Confessions of a Supply-Side Liberal

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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


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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Allan H. Meltzer: Don't Be Distracted by the Last 5+ Years--Massive Inflation is Coming

There is a good reason to focus on nominal GDP as the best rough-and-ready measure of monetary policy rather than measures of the money supply: velocity is not constant. I give my views on that in my column “Optimal Monetary Policy: Could the Next Big Idea Come from the Blogosphere?" I also have a children’s storybook to explain why velocity drops dramatically when interest rates are stuck at zero rather than being able to go into negative territory: “Gather ’round, Children, Here’s How to Heal a Wounded Economy.”

Allan Meltzer, by contrast, has these thoughts:

Never in history has a country that financed big budget deficits with large amounts of central-bank money avoided inflation. Yet the U.S. has been printing money—and in a reckless fashion—for years. 

The Fed focuses far too much attention on distracting monthly and quarterly data, while ignoring the longer-term effects of money growth.

We are now left with the overhang. Inflation is in our future. Food prices are leading off, as they did in the mid-1960s before the “stagflation” of the 1970s. Other prices will follow.

Postscript: I begged Brad DeLong in a tweet to show Allan Meltzer the error of his ways, but Brad didn’t want to repeat himself. So I have tried to do my bit. 

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Quartz #47—>Meet the Fed’s New Intellectual Powerhouse


Link to the Column on Quartz

Here is the full text of my 47th Quartz column, "Meet the Fed’s new intellectual powerhouse," now brought home to It was first published on March 24, 2014. Links to all my other columns can be found here.

I wrote this column just in time. On April 3, 2014, Jeremy Stein announced he was resigning from the Fed. But we might see him again in the future in high government office. And this column is at least as much about enduring issues of monetary policy as it is about Jeremy. 

If you want to mirror the content of this post on another site, that is possible for a limited time if you read the legal notice at this link and include both a link to the original Quartz column and the following copyright notice:

© March 24, 2014: Miles Kimball, as first published on Quartz. Used by permission according to a temporary nonexclusive license expiring June 30, 2017. All rights reserved.

I have two related columns not directly linked in this piece: “Monetary Policy and Financial Stability" and my discussion of Janet Yellen’s views: "Janet Yellen is Hardly a Dove: She Knows the US Economy Needs Some Unemployment.”

What I say in the column about how a low elasticity of intertemporal substitution affects how the Fed should respond to risk premia is informed by the discussion I gave of a paper of Mike Woodford and Vasco Curdia at a Bank of Japan conference (which I mentioned and linked to here.) Claudia Sahm, Matthew Shapiro and I are working on literature review of empirical work on the elasticity of intertemporal substitution for our paper on that topic. I will have more to say on that in the future. 


Janet Yellen led her first monetary policy meeting as chair last week. But with Yellen’s emphasis so far on consensus and continuity, the key news from the Fed last week wasn’t anything Janet Yellen said, but what Federal Reserve Board Governor Jeremy Stein said at the International Research Forum on Monetary Policy on Mar. 21.

Jeremy Stein is currently the junior member of the Federal Reserve Board, having served only since May 30, 2012. (Several recent nominees to the Federal Reserve Board have yet to be approved.) But with Ben Bernanke’s departure, Stein now has the most distinguished academic record of anyone currently making decisions about US monetary policy. His background as a Harvard Professor of Economics and former President of the American Finance Association shows. He holds office hours for staff at the Federal Reserve Board, and from the half hour that I once spent with him, I can say that he stands ready to debate the fine points of economic models with anyone. In his speech last Friday, Governor Stein showed how much genuine light an academic approach can shed on practical monetary policy questions in the right hands.

Victoria McGrane and Jon Hilsenrath at the Wall Street Journal summarize Stein’s speech with the headline, “Financial Stability Considerations Should Influence Monetary Policy.” But Stein’s message is subtler than that headline suggests. He asks first: “Should financial stability concerns, in principle, influence monetary policy decisions? … This question is about theory, not empirical magnitudes, and, in my view, the theoretical answer is a clear ‘yes.’”

