Confessions of a Supply-Side Liberal

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The Wall Street Journal’s Big Page One Monetary Policy Mistake


                    Ian Talley                                         Brian Blackstone

(I couldn’t validate any Google image of Raymond Zhang)

Working at the Wall Street Journal, Ian Talley, Brian Blackstone and Raymond Zhang are near the top of the heap for reporters. And I evidenced in my post "Will the ECB Go Negative?" my admiration for Brian Blackstone’s reporting in "ECB Mulls Bolder Moves to Guard Against Low Inflation: Officials Indicate They Will Consider Negative Interest Rates, Asset Purchases." So it is disappointing to see Ian, Brian and Raymond write last Monday in ”Global Signs of Slowdown Ripple Across Markets, Vex Policy Makers" something that is seriously misleading, whether from ignorance, depending too much on what central bank officials and other government officials say, or an unwillingness to complicate their narrative. (You can jump over the paywall just by googling the title.) They write:

More than five years after the recession, officials are facing a difficult policy environment: Major central banks, which stepped up repeatedly to ease fears and energize markets, are reaching the limits of their powers.

Except perhaps due to legal limitations that Ian, Brian and Raymond do not address, this is not true. As I told at attentive audience at the European Central Bank in July, the European Central Bank could cut its target rate to negative 1.25% immediately, as long as it charges a time-varying fee when private banks deposit paper currency at a cash window of the European System of Central Banks. The European Central Bank should do exactly that. 

After the title, the first slide in my Powerpoint file “Breaking Through the Zero Lower Bound” says

The zero lower bound is a policy choice, not a law of nature. 

Here is a list, copied from my post "Electronic Money: The Powerpoint File" of places I have presented or am slated to present this seminar (other than the University of Michigan, where I have presented it multiple times to different audiences):

  • Bank of England, May 20, 2013
  • Bank of Japan, June 18, 2013
  • Keio University, June 21, 2013
  • Japan’s Ministry of Finance, June 24, 2013
  • University of Copenhagen, September 5, 2013
  • National Bank of Denmark, September 6, 2013
  • Ecole Polytechnique (Paris), September 10, 2013
  • University of Paris, September 12, 2013
  • Banque de France, September 13, 2013
  • Federal Reserve Board, November 1, 2013
  • US Treasury, May 19, 2014
  • European Central Bank, July 7, 2014
  • Bundesbank, July 8, 2014
  • Bank of Italy, July 11, 2014
  • Swiss National Bank, July 15, 2014
  • Princeton University, October 13, 2014
  • Federal Reserve Bank of New York, October 15, 2014
  • New York University, October 17, 2014
  • European University Institute (Florence), October 29, 2014
  • Qatar Central Bank and Texas A&M University at Qatar joint seminar, November 17, 2014

There has also been quite a bit of discussion of my proposal in online journalism, including quite a few interviews listed in my bibliographical post "How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide." To quote Paul of Tarsus, "these things were not done in a corner." 

I have now been to enough central banks that I can talk about their reaction without revealing inside information about any particular central bank. Both the staff in each central bank and the 7 members of monetary policy committees who heard my arguments took my proposal for a time-varying paper currency deposit fee very seriously. Some in each category want to take things to the next step of preparing for possible implementation. Everyone recognizes that subordinating paper currency to electronic money is a big step, and not one to be taken lightly.    

There are two reasons why I think that the kind of thing I propose will in fact happen. The first is that technical progress will lead to an increased fraction of transactions happening in electronic form in the future—that is with credit cards, debit cards, electronic transfers, etc. The second is that there are many central banks in the world, each of which faces a different political situation. Once one central bank puts a time-varying paper currency deposit fee into its toolkit, it becomes much easier for other central banks to do so.

