among different schools of economic profession. This
paper challenges to demonstrate how it can be attained under the public mont
system, while monetary and financial instability of “booms and depressions”
is inevitably caused under the current debt money system. This paper, then,
completes the validation of the proposals made by the Chicago Plan and the
American Monetary Act.
concern of all economi:
2 Debt vs Public Money Systems Simplified
Ihave already presented two macroeconomic models of the Ame!
Act in [7] and [8] based on the method of accounting system dynamics developed
in [5]. To focus on our main concern of the monetary and financial stability in
this paper, a simplified model is constructed here, consisting of three economic
sectors as producers, consumers and commercial banks?.
an Monetary
Producers
Main transactions of producers are illustrated in Figure 1, which are summarized
as follows.
¢ Producers’ income is, under the accounting principle, booked as an inflow
of the stock of retained earnings when production of GDP is completed,
and at the same time inventory is increased by the same amount.
« Their actual income is realized when GDP are sold out and shipped from
the inventory to consumers and bankers as consumption and to producers
‘ment.
as inves
subtracted first
Out of the income thus realized, capital depreciation is
and interests of their debt are paid to the banks.
¢ Next, a portion of GDP (say, 20%) are assumed to be made as mark-up
profits, and paid to their sharcholders (that is, consumers) as dividends.
The remaining amount is paid to workers (as consumers) as wages. That
implies that workers are placed in a relatively weaker position against
shareholders. (Surely, this assumption could be reversed in simulation).
Produ
come are paid out to consumers and bankers as factor income and interest
are thus constantly in a state of cash flow deficits, since all in-
income. To make new investment, therefore, they have to borrow money
from banks and pay interest to the banks.
2The model is also motivated by the work of Steve Keen [4, 2011], specifically his monetary
model of capitalism in chapter 14.
e Their debt is assumed to be a long term debt of 10 years.
rende pom
(naa)
sey tNMoID
pouty
uous ut
su 205 sn
ous se
w stay suns any
(smpoig)
sep em
)
poasoq.
Buwouog-
‘SHPO
Figure 1: Transactions of Producers
Consumers
Main transactions of consumers are illustrated in Figure 2, which are summa-
rized as follows.
e Consumers receive wages and dividends from producers and interest from
banks.
They spend 80% of the income on the consumption, and the remaining
will be saved.
In this model, their cash/deposits asset is assumed to include demand
deposit only when credits are created by banks and lent to producers who
pay factor income with credits as well as cash. In other words, demand
deposits by consumers are not liabilities of commercial banks.
Their demand for cash/deposits as transaction payment out of saving ac-
count will be constantly adjusted by the currency ratio (of 20%) they wish
to hold at hand.
Banks
Main transactions of banks are illustrated in Figure 3. Transactions under the
debt money system are summarized as follows (transactions under the public
stem are explained below in Section 4).
money Ss}
¢ Banks receive deposits from consumers, against which they pay interests.
© Out of the deposits, loans are made to produce
for desired borrowing by producers.
ccording to the demand
If loanable fund is not enough under the debt money system, banks can
ate credits and put them into the demand deposits account of produc-
In this process, vault cash asset is assumed to play a role of the
required reserve as well (with the central bank behind the screen), against
which credits are created. (This proc led money
out of nothing under a fractional reserve banking.) The upper limit of the
credit is set by a required reserve ratio or a required equity ratio of loans
imposed by the BIS rule’.
ers
of credit creation
« Banks receive income as prime rate interests against their loans. 80% of
the income is assumed to be spent on consumption, and the remaining
will be retained as equity.
Remarks: In our simplified model, the total amount of cash in circulation
such as the ones in the cash assets of produces, consumers and banks is consid-
ered as base money (M0) (or monetary base, or high-powered money) initially
provided by the central bank.
3This limit is not explicitly considered in our model
q
H
Figure 2: Transactions of Consumers
3 Behaviors of A Debt Money System
Determination of GDP
Our model is one of the most simplified models of macroeconomy with a focus on
the monetary and financial stability. For this purpose, Keynesian determination
of GDP is simplified as follows. First, aggregate demand (AD) consists of con-
sumption (C) and investment (1), and investment is assumed to be exogenously
determined together with depreciation.
AD=C+H+I (1)
Next, consumption demand is determined as a portion of actual Gross Do-
sy sie <q
suvo7] HIMUUEXD YA,
ff gar see ane, pent
(wea
—————
Prva 1S310HHT
(siueg)
uwondumstoy
(soured) Dav
purewiog ys
woqwary Kauoyy, ‘wonenoa3
‘ggqnd 40} au, Pon Kau,
ona
TYME ae" uaeary
‘yours xpaay [young ps. ‘upc 40} au
Yountans
waists < :
Wn otk ‘woreai 3pary
[uoneai3 pai
sug,
Figure 3: Transactions of Banks
me:
Products (GDP or Y), where ¢ is a marginal propensi
(whose value is set at ¢ = 0.8 in this model).
