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. The latter is possible, because bank deposits that are used as means of payment by their holders are subject to very low minimum reserve requirements. Since long, renowned economists have argued in favour of a 100% reserve backed monetary regime to stabilize the financial system. As a result of the combination of

a) saving surpluses in Japan’s non-financial corporate sector and

b) extreme quantitative monetary easing by the BoJ,

de facto deposit reserve ratios have steadily increased.

The paper argues that Japan’s legislators should use this window of opportunity to introduce 100% de jure reserve requirements for transfer deposits. Such a move would not only take advantage of the benefits propagated by supporters of a reserve-backed regime. The implied BoJ’s balance sheet expansion would allow the Bank to further purchase JGBs. As the expansion would be permanent, the regime shift would not only stabilize the government’s fiscal condition, the BoJ, too, would no longer have to worry about exiting its policy of quantitative easing. Both the government and the central bank could focus on their primary policy goals.

Keywords: Japan, monetary policy, qualitative easing, fiscal debt, reserve backed money

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