As he clearly spells out, the key to his argument is his “third and final assumption … that the risks associated with an elevated value of [financial market vulnerability] cannot be fully offset at zero cost with other non-monetary tools, such as financial regulation.” Stein summarizes:

Thus one way to think of my construct of FMV [financial market vulnerability] is that it is a stand-in for the level of financial vulnerabilities that remain after regulation has done the best that it can do, given the existing real-world limitations.

To explain what he is saying, let me make the analogy to cancer treatment. Because the newer targeted chemotherapies are still not 100% effective, they are still often combined with the older chemotherapies that attack any and all growing cells—leading to the all-too-familiar side effects of hair loss, nausea, anemia, and so on. Similarly, if targeted policies such as financial regulation can’t fully prevent financial crises, then it might sometimes make sense to add a bit of tight monetary policy to help rein in financial excesses.

But the same logic says that the better we get at using targeted tools to prevent financial crises, the less we will need to rely on a monetary broadside—with all of its undesirable side effects—as a secondary preventative measure. So it matterswhen Anat Admati and Martin Hellwig make a careful argument that high equity requirements for banks have very few true social costs or when I argue that a US Sovereign Wealth Fund would not only stabilize the financial system, but also make money for US taxpayers.  (I am not alone in advocating for contrarian debt-financed sovereign wealth funds. UCLA Economics Professor Roger Farmer is just as strong an advocate, as well as top-flight economics journalist John Aziz and my fellow Quartz columnist and coauthor Noah Smith.)

Governor Stein, after making the case that financial stability concerns should play at least some role in monetary policy-making, however small, makes an excellent suggestion of how to guess when financial excess is a concern. He suggests focusing on the size of risk premiums in the bond market. If people are willing to pay almost as much—or equivalently, willing to accept interest rates almost as low—for junk bonds as they are for the very safest bonds (still US Treasuries, despite all of our government debt follies), that is the time to worry.

In addition to all the reasons Governor Stein gives for focusing on risk premiums in the bond market as a way to guess the extent of financial dangers, a focus by the Fed on risk premiums in the bond market has another benefit. Too much discussion of monetary policy has proceeded under the fiction that there is only one interest rate. As soon as one recognizes that there are as many different interest rates as there are types of assets, an obvious question arises: “Which interest rates give the best idea of the cost of borrowing for the home-building, consumer spending, and business investment that drive aggregate demand for the economy?” The obvious—and correct—answer is that it is rates for mortgages, consumer loans, and loans to businesses (of which the lending represented by corporate bonds is an important part) that best represent the borrowing costs that matter for aggregate demand.

So even when the Fed states its policy in terms of the safe fed funds rate, it should be looking past that safe rate to the mortgage rates, consumer-loan rates, and corporate borrowing rates that result. Even before considering the risk of a financial crisis, the Fed should react to an increase in bond risk premiums almost one-for-one by a reduction in the safe rate, and should react to a narrowing of bond risk premiums almost one-for-one by an increase in the safe rate. (The reason I write “almost” one-for-one is that the risk premium has an effect on savers as well as on borrowers, but evidence suggests that savers are not very sensitive to interest rates, so it is the effect of the key rates on borrowers that is of greatest concern.)

The metaphor of an ivory tower is used to contrast academia to the “real world.” But differences among academics in how much they understand the real world are just as big as any gap between academics in general and non-academics. The details of Jeremy Stein’s academic publications and government experience indicate that he combines a respect for theory with a practical bent. And the fact that his specialty is finance is a good sign in that regard: the abundance of good financial data anchors the field of finance into the real world, as reflected in the lack of a divide within finance to match the divide in macroeconomics between “Freshwater” and “Saltwater” macroeconomists. In intellectual style, Jeremy Stein reminds me of the brilliant Larry Summers, but Stein is free of the political baggage that led to Summers being passed over for Chairman of the Federal Reserve Board. My crystal ball is often cloudy, but if I make no mistake, I see an exhilarating trajectory ahead for Jeremy Stein.

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Pranav Krishnan: Fighting European Deflation with Negative Interest Rates


Pranav Krishnan is a student in my my "Monetary and Financial Theory" class. Pranav also has a blog that focuses on the finances of European football. Here is what Pranav has to say about eurozone monetary policy:


There were some positive signs around Europe, where it appeared that Spain’s unemployment rate had bottomed out in late 2013.