ity to consume
C=0 (2)
Keynesian model claims that GDP is determined by the level of aggregate
demand;
Y=AD. (3)
three equations, Keynesian equilibrium of GDP is determined
by the following equation:
From th
(4)
For instance, when exoge-
nous amount of investment ,
Wages
without depreciation are I
80, 100, and 120, respec- (cor)
tively, equilibrium GDP are
determined at Y = 400, 500,
Factor Income
and 600. +) or
Analysis of determining [ae (Mapesiand Profs)
GDP at the different levels
i IS Ageregnte _Eauiibrium GDP
of exogenous investment is “Demand
called a comparative static
analysis. em dynamic caisaagted
modeling method can ¢
convert this stati
analysis
a dynamic process of GDP
determination as follows:
Investment
Consumption
(Bankers)
dy _AD~Y (5) Figure 4: Keynesian GDP Determination
dt AT
where AT is an adjustment time. In our simplified model, this dynamic proces
is assumed to be further affected by an inventory level, as illustrated in Figure
5, such that
S
dY _AD-Y __Iinw
do AT ATi
where ATjny is an adjustment time of inventory.
Figure 6 illustrates how GDP are determined by the increase in investment
by 20 and 40 at t=10 from the initial investment level of J = 80. Specifically,
lines 1, 2 and 3 correspond to the investment levels of 80, 100 and 120, respe
tively, while lines 4, 5 and 6 correspond to the same investment levels with 4%
depreciation of the existing capital. Surely GDP will become larger to replace
capital depreciation, yet capital levels stay the same for the same net investment.
Whatever levels of investment, these behaviors demonstrate that an equilibrium
GDP will be eventually attained through the over-shooting fluctuations.
(6)
o
Debt
— (Producers)
Debt-GDP Ratio——
—<Debt (Credits)
Debt (Credits)-GDP << ————
| Ratio
Growth Rate
cpp
Change in GDP.
a Initial GDP =
Growth Rate
(GDP) | Inventory’
|
Demand |
snl Inventory
vest —__ SD -Demmand Adiustment Time Adivstment Time
(Financial Ba
Price Sensitivity of
Financial Investment
Desired
Ratio Elasticity pring
of Price
ies, Z Price Inflation Rate
Change in Price
Initial Price Level
Price Adjustment
Time
Figure 5: Determination of GDP and Price
Price Determination
Monetary stability is measured by the price stability or inflation rate. For this
purpose, we assume a passive mechanism of the determination of price level. By
the passive mechanism, we mean that a price level has no feedback effect on the
determination of GDP in our simplified model. Specifically, the price level is,
as illustrated in Figure 5, assumed to be adjusted by the following dynamic
dP P*-P
‘dt «AT
in which the desired price P* is obtained as
P
= tay (8)
(ap
where ¢ is a GDP-AD ratio elasticity of price*.
“This is a simplified equation of price flexibility presented in [7]
10
GDP (No Monetary Constraints)
1,000
800
600
400 “
200
0 4 8 12 16 2 24 28 32 36 40
Time (Year)
GDP toes
GDP nvm
Figure 6: Keynesian Determination of GDP
On the other hand financial stability is hard to measure in our simplified
model. “To finance” literally means “to provide money”. Hence, financial sta-
bility is related with credit-creating (crunching) and stable lending behaviors
of bankers at a microeconomic level of activities. These micro-level activi
affect macro-level behaviors collectively in terms of loan and debt. Since our
macroeconomic model, though simplified, is based on micro-foundation behav-
iors, it would be appropriate to use monetary and financial stability inseparably
here.
Monetary Constraints
Dynamical equilibria in Figure 6 can be attained only when producers have
enough amount of money to pay factor incomes such as wages and profits (div-
idends) and investment, etc. Most macroeconomic textbook analyses are based
on this assumption of unconstrained availability of money or liquidity for trans-
action.
To examine the effect of monetary constraint on the determination of GDP,
let us first calculate net cash flow of producers. It is obtained as inflow and
outflow of producers’ cash stock in Figure 1. Thus, it is calculated as follows:
Net Cash Flow = Cash Inflow - Cash Outflow
Co and Bankers) + Inves'
- Factor Income - Interest Income (Banks) - Inves
umption (Consumers
- Loan Payments
s and Banker
=- Savings (Consume
- Loan Payments (9)
ll
where Factor Income is defined as the sum of wages and profits (dividends).
Net cash flow of producers thus obtained becomes equal to the sum of nega-
tive amount of savings by consumers and bankers and loan payments. In other
words, producers
monetary economy. Accordingly, to make new investment and reimburse loans,
ined to be inas
re des ate of cash deficiency in a capitalis!
they are obliged to constantly raise funds. This amount of fund is called here
a desired borrowing amount. This becomes a fundamental framework of our
macroeconomy constrained by the liquidity availability
Theoretically, there are only four ways to raise desired borrowing fund as
follows:
¢ Borrowing from banks (bank loans)
e Issuing corporate bonds (borrowing from the public)
e Issuing corporate shares (sharing ownership)
¢ Retaining earnings for investment (retained saving)
In this paper we assume that producers can raise all nec
rowing from commercial banks.