To understand how different the political situations faced by different central banks can be, consider a central bank in a nation that has been running about 6% inflation for quite some time that decides it is time to go down to a lower level of inflation. If as part of bringing its inflation rate to zero, that central bank puts in place the machinery for breaking through the zero lower bound with a time-varying paper currency deposit fee, it will be hard to accuse that central bank of following a “soft-money policy.” And it will be hard to complain about the possibility of future negative interest rates during a time when the central bank has raised interest rates to begin gradually reducing its inflation rate.    

There are many practical reasons why people would want to know about the possibility of (a) negative interest rates, (b) an exchange rate or paper currency that is away from par, and (c) inflation targets well below 2% for major central banks at some point in the future. Investors in the stock market would care. Bond traders would care. Bankers would care. Anyone writing a debt contract would care. The Wall Street Journal should clue its readers in—as many other news organizations have.

The overall tenor of Ian, Brian and Raymond’s article is to talk about the many different approaches that are being discussed to deal with the persistent slump in Europe. But they missed the best and most straight forward approach: for the European Central Bank to cut it target rate to -1.25% with the help of a time-varying paper currency deposit fee.

The discussion in my seminar at New York University last Friday made me appreciate a little more the virtues of my very first column on eliminating the zero lower bound: "How Subordinating Paper Currency to Electronic Money Can End Recessions and End Inflation." And you can see the later development of the ideas in the Powerpoint file and in the other posts I lay out in "How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide."  

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Terry Pratchett: How High Interest Rates Hurt the Poor


Link to Wikipedia article on Terry Pratchett’s Men at Arms

Part of the resistance to monetary policy remedies to serious recessions comes from the idea that high interest rates are inherently good. Not so. High interest rates are good for those earning them, and bad for those who are paying them. It is not clear that those who earn high interest rates are always morally more deserving than those who pay them. Through one of his fictional characters, Terry Pratchett gives this example of the suffering sometimes caused by high interest rates that make it hard to make good investments.  

The reason that the rich were so rich, Vimes reasoned, was because they managed to spend less money.

Take boots, for example.  He earned thirty-eight dollars a month plus allowances.  A really good pair of leather boots cost fifty dollars.  But an affordable pair of boots, which were sort of OK for a season or two and then leaked like hell when the cardboard gave out, cost about ten dollars.  Those were the kind of boots Vimes always bought, and wore until the soles were so thin that he could tell where he was in Ankh-Morpork on a foggy night by the feel of the cobbles.

But the thing was that good boots lasted for years and years.  A man who could afford fifty dollars had a pair of boots that’d still be keeping his feet dry in ten year’s time, while a poor man who could only afford cheap boots would have spent a hundred dollars on boots in the same time and would still have wet feet.

This was the Captain Samuel Vimes “Boots” theory of socioeconomic unfairness.

The upshot is that the good boots cost less if you can borrow to buy them at a reasonably low interest rate, but if you either can’t borrow at all, or can only borrow at a very high interest rates, you face high expenses either way: either paying high interest rates on the money you borrowed to buy good boots, or paying to replace the bad quality boots frequently. The rich effectively face low interest rates, while the poor face high interest rates.  

Stepping away from the difference in interest rates the poor face as compared to the rich, whatever the level of interest rates, the poor are likely to suffer more from a given increase in all interest rates simply because they are more likely to have a negative wealth position that makes them pay interest on net, while the rich are more likely to have a positive wealth position that enables them to receive interest on net. So it takes more to justify high interest rates than to say that they are always better morally and ethically than low interest rates. If high interest rates make the economic system as a whole work better, that could be a good justification. But when low interest rates would help the economic system as a whole work better, any complaints by those earning low interest rates as a result need to be counterbalanced by the benefits to those paying low interest rates. 

Hat tip to my brother, Joseph Kimball, for pointing me to this passage

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Jo Craven McGinty: Easy to Lose and Expensive to Produce: Is the Penny Worth It?