Perhaps talk of Europe’s recovery has come a little too early. While there were signs of positive growth in countries like Spain and Italy over the past few months, inflation was very low, and even more so inflation expectations.  David Roman of the Wall Street Journal wrote about a significant deflationary risk in Europe and how officials are expecting the European Central Bank to take the appropriate measures necessary to stem the tide. Josef Makuch, Slovenian Central Bank governor-rightly-feels that deflation could cause even more problems in the long term.

“Several [ECB] policy makers are ready to adopt nonstandard measures to prevent slipping into a deflationary environment,”

It appears that there might be more to this issue, than simply highlighting the risk of deflation.  The article was largely skimming the surface of what could become a wider problem later on.  Demosthenes Tambakis, a professor at the University of Cambridge, wrote for The Economist, outlining his opinion on why the Eurozone is at risk for deflation in further detail,  He points to very low inflation expectations across Europe and that alone increases a risk in deflation.  While he admitted that this risk shouldn’t rise so dramatically based on expectations alone, he does point out a few other institutional design elements that could contribute; Most notably, the European Central bank’s mandate, and the Zero Lower Bound.

The European Central Bank mandate is a bit pedantic in terms of legislature but it can play a role in the eyes of most economists.  The ECB, cites Tambakis, is committed to just below 2%, in contrast to say the Fed who wants to maintain a 2% average over time.  Tambakis believes that this causes an asymmetry which assures everyone that while they do not have to fear runaway inflation, they should worry when prices are too low because the ECB by design would be more reluctant to embark on expansionary monetary policy (increasing the money supply) than they are to contract.  While this point could make some sense in that the ECB might be unintentionally ‘guiding’ people to expecting less inflation in the medium-run and long-run, I would be surprised if this had a serious impact on inflation expectations.  Given the low levels of inflation in Europe, most economists and investors would likely expect lower levels to continue especially with the reduction in German growth rates.

The more likely argument seems to be the one about the Zero Lower Bound.  These risks are determined by the Shiller Index which predicts the long-run frequency of international stock market crashes.  Europe has faced two issues, in that they’ve suffered from the original financial crisis of 2008 and then the individual debt issues that each country faces. So, the natural reaction would be to cut interest rates to stimulate demand, but the Zero Lower Bound in Europe threatens to create a liquidity trap for the Eurozone.   In tandem with the dual mandate language set by the ECB, everyone already has very low expectations of inflation and the inability for countries to set monetary policy and stimulate demand individually threatens to worsen the situation for the Eurozone as a whole.

While there could be some legislation to create a more unified Europe fiscally and financially, the best thing the ECB can hope to do now is if they are going to be rigid about keeping inflation below 2% they should be more flexible about the Zero Lower Bound and allow the interest rate to hover in a broader range of negative interest rates.  The process will be rather painful because inflation expectations could plummet but in the long term, Europe could be better for it and escape the dangers of a long-term liquidity trap.

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Will the ECB Go Negative?


Photo of the European Central Bank from Wikimedia

On Wednesday (March 26, 2014), the Wall Street Journal had a remarkable news article by Brian Blackstone reporting on how the European Central Bank might be getting more serious about the idea of negative interest rates: "ECB Mulls Bolder Moves to Guard Against Low Inflation: Officials Indicate They Will Consider Negative Interest Rates, Asset Purchases." Here are the key passages: 

  1. "We haven’t exhausted our maneuvering room" on interest rates, Bank of Finland Governor Erkki Liikanen, told The Wall Street Journal in an interview in Helsinki. … Asked what tools the ECB has remaining, Mr. Liikanen cited a negative deposit rate as well as additional loans to banks and asset purchases.
  2. Bundesbank President Jens Weidmann, in an interview with news agency MNI, didn’t rule out large-scale asset purchases, known as quantitative easing, as a possibility. He also raised the option of negative deposit rates, though he said he wasn’t talking about any imminent decision.
  3. Mr. Draghi was less specific Tuesday on what the central bank might do. But in a speech in Paris, he sought to underscore the bank’s resolve in fighting excessively low inflation, which weakens consumer spending, business profits and investment. “We will do what is needed to maintain price stability,” …

    [Mr. Draghi’s] comment was reminiscent of his July 2012 pledge to do “whatever it takes” to keep the euro together. That remark triggered a lasting rally in government bond markets in southern Europe. The ECB didn’t even have to purchase any government bonds—Mr. Draghi’s words were enough.