Now suppose that producers initially have $300 (the reader may consider its
unit as billion dollar), while banks have $500 as their initial vault cash. That
is, the monetary b:
be interpreted as coit
issued by the government in a public money
sumed to be determined by the investment consisting of the net investment of
iates of 4%; that is line 4 in Figure 6. Accordingly, (gros
a sum of net investment and depreciation. Then GDP will
ary funds by bor-
se of our economy is $800. This amount of currency could
and banknote:
in a debt money system, or public money
ystem. From now on, GDP is
as
$80 and capital depr
investment become
be determined as illustrated by line 1 in the left-hand diagram of Figure 7. Line
1 in the right-hand diagram shows that cash assets of producers are running out
by the amount of -$517 at th 40.
Now suppose that producers fail to raise the desired borrowing amount.
Under such monetary constraint, produces cannot fully meet their net cash flow
deficits; specifically they cannot make d
shortage of fund. This in turn decreases aggregate demand, toward which GDP
will be eventually pulled back. In short, GDP begins to shrink due to the
constraint of the shortage of cash. Line 2 in the left-hand diagram of Figure 7
illustrates how GDP gets reduced, while that of the right-hand diagram indicates
that producers’ cash is getting depleted to zero.
This implies that moncy or liquidity does indeed matter for the attainment
of equilibrium GDP. Unfortunately, most macroeconomic textbooks neglect this
important role of money, and assume that macroeconomic behaviors are not
constrained by the availability of money or liquidity.
esired amount of investment due to the
Money out of Nothing
How can our economy avoid this monetary constraint and create enough money
to attain the equilibrium GDP ? In order to meet the demand for the desired
12
GDP Cash/Deposits (Producers)
on
co
400
Dollars Year
Ta
e303
“Time (Yea) — ea
“Time (Yea)
GDP : No Constant 1-80, D=#%)
‘GDP Constrint (1-30, D
Figure 7: Monetary Constraint GDP
stem, banks
borrowing amount under the current fractional reserve banking s
can make loans to producers by creating credits against the bank r
the central bank. The credits thus created are put into the demand deposits
account of producers. In our model it is denoted as the stock of Deposits
(Credits) under the liabilities of banks. In this way, banks are able to create
demand deposits out of nothing for producers, who then utilize them for their
transactions. Figure 8 illustrates how money is created and put into circulation
as credit creation.
serves with
Base Money
(Mo)
; Money Supply
Wages (M1)
Credit
Factor Income Creation
4) (Wages and Profits) +4 (Loans)
Actregate Eauibrin DP Monetary Constraint
Demand
; ; Desired
Consumption Borrowing
Investment
Consumption
(Bankers)
Figure 8: Credit Creation
In this way, whenever producers can raise desired borrowing amount suc-
cessfully, the equilibrium GDP is attained. Figure 9 illustrates how equilibrium
GDP is restored by banks who create enough credits and make loans to the
producers. In our model, the amount of money banks have to create to attain
13
the equilibrium GDP is denoted as “Desired Borrowing (Banks). In the figure,
the data file name of Credit Creation(100%) implies that this amount is fully
created; that is, 100% of what banks want to borrow to meet their cash defi-
ciency. Consumption (Bankers) (line 4) will become zero if (prime) interest rate
is zero and bankers have no income. In this case, lines 5 and 6 become identical
and net investment becomes equal to saving.
GDP
800
600 + rs = +
2
% 400
: Laer eee
200
oP DPE Pere i
0 4 8 12 16 20 24 28 32 36 40
Time (Year)
GDP = Credit Creation(100%)
Aggregate Demand : Crit Creation(100%) ~ 2
CConsunspion : Credit Cretion(100%)
‘Consumption (Bankes) : Crit Creation(100%)
Net lavestmeat : Credit Creion(100°)
Savings : Crit Creaton(100%)
Figure 9: Equilibrium GDP by Credit Creation(100%)
It is often
tained. And this reasoning is used as a justification that credit creation through
a fractional reserve banking system is essential for economic growth and pros
perity. In other words, activities of bankers are good to the society, because
they are providing enough money or liquidity for the prosperity of society! If
that’s the only way to create money for economic growth, we have to be grateful
for their banking services of credit creation out of nothing.
aid that without credit creation by banks, no growth can be at-
Money Supply
Before we examine this justification of banking services of c
us define the amount of money that is created and put into circulation. In
our model, initial currency in circulation is the sum of cash held initially by
producers ($300) and banks ($800); in total, $800. This amount of currency is
assumed to be provided by the central bank or the public money administration.
Hence,
edit creation, let
Initial Base Money = Initial Cash (Producers) + Initial Vault Cash (Banks)
(10)
Base money (M0) is increased whenever banks borrow money from the cen-
tral bank or the public money administration. For the analysis of the current
4
created as credits
debt money system, money is assumed to be endogenously
by banks. Under a public money system, banks are assumed to borrow money
from the public money administration. Hence,
Base Money (M0) = Initial Base Money + Debt (Banks) (11)
where Debt (Banks) constitutes a liability of banks for the money they borrow
from the central bank or the public money administration.
