In June 2018, the Swiss people will vote on a sovereign money initiative.1 This initiative proposes to drastically reform the monetary system by transferring all sight deposits in Swiss francs off commercial bank balance sheets and depositing them at the Swiss National Bank (SNB). This would be consistent with previous proposals for 100% reserve requirement (Benes and Kumhof 2012, Cochrane 2014, or Prescott and Wessel 2016).
The initiative would introduce several fundamental changes to the Swiss constitution. It would declare that money is not debt, and that the SNB could distribute funds to the state or directly to households. The SNB would also guarantee a sufficient supply of credit by financial intermediaries and would be allowed to impose minimum holding periods on financial assets.
A debate on monetary reforms is obviously of academic interest, but the debate in Switzerland has now reached the political arena, in which the arguments are less rigorous and often confused or misleading. Most politicians and economists have spoken against the initiative, but it is nevertheless useful to review the arguments, and examine its potential implications from an economic perspective. I have done this in a recent paper (Bacchetta 2018).
The initiative has ethical and political motivations that ignore most of what we know about macroeconomics or monetary economics. One motivation is negative sentiment towards commercial banks following the recent financial crisis. In particular, promoters of the initiative would like to suppress the ability of banks to 'create' money through sight deposits and would like to take more of their profits. They also claim that the reform would avoid financial crises and generally increase financial stability, and often accuse critics of the reform of being advocates for the interests of the banks.
My survey is negative about the initiative. Some of the issues relate to basic weaknesses behind the proposals of sovereign money, but other issues are specific to the planned implementation of the Swiss case. In Bacchetta and Perazzi (2018), my co-author and I show that the redistributive impact of the Swiss reform clearly decreases welfare, and there could be better ways to implement a sovereign money reform.2 In particular, the proposed reform:
- would require that reserves at the SNB do not pay any interest,
- deals only with sight deposits in domestic currency (representing less than 20% of bank liabilities), and
- imposes various restrictions on the SNB
Moreover, several aspects of the implementation are not specified, which introduces a high degree of uncertainty.
Mistaken claims behind the reform
Some arguments for the reform are based on claims that are either incorrect or inconsistent with empirical evidence.
- Banks and money creation. One can distinguish between two perspectives: on one hand, banks can create deposits when granting loans; on the other hand, banks serve as intermediaries between deposits and loans. As explained for example by Tobin (1963), these two perspectives are consistent. In equilibrium the amount of deposits created by banks has to be equal to the amount desired by depositors, and the central bank can influence this equilibrium. There is, however, a group that only accepts the first perspective and rejects the second one, which is obviously incorrect.3 This leads to theclaim that banks create money 'out of thin air'. Supporters of sovereign money find this freedom unacceptable, and consequently believe that the central bank should control sight deposits. But this belief is based on the incorrect view of 'monetary mysticism'.
- Sovereign money and financial crises. Theoretically the claim that sovereign money can avoid crises could be correct if the crises were caused by a run on sight deposits, similarly to a Diamond-Dybvig bank run. But no financial crisis in recent decades has been caused by such a run. Defenders of sovereign money also claim that controlling deposits would allow stabilisation of credit. This in turn would help stabilise the business cycle. But this reasoning would require a high short-run correlation between money and credit. Empirically, this is not the case. Schularick and Taylor (2012) have actually shown that, while there was a close link between credit and broad money before WWII, there has been a decoupling since then. In the Swiss case, we find no correlation between the monthly changes in money and credit.
What impact would the reform have?
Independent of the arguments for and against reform, we can also ask what would happen if it occurred.
Stage 1: Sight deposits are excluded from balance sheets, but bank funding is unchanged due to loans from the central bank.
The focus is then on the redistribution of resources among banks, the state and depositors. I examine this using a model of monopolistic competition of banks. Since results depend on the level of interest rates, I consider the pre-crisis period 1993-2006. (For the current period of roughly zero interest rates, redistribution effects were negligible.) Table 1 shows the results in a benchmark case. Not surprisingly, the central bank would gain because it does not pay any interest rate on deposits. On the other hand, the absence of interest payment means depositors would lose, as they also have to pay for operational costs. The impact on banks would be more limited. Overall, the reform would generate an aggregate loss.
Table 1 Redistributive impact of Swiss sovereign money proposal, phase 1, as annualised percentage of GDP
Note: Does not include cost to borrowers, additional costs to SNB, regulation costs.
Phase 2: Banks find alternative sources of funding to replace sight deposits.
Beyond the phase 1 redistribution, several aspects of the reform would have significant macroeconomic implications. Alternative funding, for example through international financial markets. is likely to be more expensive and would in principle raise the cost of borrowing. Alternative funding is likely to be less stable than domestic sight deposits, and may increase instability. The reform would also interfere with fiscal policy by increasing central bank transfers.
It would clearly hamper monetary policy. The SNB may no longer be able to use its current instruments, which work in a large part through a quick impact on the monetary base. This would imply that the SNB returns to monetary targeting. The SNB adopted such a strategy after the end of the Bretton Woods system until 2000, when it shifted to a policy focusing on inflation forecasts and on the control of short-term interest rates. There were good reasons to abandon such a system and going back to it would clearly lead to worse monetary policy. More generally, setting constraints in the Federal constitution on the way monetary policy can be implemented would be undesirable and inconsistent with central bank independence.
The implementation of sovereign money would represent a major economic reform in any country, and so a thorough economic analysis would seem to be a prerequisite to its implementation. But both the motivation and the specifics of the proposed reform in Switzerland have abstracted from current knowledge in economics. It is a weakness of the Swiss democratic system that citizens can vote on economic initiatives in the absence of this type of analysis.
Bacchetta, P (2018), “The soveregn money initiative in Switzerland: an economic assessment,” Swiss Journal of Economic and Statistics 154(3): 1-16. (see also CEPR Discussion Paper 12349)
Bacchetta, P and E Perazzi (2018), “Sovereign Money Reforms and Welfare," mimeo.
Benes, J and M Kumhof (2012), “The Chicago Plan Revisited,” IMF working paper WP/12/202.
Cochrane, J H (2014),"Toward a run-free financial system", in M N Baily and J B Taylor (eds.) Across the Great Divide: New Perspectives on the Financial Crisis, Hoover Press.
Prescott, E C and R Wessel (2016), “Monetary Policy with 100 Percent Reserve Banking: An Exploration", NBER working paper 22431.
Schularick, M and A M Taylor (2012), “Credit Booms Gone Bust: Monetary Policy, Leverage Cycles and Financial Crises, 1870-2008," American Economics Review 102: 1029-61.
Tobin, J (1963), “Commercial Banks as Creators of 'Money'", Cowles Foundation paper 205.
 For details on the initiative see the SNB website or the website of the initiative committee.
 In Bacchetta and Perazzi (2018) we conduct an analysis in the spirit of Benes and Kumhof (2012), but we use a simpler framework and assumed a small open economy calibrated to the Swiss economy. We also focus on the specific Swiss reform. We find that there wasisa key trade-off between a reduction in distortionary labour taxes, and an increase in the opportunity cost of holding money. In the proposed Swiss reform it would be the latter cost that would dominate. We therefore find that the reform would unambiguously lower welfare.
 They also argue that most economists do not understand how banks work, since economists' models tend to focus on the second perspective. In his blogs, Paul Krugman has called this view 'monetary mysticism' or 'banking mysticism', related to the 'mystique of money' in Tobin (1963).