Like my graduate school advisor Greg Mankiw, I am for the abolition of the penny. This Wall Street Journal article gives good reasons why. If you hit the paywall, googling the title like this jumps over it. 

The problem with pennies isn’t just the cost of producing them, it is the extra time it takes to handle them. My former student Ed Knotek provides some evidence that there are costs to non-round transaction amounts in this paper. (There is no problem with individual items having non-round prices, if the total transaction amount rounded off. Ed’s evidence is that items that are often purchased individually, rather than as part of a basket, often are given round prices. Establishing that it is legally OK to round off transactions amounts to the nearest or next nickel is what getting rid of the penny is all about.)  

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Leaving Dead Presidents in Peace: Callum Williams of the Economist Picks Up on Ken Rogoff's Pitch for Abolishing Cash

This is a nice article by Callum Williams in the Economist, picking up on Ken Rogoff’s pitch for abolishing cash.  

For clarity, I wanted to distinguish my approach from Ken Rogoff’s.  I wrote in "Q&A: Apple Pay and the Future of Electronic Money" 

I think physical cash is likely to play a minor role for a long time after it has been mostly eclipsed by electronic payment. For example, I think the strong demand for anonymity for certain kinds of purchases will make it very hard to eliminate paper money entirely. (If we tried to abolish paper dollars entirely, people would start using paper euros or yen or pounds for the purchases they wanted to make anonymously.)

So it is important to make some provision for what happens with paper currency rather than just assuming it can be abolished. 

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Richard Serlin: In Theory (but Not in Practice) the Minnows Counter the Whale to Yield Wallace Neutrality


white whale handbag with black minnow zipper pull

Wallace Neutrality says that in theory, quantitative easing (QE) should do almost nothing. (See "Wallace Neutrality Roundup: QE May Work in Practice, But Can It Work in Theory?") In the Twitter discussion I storified as "Noah Smith, Brad DeLong and Miles Kimball on Wallace Neutrality," Noah raised a question of how Wallace Neutrality works. Richard Serlin, who has made himself one of the world’s experts on Neil Wallace’s original paper, was good enough to  agree to write a guest post giving his answer:


Miles kindly asked me to comment on the recent Twitter discussion he had with Berkeley economist Brad DeLong and Stony Brook economist Noah Smith on Wallace neutrality. He was specifically concerned with how I would answer this question which comes up in the discussion: Does Wallace neutrality result from (in theory) fiscal policy canceling out the Fed, or many private agents (the minnows) canceling out the Fed (the whale)?

My answer is that in the Wallace model it is the minnows (agents, investors, people) all working to completely undo what the whale (the government) does.

Some specifics from the tweets:

I won’t get into the Sumner part, but, like Miles, I think the Wallace neutrality part is wrong. If you look at the irrelevance proposition on page 270 of the AER paper, it holds even if taxes and transfers (w(t)) are unchanged; you are allowed to select that option in the proposition, which is proven to hold. And, government consumption is required to be unchanged. Moreover, the choice of taxes and transfers is, in any case, restricted to not be any different in net present value, based on the original state prices, by the condition (a).


This really doesn’t even happen. It’s, the government starts printing money and buying more oranges, and storing them until next period, when it will sell all these extra oranges back again. All agents know this, and they immediately sell an equal amount out of their stores because they know they won’t need as many next period with the government storing more and planning to sell them next period. So, the price never moves. People in this model are all superhumans. They have perfect foresight, expertise, and optimization, and act instantly.

I think one big difference here with the world of Wallace’s model is that in Brad’s story the hedge fund managers could not be that sure what the whale would do in the future. In Wallace’s model they know precisely, and with 100% certainty, what Bernanke (the government) will do at every point in the future. They can trade with confidence and hold the line. By contrast, the hedge fund managers in Brad’s story got hurt badly because they did not, in fact, predict well how Bernanke (the government) would behave.

Basically, I discussed this in my recent post on Wallace neutrality, The Intuition behind Wallace Neutrality, Attempt 3.

