Confessions of a Supply-Side Liberal

A Partisan Nonpartisan Blog

Posts tagged money

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Allison Ross: Many Don't Carry Much Cash Any More

As you can see from the link above, for most people, it might not be that big a deal if paper currency were demoted, as I advocate in my column “How Subordinating Paper Money to Electronic Money Can End Recessions and End Inflation.” For those who actually use paper currency a lot, the system I advocate would help them financially because it would lead to lower inflation, and therefore a lower implicit tax on paper currency. And of course, other than those who use it for illegal purposes, those who use paper currency for a large share of their transactions are more likely to be borrowers than lenders, so they would benefit in the short run from the low interest rates possible when the safest interest rates are negative. And in the long run, they would benefit along with everyone else from a more stable economy.   

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Q&A on Electronic Money and International Finance

Question: I can’t resolve a question I have about breaking the ZLB with electronic money, and it’s driving me nuts.

I re-read a couple of your posts that mention a kind of ‘first-mover’ advantage in breaking the zero lower bound: not only does a first-mover get the usual stimulus from lowering the interest rate, but the fact that it is the only country in the world that can offer such a low interest rate is likely to boost demand further.

I’m struggling with the effect on the supply of loanable funds within the first-moving country. Essentially, as the central bank lowers the interest rate, and economy-wide interest rates fall, won’t some investors begin to look abroad for better risk-reward alternatives? I know that it’s not costless or riskless to transfer to a different currency, but it seems that the central bank’s effectiveness in unilaterally changing interest rates would be hampered by the existence of outside options: either some interest rates will remain high or some agents will begin to ‘cash out,’ if you’ll pardon the pun, and move their money abroad. 

I hope it’s clear what I’m trying to ask. Would you help me figure out what I’m missing?

Answer: Great question. I am using logic from Mankiw’s textbook treatment of international finance, which I lay out in my post "International Finance: A Primer."

Basically, when people start investing abroad because rates of return are higher abroad, that is a capital outflow, and that is why exports go up. Capital outflows put domestic currency in the hands of those abroad. They don’t really want it, so exchange rates adjust until that currency (whether physical or virtual) makes its way back to its home country to buy exports. “Moving money abroad” is a stimulus to exports, because goods follow money.  

The only way an outside option would cause trouble is if firms starting setting prices and wages in a foreign currency. It is crucial that sticky prices and/or wages (or at least most of them) be set in terms of the electronic dollar (or whatever the domestic electronic currency unit is called). 

In my electronic money seminar, I make the point that, when they occur, negative interest rates on paper currency are not meant to disadvantage paper currency. What those negative interest rates on paper currency do is make it so there is nowhere to hide from the negative interest rates except by spending the money. You can send your own funds abroad, but then the person who took your dollars in exchange for their own currency now can’t hide from the negative interest rates except by spending the dollars. In that situation, by sending dollars abroad, you haven’t eliminated the hot potato of dollars earning a negative interest rate from the world, you have only made it someone else’s problem. The only escape from those negative interest rates is to spend the money, so someone—you or someone further down the chain—will be driven to spend it.  

Follow-up Question: Ok. In other words, this kind of behavior (bailing on the domestic currency) will just lead the exchange rate to adjust until some form of interest rate parity is achieved again. Is that the right?

Answer: No. There might continue to be an interest rate difference. But the international flow of funds to the higher interest rate stimulates exports through its effect on the exchange rate. 

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Paul Krugman: That 80s Show

Here is the key passage, but the whole thing is eminently worth reading:

What actually happened in the 80s, however, was that central banks — most famously the Fed, but also the Thatcherite Bank of England and others — drastically tightened monetary policy to bring inflation down. And inflation did indeed come down — eventually. But along the way there were deep recessions and soaring unemployment, which went on much longer than you could justify with any plausible story about the monetary shock being unanticipated.

This was very much a vindication of more or less Keynesian views about the economy, and the 80s were in fact marked by the New Keynesian comeback.

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Von Günter Heismann in the Süddeutsche Zeitung: Economists Ken Rogoff and Miles Kimball Want to Abolish Cash

I made it into the German press for wanting to demote—not abolish—cash, along with Ken Rogoff, who does indeed want to get rid of cash. (i wrote about Ken Rogoff’s views here.Google Translate works fine on this article. Thanks to Rudi Bachmann for letting me know about this article. 

See what I have to say about breaking through the zero lower bound with electronic money in "How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide." The article in the Süddeutsche Zeitung should have mentioned that I visited the European Central Bank and three of its associated national banks (France, Germany and Italy) to talk about how to keep paper currency from creating a zero lower bound. 