Money supply (M1) is generally defined as®
Money Supply (M1) = Currency in Circulation + Demand Deposits (13)
Under the debt money system, banks can create credits by setting up new
deposit account for producers and typing in the digital figures of credit or loan
on it. Nowadays this can be done electronically. This amount of money thus
created by banks becomes demand deposits. In the balance sheet of producers
this implies that their debt as liability and deposits a t are simultaneous
increase by the same amount. Now producers are ready to use thi
for factor payments together with original base money. When this payment is
done electronically to the deposit account of consumers, their cash account in-
edit money
ingly, their cash account need to be reinterpreted a
Hence, money supply (M1) is also redefined as
Money Supply (M1) = Currency in Circulation (14)
= Cash/Deposits(Producers)
+ Cash/Deposits (Consumers)
+ Vault Cash (Banks). (15)
The difference between money supply (M1) and base money (M0) is nothing
but the money endogenously created by banks out of nothing (or thin air):
Money out of Nothing = Money Supply (M1) — Base Money (M0) (16)
Deposits of consumers are made out of their cash/deposits assets as savings
after consumption expenditure is made. Accordingly, it could be interpreted as
time deposits. Money supply (M2) is then defined as
is
Money Supply (M2) = Money Supply (M1) + Time Deposits (17)
With these dentitions of money in mind, let us examine how money is
ated. In Figure 10, line 1 represents initial base money that is made ini
‘Money supply is also defined in terms of base money (MO) as
Money Supply = m * Base Money (12)
where m is a money multiplier.
15
available, which is also regarded as base money (M0) of line 2. On the other
hand, demand deposits are created by bank loans as credit creation, which is
illustrated by line 5. Hence, M1 is obtained here by adding line 2 and line 5 as
line 3. At the year 40, the amount of credit creation or money out of nothing
Money Supply
3,600
2,700
3 1.800 Sa
900 ty eT |
. oe a °
el
0 [+4
0 4 8 12 16 20 24 28 32 36 40
Time (Year)
Initial Base Money : Credit Creation(100%) —t———t——+—+—+——
"Base Money (MO)": Credit Creation(100%) —> z 2 z z
joney Supply (M1)" : Credit Creation(100%). —3———3———3 s+
"Money Supply (M2)" : Credit Creation(100%) ——3——————
‘Money out of Nothing : Credit Creation(100%)
Figure 10: Money Supply: MO, M1 and M2
becomes $918. Accordingly, M1 becomes $1,718 together with the base money
(MO) of $800.
In conclusion, the Keynesian equilibrium GDP can only be attained with the
appropriate amount of money, half of which is in our model created by commer-
cial banks out of nothing under the current fr ve banking system
of debt money. Most macroeconomic textbooks neglect this important role of
money in the proce ,
defend credit creation proce
growth.
ctional re:
of GDP determination, while many monetary economis
s as an essential banking service to drive economic
Driving Forces of Credit Creation: Greed
We are now in a position to explore the motives of bankers to create credits
by making loans. Generally speaking, for the attainment of mostly equilibria,
enough amount of money has to be put into circulation to avoid rece:
caused by credit crunches such as analyzed in [6]. This amount is denoted in
our analysis by the file name of Credit Creation (100%). What drives bankers
to create credits, then? Are they really social philanthropists, as often claimed,
who create credits for the economic growth and welfare of people?
Left-hand diagram of Figure 11 illustrates three different levels of money
ions
supply (M1) created by banks. M1 increases as the level of credit creation by
banks increases from 70% (line 1) to 100% (line 2), then to 130% (line 3). Right-
hand diagram indicates how net interest income of bankers increases as credit
16
Money Supply (MI) under 3 Credit Creation Levels Net Interest Income (Bankers)
3.000 20
2400 %”
4 1:00
z «
1200
+ * 2 6 0 6 8 2 6 OO
Tne (Yew) ose a 0 wo ew
"Money Supply (M1): Cre Crestin(70%) Tins (Yeu)
"Money Sippy (M1) Creda Creating 09%) —=
"Money Supply (S1)"- Cred Creat 30%)
Figure 11: Changes in Money Supply and Net Interest Income of Bankers
creation expands by increasing loans. It costs almost nothing for bankers to
create credit. Accordingly, their income will be increased as they make more
loans. Since interest income is increased without incurring cost, all bankers will
surely tend to make more loans. It may be concluded, thus, that greed is the
motive of bankers for their credit creation.
Even so, their greedy be
economy, because all agent
ing to market rules. Accordingly, a fractional reserves banking system or debt
money system which allows greedy behaviors of bankers should be to blame.
