Separating payments from lending
The Chicago Plan tried to solve a problem built into ordinary banking: the same deposit can look like money to a customer and like funding for a loan to a bank. When a bank makes a loan, it typically credits the borrower with a new deposit. That deposit can then be spent and transferred elsewhere, expanding the money people use to pay bills.
Under the plan, a bank’s payment accounts would have to be backed in full by money held as reserves—cash or balances at the central bank. A customer could still make payments from an account, but the bank could not use that account’s backing to finance a mortgage or business loan. Lending would instead rely on other funding, such as investors’ capital or funds specifically placed with the bank for that purpose.
Why the proposal followed bank runs
The idea took shape among economists associated with the University of Chicago during the Great Depression, when waves of bank failures made deposits seem unsafe. If many customers demanded their money at once, a bank that had lent much of it out could not repay everyone immediately. Full reserves were intended to make payment accounts safer and prevent lending from creating additional deposit money.
The tradeoff was substantial. Banks could no longer expand deposit money through lending, so control over the amount of money in circulation would shift more directly toward the government or central bank. Credit would still be possible, but its supply and cost could change because lenders would need funding from sources other than ordinary payment deposits.
The proposal was never adopted. Its lasting significance is the question it puts plainly: should the money people rely on for everyday payments also be the pool banks use to fund loans? The Chicago Plan’s answer was no—and that separation would have changed both the safety of deposits and the way credit reached borrowers.
