Confessions of a Supply-Side Liberal

A Partisan Nonpartisan Blog

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Paper Currency Policy: A Primer

The title is a link to storified tweets. I have transcribed them below as well. The last tweet is a link to what will be tomorrow’s post. So you can get a sneak peak.  

  1. Let me explain paper currency policy a little more. Our current paper currency policy is that 1 paper $ = 1 electronic $ always.
  2. Let’s treat the electronic $ (e-$) as our yardstick—the unit of account. We want to encourage people to state prices in terms of the e-$.
  3. With 1 paper $ = 1 electronic $ all the time, paper currency earns a zero rate of interest. So people won’t lend at a worse negative rate.
  4. So a paper currency policy of pegging paper currency at par (1 p-$ = 1 e-$) puts a floor of zero under interest rates.
  5. Like other price floors, a floor of 0 on interest rates messes up markets big time when the equilibrium interest rate would otherwise be <0.
  6. We see the messed up markets from the floor of 0 on interest rates all around us these days in the troubled world economy.
  7. The alternative paper currency policy looks like this: In January 2013, 1 paper $ = 1 e-$. In January 2014, 1 paper $ = .95 e-$.
  8. If 1 paper $ = 1 e-$ now, but 1 paper-$ = .95 e-$ a year from now (95 e-cents), then paper currency effectively earns a -5% interest rate.
  9. Call our current paper currency policy “pegging at par.” (Par: 1 p-$=1 e-$) The alternative paper currency policy is called a crawling peg
  10. With a crawling peg that allows paper currency to depreciate relative to electronic money, paper money earns a negative interest rate.
  11. If the crawling peg makes paper money earn -5%, there is no reason the Fed can’t choose any interest rate above -5%.
  12. Institutionally, the Fed should be given control of paper currency policy and have the target rate and ROR on paper money move together.
  13. ROR = rate of return = effective interest rate in a case like this, when the ROR is a fixed, certain number.
  14. The Fed should move the effective interest rate on paper money in tandem with the fed funds rate and the interest rate on excess reserves.
  15. For those just tuning in, here is my first column on electronic money and a followup column: http://qz.com/21797/the-case-for-electric-money-the-end-of-inflation-and-recessions-as-we-know-it/   http://qz.com/35991/could-the-uk-be-the-first-country-to-adopt-electronic-money/
  16. Twitter Round Table on Our Disastrous Policy of Pegging Paper Currency at Par: http://storify.com/mileskimball/twitter-round-table-on-our-disastrous-policy-of-pe

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  1. supplysideliberal posted this