Figure 12 demonstrates the
existence of a built-in positive
feedback loop that enhances
credit creation in our debt
aviors may be justified as rational ones in a market
are allowed to pursue their own self-interest accord-
money system, It is called Pcie Wage
“Bankers’ Greed” loop in this Distribution
apa Credit gx
paper Creation ( 4
(Loans) q 4 =
Consequences of Greed pen? Income
Bankers’ Greed
Inequality
Now we have identified a pos
itive feedback loop of banker:
greed built in the debt money
system. This has been a driv-
ing force of capitalist economic
development, and justified by
its proponents. What will hap-
pen if credit creation of banks
overshoots 100% level of desired borrowing of banks for further loans and inter-
est income? Figure 13 of prices and inflation rates indicates how our economy
tends to become inflationary as a consequence of bankers’ greed to make more
loans than 100%.
The other consequence is the inequality of income distribution in terms of
wage distribution. It is defined as a portion of wages out of net national income
Interest Income
(Bankers)
Figure 12: Greed of Bankers
17
Prices under 3 Crodit Creation Levels Inflation Rates under 3 Credit Creation Levels
o 4 © 2 Wm 2 of 4 a o «4 8 2 6 20 4 oe ew
Tans (Yeas)
cae
Tine (Yeu)
Price Crt Creation, 70%) Indatoa Rate Cred Creation 702)
Price {Crt Creao(100%9) ==> == non Rate Cred Creation 100%
Price {Cre Creatn(130%9) >> lin Rate Crt Creation 130%)
Figure 13: Price Levels and Inflation Rates with Credit Overshooting
(NND); that is, wage/NNI. NNI here becomes the same as GDP less Depreciation
in our model. Left-hand diagram of Figure 14 illustrates a decreasing trend of
wage distribution irrespective of the levels of credit creation from 70% through
130%! Furthermore, it is observed that income inequalities at the credit creation
levels of 70% and 130% (lines 1 and 3) get worsened compared with the level of
100% credit creation (line 2).
Graph Lookup - Credit Crunch 2 Level Table
Wage Distribution
o 4 8 2 Ww 2% 2 2 3 36 40
Tim: (Yeat)
Wage Di Crea Creations 0
Wage Distibuton : Credit Creaton(10
‘Wage Distrbution = Credit Creation( 130%)
ou os 09
Figure 14: Interest-Wage Ratio and Wage Distribution
When income inequality gets worsened for workers, their income is reduced,
followed by the deduction of their consumption, which in turn reduces aggre-
gate demand. That is, bankers’ greed to create more credits to increase their
own income, sooner or later, triggers the decrease in GDP and economic reces-
sion. Once recession gets started, bankers lose confidence in the safety of their
loans, and surely try to reduce and/or retrieve them. This reducing behavior is
called “Kashi-shiburi”, and retrieving one is called “Kashi-hagashi” in Japanese.
There two terminologies became houschold names in Japan during the lost two
decades starting 1990’s. This balancing feedback loop is called “Income Inequal-
ity” loop in Figure 12. Once this loop gets triggered, positive feedback loop of
Bankers’ Greed may begin to be dominated by this balancing feedback loop.
In other words, under the debt money system, a reinforcing proc
creation could be easily reversed into the process of credit crunch.
18
These observations suggest that it is legitimate to assume that the level
of credit creation is forced to be reduced according to the reduction of wage
distribution. To bring this feedback structure to the model, a table function
s constructed such that a level of credit creation is determined by the wage
distribution. Specifically, it is assumed that whenever wage distribution drops
to 50%, credit creation level gets reduced by 20%, as illustrated in the right-hand
diagram of Figure 14.
In the case of 100% level of credit creation, wage distribution drops to 50%
at the year 30, as shown by line 2 in the left-hand diagram of Figure 14; that
is, a start of credit crunch of 20%. Left-hand diagram of Figure 15 illustrates
how this credit crunch reduces credit creation of money out of nothing (line 2),
which triggers deflation as shown by line 2 in the right-hand diagram. Figure
Money out of Nothing Inflation Rates
“| (Peet LL
y : F tL |
000s
Dollars
008s
008
oa ee a0
‘Tne (Yew) “Tne (Yeu)
Money out of Nong Cred Creat 10 Indton Rat Crt Creation 100%)
Money ut of Noting Cred Crch === Inlion Rate Cred Couch
Figure 15: Reduction of M1 and Deflation by Credit Crunch
16 illustrates how this credit crunch affects GDP level and its growth rate.
cpp Growth Rates (GDP)
soo 00 POL,
pet tte tt
Patna aaiaaii gata
a) oa ae
Tine (Yeas)
Dollars Year
380
DP : Cred Cweatoa( 100%) “Grow Rate (GDP) Cet Creation 100
GDP : Cet Cinch = rot Rate (GDP): Crt Ce
Figure 16: Recession (GDP and Growth Rate) triggered by Credit Crunch
As seen above, the balancing loop of “Income Inequality” we have observed
here is the most fundamental endogenous feedback mechanism, built in our
simple debt money system, that causes “booms and depressions” as criticized
by the Chicago Plan.
