Fully Reserve-Backed Money: A Solution to Japan’s Fiscal and Monetary Challenges

Modern monetary systems rely on two money creation channels: the issuance of new banknotes by the central bank and increases in loans by commercial banks financed by cash deposits. The latter are possible, because bank deposits that are meant as means of exchange by their holders are subject to very low minimum reserve requirements. For a long time, renowned economists have proposed to protect cash deposits fully by 100% reserve requirements, because depriving banks from creating new money would stabilise the financial system. The chapter argues that, under the prevailing fiscal and monetary conditions, Japan would greatly benefit from shifting to a 100% reserve-backed money regime. Such a move would not only take advantage of the benefits propagated by the supporters of a reserve-backed regime. The implied Bank of Japan’s (BoJ) balance sheet expansion would allow the Bank to purchase further Japanese Government Bonds (JGB). As the expansion would be permanent, the regime shift would not only stabilise the government’s fiscal condition, the BoJ, too, would no longer have to worry about exiting from its policy of quantitative easing. Both the government and the central bank could focus on their primary policy goals. The shift to a 100% regime would also very likely reduce Japan’s very high ratio of cash to GDP.