Icelandic MP posits radical monetary reform

Report proposes scrapping fractional reserve banking and handing Central Bank of Iceland authority over money creation; central bank says it is not considering the plans further
Central Bank of Iceland
The Central Bank of Iceland

A report commissioned by the Icelandic prime minister proposes scrapping the country's system of fractional reserve banking and handing the Central Bank of Iceland sole authority over money creation.

The report is authored by Frosti Sigurjónsson, a member of Iceland's ruling Progressive Party. In it he argues the central bank is "not in control of the money supply", as lending by commercial banks is the main determinant of money in circulation, with central bank interest rates relegated to a secondary role.

From 1986 to 2006 Iceland's GDP grew by an average of 3.2% a year, but the money supply rose by an average of 18.6%, Sigurjónsson says. He calls this a "leading cause" of inflation in the run-up to the financial crisis and the subsequent crash and devaluation of the króna.

Furthermore, he warns, because the government guarantees bank deposits, giving an implicit subsidy to the banking system, which in turn encourages risky lending.

As an alternative, Sigurjónsson proposes a "sovereign money system", under which all money is created by the central bank.

Under the system, consumers have a "transaction account" for making payments, and an "investment account" to invest their savings at longer maturities.

Banks continue to take these deposits, as well as continuing to offer payments, but all demand deposits (the transaction accounts) are held at the central bank.

Banks also continue to lend money, but only from the investment account. When this is lent it is transferred to the transaction account and deposited at the central bank.

Money is created as necessary by the central bank and enters circulation via the government cutting taxes, repaying public debt or issuing a citizens' dividend. The central bank also lends to commercial banks for onward lending to the real economy. Decisions are taken by an independent committee, much like the existing one.

Sigurjónsson argues his system will make banking less risky, reduce the likelihood of bank runs, reduce debt in the economy and boost the dividends paid by the central bank to the state.

"The sovereign money proposal seems to offer a very promising basis for reform," he writes. "It is therefore recommended that a feasibility study of its potential implementation in Iceland will be conducted."

Adair Turner, the former head of the UK's Financial Services Authority, wrote the foreword to the report. Turner has backed radical ideas in the past, including ‘helicopter money', but hedged his endorsement of the report by saying "the feasibility and merits of that specific solution need to be debated".

The government was also cautious in its response, calling the report an "important contribution" but adding: "further study is needed".

A spokesman for the Central Bank of Iceland said it did not have any plans to investigate Sigurjónsson's proposals further.

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