In Wallace’s model, the government is like a big MM firm. And the citizens are shareholders of the government. When the government does the Wallace version of a QE, it basically is like it borrows more money (really lends, but let’s look at the converse for now). That makes its citizens overall debt level higher than they like, so they borrow less by an equal amount to get back to their optimal overall debt level. The total demand for debt in the market remains unchanged. Government demand goes up by X, and private demand goes down by X, so the interest rate remains the same…

But why wouldn’t this work in the real world?

Well, first off, people are far from perfectly expert (especially in the super complex modern world), with perfect public information that they can gather, digest, and analyze at zero time, effort, or money cost…

So, when the government “firm” starts to lend a lot more, almost no one thinks, MM style, or Wallace style, I’m going to start selling some of my bonds to compensate in equal measure as I see them doing that. And so total lending in the market does, in fact, go up, and market interest rates drop. People just don’t react that way. And it won’t be nearly enough if a savvy minority do. They won’t control enough money to drive us to Wallace neutrality.

It’s like in Miller and Modigliani’s model if the firms start borrowing a lot more, but the shareholders are mostly not really paying attention, and/or don’t know well the implications, so for the most part they don’t borrow any less to compensate. In that case, aggregate demand for borrowing would not remain unchanged. The aggregate demand curve for borrowing would, in fact, shift out, and the interest rate would rise.

Other issues: In the real world there are a lot more different kinds of financial assets than just money, and borrowing and lending the single consumption good risk-free, like in Wallace’s model. So, if the government does QE in just some types of assets, people, even if they are perfect at optimizing, won’t be able to funge their portfolios to relieve completely price pressure on those assets. Markets are not complete, and far from it, so that you could construct a synthetic for any asset. I talk about this in an earlier post on Wallace neutrality when I ask “What if the government did a QE intervention where they printed up dollars and used them to purchase 100 million ounces of gold?”

Next, Miller-Modigliani irrelevance doesn’t hold if investors face different borrowing costs and liquidity constraints than the firm. Likewise, Wallace irrelevance will not hold if individuals and firms face different borrowing costs and liquidity constraints than the federal government. Do they?

Finally, Wallace’s model assumes that with 100% certainty the central bank will completely reverse the QE one period later, and everyone knows this…In the real world, investors cannot be completely certain a QE will be 100% reversed in the future.

And empirically we see Wallace neutrality not holding. UCLA economist Roger Farmer recently wrote, “A wealth of evidence shows not just that quantitative easing matters, but also that qualitative easing matters. (see for example Krishnamurthy and Vissing-Jorgensen, Hamilton and Wu, Gagnon et al). In other words, QE works in practice but not in theory. Perhaps its time to jettison the theory.”

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Q&A: Apple Pay and the Future of Electronic Money


image source

In the wake of Apple’s announcement of Apply Pay last week I had two different journalists contact me with questions about what this meant for the future of electronic money. I wanted to give the full text of my answers (very lightly edited) here. The journalists’ questions are in bold. My answers follow. 

First Journalist’s Questions

Do you see Apple Pay taking us closer to the end of physical cash?

Apple Pay is a big step toward electronic payments being a bigger and bigger share of all payments. Already more than half of retail spending is by credit and debit card. With Apple pay as another, even more convenient form of electronic payment, that fraction should go up. 

I think physical cash is likely to play a minor role for a long time after it has been mostly eclipsed by electronic payment. For example, I think the strong demand for anonymity for certain kinds of purchases will make it very hard to eliminate paper money entirely. (If we tried to abolish paper dollars entirely, people would start using paper euros or yen or pounds for the purchases they wanted to make anonymously.)

What are the key benefits for monetary policymakers that could arise from a cashless society?

