Markets, Productivity, and Happiness in a Historical Perspective

Mints and Friedman on fractional-reserve banking: How credit cycle analysis was left out of monetarism

Demeulemeester Samuel , Triangle

Milton Friedman supported the idea of a “100% money” reform on many occasions all along his career, explicitly claiming to follow, in this respect, the authors of the 1930s’ Chicago Plan, such as Simons and Mints. Unlike them, however, he considered such a reform to be “desirable” but not necessary, because, on the one hand, the adoption of deposit insurance in 1934 had largely ruled out the risk of bank failures, and, on the other hand, monetary instability was above all caused, in his view, by the failures of discretionary policy. In this article, I highlight another reason why the “100% money” idea has not been a central feature of Friedman’s monetary thought, which relates to his interpretation of bank money instability. Although Friedman, like his predecessors of the 1930s, denounced the “inherent instability” of the fractional-reserve banking system, his explanations were fundamentally different. The original Chicago Plan, in 1933, was based on an analysis of credit cycles: when explaining the instability of bank-created money, these authors emphasized the decisions of lenders and borrowers as part of a process involving cumulative changes in profits, bank loans and deposits. Friedman, on the other hand, solely focused on the decisions of money holders as to the form (cash or deposits) in which they preferred to hold their money balances. These decisions, he held, because of the different reserve requirements respectively applying to notes and deposits, would explain the system’s inherent instability. Any consideration of a credit cycle having to do with lending and borrowing decisions was absent from his analysis. This explains why, alternatively to 100% money, Friedman was ready to support totally opposite reforms, such as allowing the banks to issue bank notes as well as deposits, or eliminating all reserve requirements behind deposits. These notable differences between Friedman and his Chicago predecessors never seem to have been stressed in the literature so far. It appears that Lloyd Mints — who, in the 1940s, exerted a certain influence on Friedman — may have played a key role in this evolution.


Keywords: Friedman, Mints, 100% money, Chicago Plan, fractional-reserve banking