Confessions of a Supply-Side Liberal

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


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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.  

Filed under money emoney

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The Future of Dough: A Rap Video for Money20/20

This is an entertaining rap video about the dramatic changes coming for payment systems. One prediction I think is a bit off target is the second sentence in this part of the rap lyric: 

You can pay by finger, by eye or Google glass. The next evolution: PayByAss. …

By the way, you can see my rap video about the monetary policy possibilities opened up by electronic money here (and here is Tom Grey’s better rendition of the same lyrics). 

Filed under emoney humor money

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Shark Tank Markups


Mark Cuban, Daymond John, Kevin O’Leary, Barbara Corcoran and Robert Herjavec are judges on “Shark Tank.” Credit Richard Cartwright/ABC

For an economist, one of the most educational and entertaining shows on TV these days is Shark Tankwhich lies squarely in the intersection between venture capital and reality TV. The judges, called “sharks” are shown as choosing whether or not to invest their own money in ventures on the spot as entrepreneurs make their pitch during the taping of the show. There are also some follow-up segments about how ventures one or more of the sharks invested in previously have been doing.  

It is well worth hearing the incisive questions and opinions given by the sharks. Among the inevitable questions are “How much do you sell it for?” and “How much does it cost to make and deliver?” or in the case of a service “How much does it cost you to do it?” The intriguing thing to me about that is being able to get a measure of the actual markup ratio

Actual Markup Ratio = Price/Marginal Cost

for a wide variety of goods and services. I think a great undergraduate economics thesis could be written by watching all of the episodes of Shark Tank, compiling all the data on price and marginal cost and then analyzing the determinants of the markup ratio (such as sector and how different the product is from competing products—something that could be coded up systematically from the televised discussion in the show).

Once price has had a chance to adjust optimally, the markup ratio should equal the target markup ratio

Target Markup Ratio = Price/Marginal Revenue = ε / (ε - 1)

where ε is the price elasticity of demand seen by the firm. The price elasticity of demand seen by a typical firm (or a typical firm’s target markup ratio) is a key parameter for macroeconomics as well as for industrial organization. For example, the value of ε tells how close things are to perfect competition. and ε is important for optimal monetary policy, as you can see in my discussion of Michael Woodford and Vasco Curdia’s paper at a conference at the Bank of Japan. Macroeconomists typically assume a value of 1.1 for the markup ratio, which implies ε = 11. To me, that seems too low a markup ratio and correspondingly, too high a firm-level price elasticity of demand. In any case, the value of typical markup ratios is a central issue that should be disputed in the light of as many different types of relevant information as we can get hold of.

Sometimes the sharks also ask about marketing costs. It is important to recognize that marketing costs (for example, “customer acquisition costs”) should not be included in marginal cost. They are a different animal. When price is above marginal cost, then there is a reward to marketing that pushes out the demand curve the firm faces. If a firm is optimizing, then it should be true that 

Marginal Cost to Make and Deliver + Marginal Marketing Cost of Raising Demand by 1 Unit at the Going Price = Price

So if one (in my view mistakenly) includes marginal marketing cost as part of “marginal cost” then the markup ratio should always look like 1 for an optimizing firm. This obscures the key forces arising from a markup of price over the marginal cost of making and delivering a product.  

Filed under laborio money

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Kim Schoenholtz and Stephen Cechetti: Has Paper Money Outlived Its Purpose?


Link to Kim Schoenholtz’s and Stephen Cechetti’s post "Has paper money outlived its purpose?"

This is a nice article that speaks favorably of my proposal for enabling negative interest rates. In the end, they come down in favor of keeping paper money.

I wish Kim and Stephen had made it clearer that my proposal in "How Subordinating Paper Currency to Electronic Money Can End Recessions and End Inflation" involves keeping paper money in a subordinate role that retains the positive aspects of paper money they mention. Indeed, during periods of time in which negative interest rates haven’t been necessary for a while, the monetary system I propose would look very much like the current system. That makes it very different from proposals to abolish paper money entirely. 

Filed under money emoney

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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.   

Filed under money emoney

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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. 

Filed under money emoney