  4. Faced with a negative, or penalty, rate for parking funds at the ECB, commercial banks might instead lend their excess funds to other financial institutions, lowering short-term borrowing costs. It could also make euro-denominated assets less attractive to global investors, taking some of the froth off the value of the euro, and thereby boosting exports and inflation.

    One potential downside is that banks might pass along the added costs to customers by raising the interest rates they charge for loans. But Mr. Liikanen signaled he doesn’t think a negative deposit rate would generate unwanted side effects. “The question of negative deposit rates, in my mind, isn’t any longer a controversial issue,” he said.

  5. "The perception has been that [ECB officials] talk about it but won’t do it. I think they’re closer [to making the deposit rate negative] than has been perceived," said Ken Wattret, economist at BNP Paribas.

The next day (yesterday), Brian Blackstone had another article on the same topic: "ECB Faces Uncharted Waters With Negative Deposit Rate Move Could Encourage Lending and Weaken Euro, Bolstering Exports." One of the key worries discussed in the article is this: 

Critics say negative rates could weaken the already fragile European banking industry by sapping its profits.

"The banks that would suffer the most are those ones with lower profitability," said Alberto Gallo, head of European credit research at Royal Bank of Scotland. That includes small banks in Cyprus and Slovenia, Italian banks and some German Landesbanken, or public banks co-owned by the savings banks and regional governments, he added.

Banks also may pay less interest to savers and could raise the rates they charge on private loans to recoup their costs.

Here let me say something I say in all of my talks at central banks and their regional affiliates. Once the paper currency interest rate becomes something the central bank can choose, as in what I have proposed (see for example “How to Set the Exchange Rate Between Paper Currency and Electronic Money”) all 4 key interest rates under the central banks control can be moved up and down in tandem:

  1. The target rate (fed funds rate in the US)
  2. The lending rate (discount rate in the US)
  3. The interest rate on reserves or on excess reserves
  4. The paper currency interest rate. 

With all four rates moving up and down in tandem, the spreads between them that matter for bank profits can be kept at normal levels. In particular, reductions in the paper currency interest rate would make it possible for banks to reduce the deposit rates they pay enough that they can make profits even if the rates banks earn on loans are very low, even possibly negative. 

Note also that when people say that the demand by borrowers is low, that is at a zero or positive interest rate. At a low enough interest rate, I guarantee that the demand for loans would be high.  

By the way, I am headed to the European Central Bank this July to explain the details of implementing negative paper currency interest rates along with other negative rates. For modest negative paper currency interest rates, a time-varying deposit fee (on net paper currency deposits by banks bringing paper currency to or withdrawing paper currency from the central bank) should be sufficient to do the trick, even without the other measures I have talked about. I would be truly delighted to have Mario Draghi attend my seminar.   

Update, April 3, 2014: Brian Blackstone and Todd Buell reported on April 3 that the ECB’s discussion of negative interest rateshas the imprimatur of the ECB’s President Mario Draghi:

President Mario Draghi's revelation that the central bank had discussed negative interest rates and large-scale bond purchases—if needed to keep persistently low inflation from undermining growth—caught financial markets by surprise. …

Mr. Draghi said officials had discussed asset purchases, known as quantitative easing, as well as setting a negative rate on bank deposits parked at the ECB—moves that could help bolster the economic recovery and push up prices. The annual inflation rate in the euro zone is just 0.5%, far below the bank’s target of just under 2%. …

The ECB is “resolute” in its determination to keep its easy-money policies in place, he said, and “to act swiftly if required.”

Brian and Todd have this description of the negative interest rate being contemplated:

A negative deposit rate—it is currently zero—would force financial institutions to pay to park their excess funds at the ECB, which may encourage them to lend more to the private sector. Denmark has deployed negative rates since 2012, but it would be largely unchartered territory for a major central bank such as the ECB.

In the US, this would be called a negative interest rate on excess reserves. For negative interest rates to work best, it is important that other key interest rates also go negative, particularly the paper currency interest rate. 

Note: For more details on how to implement negative rates well, see the links collected in "How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide." 

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