 Our monetary system now, with a paper dollar standard, makes it impossible for the Federal Reserve to stimulate the economy enough in a deep recession like the one we have just been through. That is why bad economic times have dragged on for so many years after the Financial Crisis in 2008. Even if paper currency remains in use, if people’s emotional attachment to the paper dollar standard dissipates with the further rise of electronic money, it is possible to free up monetary policy so that it can even very deep recessions. Some economists also worry about “secular stagnation,” which is the name for a situation in which monetary policy can’t help much for a long, long time. (The closest real-world example has been the economic doldrums Japan has been in for most of the last 20 years.) Taking the paper dollar off of its pedestal makes it possible to avoid secular stagnation as well. 

I have written a lot about this. I collected links to it all here: "How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide." Most directly relevant is my article in Slate: "How governments can and should beat Bitcoin at its own game."

I have been traveling to central banks around the world to explain the nuts and bolts of how modest policy measures that take physical cash off of its pedestal can empower monetary policy. I make the case for the negative interest rates that would make possible here: “America’s Big Monetary Policy Mistake: How Negative Interest Rates Could Have Stopped the Great Recession in Its Tracks.”And I wrote a children’s story (illustrated by Donna D’Souza) to explain the basic idea: “Gather ‘round, Children, Here’s How to Heal a Wounded Economy.” 

What wider benefits would you imagine electronic money offering?

The one thing Apple Pay doesn’t do, but we can look forward to in the future is a rise in our effective incomes as competition in the realm of electronic payment brings down the hefty fees that credit card and debit card companies charge. One way we might see the magic of this kind of competition would be through ever bigger rebates on credit cards. Already on my Quicksilver Visa card I get 1.5 % back on everything I buy—which is still a lot less than the fees Visa is charging, but it is a good start. As the cut taken by the credit card companies shrinks, more people will want to switch to using credit cards that give them several percent back instead of using cash. So the success of electronic money will build on itself.  

Second Journalist’s Questions 

Why do you believe we are moving towards a cashless society? What behaviours/trends is this transition resulting from, in your opinion? 

 It is the progress of computer hardware and software that is making this possible and attractive.

Do you think that seamless spending (i.e. e-wallets, Apple Pay, mobile integration) is a sustainable way for us to manage our finances and why/why not?

 Yes. If security issues can be solved, there is no reason not to have most transactions happen electronically. 

How do you see the future of our interaction with money and the way we make payments? 

The advance of electronic payment systems will make it easy both practically and politically to demote paper currency to a minor supporting role in the monetary system (say, something like we think of traveler’s checks today). To the extent that people think of an electronic dollar as the real thing, it opens up new possibilities for monetary policy that could have dramatically cut short the Great Recession if they had been in place. I have been traveling to central banks around the world to talk about the mechanics of doing this, and explain it on my blog as well. You can see the relevant links here: "How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide" Most relevant to your question is my piece in Slate: "How governments can and should beat Bitcoin at its own game."

There I argue that we will still need central banks in the future, each of which will sponsor a digital currency: the e-dollar, e-euro, e-yen, e-pound, etc. For those who now pay mostly with credit and debit cards, it will actually look a lot like the current system on a day-to-day basis, but it will lead to a more stable world economy because of removing the stumbling block to monetary policy from our current privileging of paper currency. In terms of stabilizing the economy, subordinating paper currency to electronic money (as I advocated in my first column on this: “How Subordinating Paper Money to Electronic Money Can End Recessions and End Inflation”) would be the biggest advance in monetary policy since the basic idea of using monetary policy to stabilize the economy first took hold in earnest.  

Do you believe that we will soon see a global digital currency emerging?

Unlike many other things that one might want to standardize around the whole world, there are real advantages to having different monetary units in different regions. If countries that are too dissimilar share the same type of money, they can’t have different monetary policies. This has caused a lot of problems in the eurozone, where the right monetary policy for Germany is often very different than the right monetary policy for France or Spain or Greece. So there are real advantages to having multiple types of money, each governed by a central bank.  

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