)
Interest
Distribution
Interest Income
(Bankers)
+4
Bankers' Greed
ge
fos
Credit
Base Moi
\
Interest Demand
(M1) %
Creation
(Loans)
~/
Money Supply
Desired
Borrowing
+
Monetary Const
Financial
Investment
A
Factor Income
(Wages and Profits)
/
Consumption
Investment
‘Consunption
(Bankers)
44)
ae
Equilibrium GDP
Agaregate
&
Figure 17: Causal Loop Diagram of Debt Money System
Monetary and Financial Instability
In a closed economic system, money has to be issued or created within the sys-
tem. Under the current debt money system, only the central bank is endowed
with a power to issue money (called be
system, and make loans to the commercial banks directly and to the government
© money or monetary base) within the
20
indirectly through the open market operations. With this base money, commer-
cial banks create credits under a fractional reserve banking system by making
loans to producers and consumers. These credits constitute a great portion of
money supply. In Japan, 82.5% of money supply (M1) in 2009 was credit loans
and deposits. In this way , money and credits are only created when commercial
banks and government as well as producers and consumers come to borrow at
interest. Under such circumstances, if all debts are to be repaid, money ceases
to exist. This is an essence of the endogenous money supply in a debt money
system.
In our simplified model, this process is summarized as a causal loop diagram
of debt money system in Figure 17. In the diagram, there are 4 reinforcing loops
to stimulate economic growth through credit creation, meanwhile there is only
one balancing feedback loop of Income Inequality. Yet, it could trigger credit
crunch easily, because money created by loans can be easily crunched by the
restriction and withdrawal of loans.
From the left-hand diagram of wage distribution in Figure 14, income in-
equality gets worsened whenever the level of credit creation under-shoot or over-
shoot the 100% desired borrowing level of credit creation, causing credit crunch,
price fluctuation and recessions. Since these feedback mechanism is built in the
debt money system, no one in the system cannot control these cycles of “booms
and depressions”. To see these effects of monetary and financial instability, let
us run sensitivity ane using random normal distribution with mean value of
0 and standard deviation of 0.2 around the 100% level of credit creation. That
is, 68% of credit creation levels occur within the range of 80% level through
120%.
Sensitivity
50% 75% Ml 95% 100% Il
"Growth Rate (GDP)"
0.6
0.3
0 10 20 30
Time (Year)
Figure 18: Sensitivity of Credit Creation on Growth Rates
Figure 18 illustrates how economic growth rates are affected by the monetary
and financial instability, while Figure 19 shows how inflation rates fluctuate
21
Sensitivity
50% 75%E 95% Rl 100% Hl
Inflation Rate
1
0.73
0.46
0.19
0 10 20
Time (Year)
Figure 19: Sensitivity of Credit Creation on Inflation Rates
along with the fluctuation of growth rates.
4 Behaviors of A Public Money System
We are now in a position to explore monetary and financial stability under
the public money system where the central bank is incorporated as one of the
governmental organization. In our simplified model, however, the central bank
is not explicitly modeled and left out of the model boundary. Transactions of
commercial banks under the public money system are now revised as follows
(transactions of producers and consumers remain the same).
e Banks are obliged to deposit a 100% fraction of the demand deposits as the
required reserves with the public money administration. Specifically, this
requirement is assumed to be met and demand deposits are accordingly
left behind the balance sheet of bankers in the model. Hence, cash in the
vault cash stock becomes the only source for bankers to make loans.
¢ When the amount of vault cash is not enough to mect the demand for
loans from producers, banks are allowed to borrow from the public money
administration free of interest; that is, discount rate of public money now
becomes zero. In the model, it is done as a flow of money into circulation
that is managed by a level of public money creation (similar to the level
of credit creation under the debt money system) by the Public Money
Administration (PMA) (sce [7] and [8]).
22
Monetary Constraint
Let us now explore monetary and financial behaviors under the public money
stem in comparison with those under the debt money system. To attain equi-
librium GDP, banks have to create enough amount of moncy which is denoted
as “Desired Borrowing (Banks)* in the model. In what follows, a data fine
name of “Public Money Creation (100%) * implies that this desired amount of
borrowing by banks is 100% met by the PMA, while that of “Credit Creation
(100%) * means that it is 100% met by the credit creation activities of the banks
as already analyzed above.
Figure 20 illustrates how different levels of GDP are determined under the
debt and public money systems. When money supply is only met by 70%,
equilibrium GDP cannot be attained under both systems (lines 1 and 4), though
GDP under the public money system is slightly higher. Only when more than
GDP
Dollas/Year
0 4 8 12 16 20 24 28 32 36 40
Time (Year)
aoe
ape
ape
Gor
Gop
GDP : Publie Money Creation(130%)
Figure 20: GDP under Debt vs Public Money System
100% money is created, equilibrium GDP are attained (lines 2, 3, 5, 6) under
both systems. As lines 3 and 6 indicate, over-supply of money (130%) could
only be justified for the attainment of equilibrium GDP. In other words, it
becomes necessary to provide more than cnough amount of money to attain an
equilibrium GDP by avoiding the constrained levels of GDP.