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Tomas Hirst on the Decline in the Medium-Run Natural Interest Rate

In the Alphaville post linked above, Tomas Hirst gives a persuasive account of why the level of interest rates that will hold after economic recovery is likely to be lower than in the past. 

(For the difference between the medium-run natural interest rate and the short-run natural interest rate, see “The Medium-Run Natural Interest Rate and the Long-Run Natural Interest Rate.”)

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Neil Irwin: Europe Likely to Get Negative Interest Rates. What Does That Even Mean?

This is of special interest to me because I am giving to the European Central Bank on July 7 to explain how to eliminate the zero lower bound. If the ECB has decided to go to negative interest rates, it has already crossed the political rubicon. I will argue that eliminating the ZLB is therefore politically manageable. 

Note: I have organized what I have written about facilitating negative interest rates in "How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide" and wrote about it recently in “Ken Rogoff: Paper Money is Unfit for a World of High Crime and Low Inflation.”

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Ken Rogoff: Paper Money is Unfit for a World of High Crime and Low Inflation

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Ken Rogoff

The day when the zero lower bound is finally eliminated continues to inch closer. Ken Rogoff—who is not only a deep-thinking economist, but continues to be a policy heavyweight despite the weak hand he and Carmen Reinhart made the mistake of playing in relation to national debt and economic growth—has come out in favor of eliminating the zero lower bound.  He followed up a new NBER Macroeconomics Annual Chapter "Costs and Benefits to Phasing Out Paper Currency" with a May 28, 2014 article in the Financial Times: “Paper money is unfit for a world of high crime and low inflation.” Ken’s argument is straightforward:

Has the time come to consider phasing out anonymous paper currency, starting with large-denomination notes? Getting rid of physical currency and replacing it with electronic money would kill two birds with one stone.

First, it would eliminate the zero bound on policy interest rates that has handcuffed central banks since the financial crisis. At present, if central banks try setting rates too far below zero, people will start bailing out into cash. Second, phasing out currency would address the concern that a significant fraction, particularly of large-denomination notes, appears to be used to facilitate tax evasion and illegal activity.

As disadvantages of eliminating paper currency, Ken lists loss of seignorage and loss of anonymity where anonymity might be socially valuable in allowing personal experimentation that does not harm others. On both of those counts, keeping paper money in a subsidiary role can avoid these disadvantages. In particular, if paper currency is allowed to depreciate in relation to electronic money, it is possible to have seignorage without inflation, since if there is no inflation relative to the electronic money that serves as the unit of account, inflation relative to paper money is not really inflation at all.  

Ken gives appropriate credit to Willem Buiter for working out theoretically the basic options of eliminating the zero lower bound: 

The idea of finding creative ways to get around the zero bound on interest rates has been championed for more than a decade by Willem Buiter, a former UK Monetary Policy Committee member. Phasing out paper currency is by far the simplest. With electronic payments mechanisms becoming increasingly prevalent even in small transactions, and with the supply of paper currency overwhelmingly top-heavy with large-denomination notes, the case for keeping the currency status quo has weakened.

In my own recognition of Willem’s contributions, Willem appears as “Willem the Wise Warlock” in "The Story of Ben the Money Master." (See also "Henrik Jensen: Willem and the Negative Nominal Interest Rate"

Ken argues that, of the options Willem lays out “Phasing out paper currency is by far the simplest.” Simplest is not necessarily best in this case. Although phasing out of paper currency may well be the ultimate destination for our monetary system, I continue to believe that at least as a transitional phase, it is attractive to start with monetary system that is as close as possible to the current system, consistent with eliminating the zero lower bound: the system I have written about repeatedly, in some detail, and have been explaining at central banks around the world. 

Once the zero lower bound has been eliminated with a system as much like the current monetary system as possible, it is easy, if desired, to make a transition toward less use of paper currency by allowing paper currency to depreciate without ever appreciating it back to par. The quicker the depreciation of paper currency, the bigger the tax on activities that depend on then anonymity of paper currency—many of which (like criminal activity) do indeed deserve to be taxed. The higher the tax on paper currency (that is, the quicker the depreciation), the closer the monetary system would approximate the abolition of paper currency.

Note: Negative interest rates themselves are not a tax. When interest rates are negative, the money paid by the lender as a “carry charge” goes to the borrower, not the government. But setting a paper currency interest rate below the central bank’s target interest rate is a tax. In the system I have been advocating, the tax on paper currency is actually less than under the current system, since (a) inflation would be lower and (b) there would only be negative interest rates on paper currency when the central banks’ target rate was also negative, and the paper currency interest rate would be kept very close to the target interest rate during that period of negative rates.)  

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