Monetary Stability
supply of money, however, cause monetary instability? Before
ion, let us revisit the definition of money. When full reserve
em, bank reserves become equal
Doesn’t the over
answering this ques
system is implemented in the public money s
23
s so that we have
to deposi
Money Supply (M1) = Currency in Circulation + Demand Deposits
= Currency in Circulation + Reserves
= Base Money (M0) (18)
Accordingly, under the public money
equivalent to base money (M0)°.
With these in mind, let us examine the effect of over-supply of money on
monetary stability. Left-hand diagram of Figure 21 shows that the equilibrium
GDPs are attained by the similar amounts of money supply (M1) under debt
and public money systems (lines 1 and 3). When over-supply of money (130%)
is newly provided, money supply (M1) becomes larger under the debt money
em (line 2) than that under the public money system (line 4). This indicat
that money supply tends to be inflated under the debt money system by the
same amount of newly created credit. Right-hand diagram demonstrates that
stem, money supply (M1) becomes
‘Money Supply (M1) Inflation Rates
s.000 7 no
2250 nous
: 007
£1300
000s
180
11006
o 4 8 6 20 2 28 32 36 wo
Ti (Yeu) Indtoa Rat Creda Creaton(100%2)
Indo Rat Crt Creaton(130%2)
Indo Rat Pe Money Creat 100%)
Inton Rat Pubic Money Creat 3
Figure 21: Money Supply and Inflation under Debt vs Public Money
inflation rates tend to become larger under the debt money system (line 2)
than under the public money system (line 4) against the over-supply of money
(130%). From these observations, it is concluded that monetary stability is
better preserved under the public money system than under the debt money
a driving force to expand credit
creation due to the increase in interest income of bankers
This drive is shown to
worsen wage distribution simultancously, triggering credit crunch and economic
Money supply is also defined in terms of base money as
Money Supply (M1) = m * Base Money (M0) (19)
where m is a money multiplier. Under a full reserve system, money multiplier becomes unitat
m = 1, so that no more money can be
to say, no money out of nothing is c
reated by commercial banks than base money; that
ated.
24
recession. In short, debt money system is demonstrated to be a system of
monetary and financial instability. This can be reconfirmed here by Figure
22. Specifically, lines 1 and 2 in the left-hand diagram show that net interest
) s for a higher level of
credit creation, as already shown above. Compared with these behaviors, lines
income of bankers under a debt money system increas
3. and 4 indicate that net interest income of bankers does not increase extremely
for a higher level of public money creation under the public money
Moreover, net interest incomes of bankers (lines 1 and 2) become all the time
higher than those of banke
This may ically di
under a public money system (lines 3 and 4).
iscourage bankers to borrow more money from the
Public Money Administration for higher interest income, compared with the case
of debt money system in which they can create credits by themselves unbound-
edly. In other words, greed will be subdued under the public money ¢
This doesn’t imply that the banking activities to pursue their self-interest are
suppressed. On the contrary, they will become more competitive one another
in a more fair financial market under the public money system.
‘Net Interest Income (Bankers) Wage Distribution
rr a TY
Tne Yeu)
Figure 22: Interest Income and Wage Distribution under Debt vs Public Money
Lines 1 and 2 in the right-hand diagram show that wage distributions get
stem, while lines 3 and 4 show that wage dis-
tributions do not so seriously get worsened for a higher level of public money
creation under the pubic money system. In addition, they stay closer one an-
other at a higher level compared with those under the debt money system. In
the case of debt money system, worsening distribution is shown to trigger credit
crunch, On the contrary, no such credit crunch will occur under the public
money system, simply because money (M0=M1) created by the PMA never get
crunched, and continue to stay in circulation, and be efficiently used for higher
opportunities.
der the public money
remove the chief cause of both booms and depressions [2, p.8, 1936]
worsened under a debt mone
Hence, financial stability can be more likely accomplished un-
tem. Quoting Irving Fisher’s words again, “it would
Monetary and Financial Stability
From the behavioral analyses above, it could be concluded that monetary and
financial stability can be better attained under the public money system than
25
the debt money system. This feature of stability can be fully illustrated by the
causal loop diagram of the public money system in Figure 23. Compared with
the causal loop diagram of the debt money system in Figure 17, bankers’greed
loop no longer exits. This implies that the reinforcing loop of credit creation
(or bankers’ greed loop) is gone. Moreover, the balancing loop of credit crunch
(or income inequality loop) which has played a decisive role of causing “booms
and depres
ns” fails to find its place under the public money
“> Financial
Investment
™ Money
Money niga
_ . *,
Factor Income Public Money
(Wages and Profits) as A (Loans)
Asneaite AD GDP Monetary C< Constraint
Demand
Desired
Consumption Borowing
Investment eid
Consumption Interest Income
(Bankers) "(pankers)
Figure 23: Causal Loop Diagram of Public Money System
To examine these qualitative differences, comparative sensitivity tests are
performed for the variable of Desired Borrowing (Banks) that is the amount of
money banks want to raise to meet the loan demand from producers. Specif-
ically, this amount is assumed to change between 20% and 180% according to
random normal distribution with mean = 1 and standard deviation = 0.2:
20% < Level of Desired Borrowing(Banks) < 180% (20)
Figure 24 compares how inflation rates tend to occur under debt and public
money systems. Under the debt money system, inflation rates approximately
range between -1.1% and 3% with 95% of chance, while its range only falls,
roughly speaking, between -0.1% and. 0.5%, a factor of 7 smaller under the
public money system! Indeed, monetary stability is shown to be most likely
attained under the public mon
Figure 25 compares how wage distributions tend to get worsened. Under the
public money system wage distribution is maintained above 53% with 95% of
stem.
26
Salome
° w 30 w wo 8 0 30 30 7H
Yow Time (Year)
Figure 24: Debt-vs Public System Sensitivity: Inflation Rates
chance. On the contrary, the minimun range seems to further decline to 15%
with the same 95% of chance under the debt money system due to the existence
of bankers’ greed loop as discussed above.
Sent Debg =——
Se SS ose
Seasiivty Pubic)
ce on en |
Wage Distribution
os
06
oa
02 |
30
Time Yeu
Figure 25: Debt-vs-Public System Sensitivity: Wage Distribution
These substantial differences of wage distribution affect the behaviors of
GDP. Figure 26 compares how GDP are attained. With 95% of chance, GDP
will remain within the range of $460 and$630 under the public money system,
while GDP ranges from $380 to $630. This may be due to the financial instability
under the debt money system so that producers cannot rely on the stable loans.
Samm
© 7 30 Ww 0 ° 16 30 w 7
Year Time ea
Figure 26: Debt-vs-Public System Sensitivity: GDP
27
These comparative anal: do not imply that the public money
system fully attains monctary and financial stability and becomes free from
“booms and depressions”. Yet, as I have demonstrated in [8], monetary and
financial instabilities, once triggered by inflation and recession, can be better
managed by applying public money policies under the public money system than
traditional Keynesian monctary policies under the current debt money
Conclusion
This paper tries to comparatively explore monetary and financial stability under
the current debt money system and alternative public money system (proposed
by the American Monetary Act) by constructing a simplified macroeconomic
model of endogenous money creation. In the debt money system we hav
tified a reinforcing loop of credit creation called “Bankers’ Greed” , and a :
ing loop of credit crunch called “Income Inequality”. Due to these two opposing
loops built in the system, our simulation analysis found, unstable behaviors of
economic growth and inflation rat ‘apably triggered. In other words,
monetary and financial instability is built in the debt money s
On the other hand, Bankers’ Greed motives that increase bankers’
income and worsen income inequality are shown to be averted under the public
money system, because bankers lose their power to create credit. In addition,
a relatively small income inequality that still remains does not trigger credit
crunch, simply because public money never get crunched. Hence, two opposing
loops that cause credit creation and crunch are shown to have gone from the
public money system, subduing “boom and depressions” .
From these analyses it is concluded that the current debt money s
tem of monetary and financial instability, while the public money
stability.
are ines
stem of the true monetary and financ
28
References
(1)
N
Paul Douglas, Irving Fisher, Frank D. Graham, Earl J. Hamilton, Will-
ford I. King, and Charles R. Whittlesey. A program for monetary reform.
In The so-called Chicago Plan mimeograph circulated among economists,
Chicago, July, 1939.
Irving Fisher. 100% Money and the Public Debt. ThaiSunset Publications,
Thailand, Originally 1936, 2009.
Milton Friedman. A Program For Monetary Stability. Fordham University
Press, New York, 1960, 1992.
Steve Keen. Debunking Economics. Zed Books, London, New York, 2011.
Kaoru Yamaguchi. Principle of Accounting System Dynamics~ Modeling
Corporate Financial Statements —. In Proceedings of the 21st International
Conference of the System DynamicsSociety, New York, 2003. System Dy-
namics Society.
Kaoru Yamaguchi. Integration of Real and Monetary Sectors with Labor
Market: SD Macroeconomic Modeling (3). In Proceedings of the 24th In-
ternational Conference of the System Dynamics Society, Nijmegen, The
Netherlands, 2006. The System Dynamics Society.
Kaoru Yamaguchi. On the Liquidation of Government Debt under A Debt-
free Money System: Modeling the American Monetary Act. In Proceed-
ings of the 28th International Conference of the System Dynamics Society,
Seoul, Korea, 2010. The System Dynamics Society.
Kaoru Yamaguchi, Workings of A Public Money m of Open Macroe-
conomies: Modeling the American Monetary Act Completed. In Proce
ings of the 29th International Conference of the System Dynamics Society,
Washington D.C., USA, 2011. The System Dynamics Society.
Stephen Zarlenga. The Lost Science of Money: The Mythology of Money -
the Story of Power. American Monetary Institute, New York, 2002.
Stephen — Zarlenga. Presenting the American — Monetary
Act (as of July 18, 2009. American Monetary Institute,
http//:www.monetary.org/32pageexplanation.pdf, 2009.
