I am grateful to Alexander Trentin, Sandro Rosa, and Finanz und Wirtschaft (Zurich’s “Finance and Economy” online periodical) for permission to publish a translation of the corresponding article here. I translated with the help of Google Translate, my college German, the partial translation Finanz und Wirtschaft posted here, and my knowledge of the subject matter and what I had said in the interview. I posted two earlier articles by Alexander Trentin along with my reactions (and there is more coming):
Negative interest rates can only have their full effect when people can’t flee into paper money. Miles Kimball argues that the holding of paper currency can be discouraged by a time-varying paper currency deposit fee.
Miles Kimball, an economist at the University of Michigan, is a pioneer on the issue of negative interest rates. He is fighting against the so-called Zero Lower Bound, the lower limit for interest rates near zero. On his blog, he argues that if interest rates fall deep enough into negative territory any recession would be quickly resolved. He estimates that after the financial crisis in 2008, the US economy would have made a robust recovery by the end of 2009 if the Fed had maintained interest rates at -4% throughout 2009.
He sees negative interest rates as a better tool than the purchase of trillions of dollars worth of long-term and mortgage-backed bonds that goes by the name of quantitative easing (QE). For one thing, he argues that economists understand the effect of negative interest rates better than they understand the effects of quantitative easing. The main obstacle to deep enough negative interest rates is cash, because that would continue to provide a zero interest rate. In order to make the holding of banknotes unattractive, he has urged the Swiss National Bank to contemplate a deposit fee for paper money.
Mr. Kimball, your idea is to introduce a fee for depositing paper currency during periods of time when bank accounts face negative interest rates. Withdrawing money would face no fee, but deposits would. This would discourage people from trying to circumvent negative interest rates through paper currency. Do you realize that some people would rebel at this idea?
It is all about how to present it. People don’t like the word fee. Since there is also a discount when withdrawing money it is analytically equivalent to an exchange rate between electronic money – money on reserve accounts – and paper money. I use the phrase “paper currency deposit fee” to indicate a possible basis for the legal authority of the central bank to create such an effective exchange rate. The fee would be de facto a tightly controlled crawling peg exchange rate policy.
Why do you prefer a deposit fee to a withdrawal fee for paper currency?
At every central bank I visit, I warn about a withdrawal fee. Having to pay an extra fee to get cash out of the bank would alarm people much more than a slowly increasing deposit fee.
If the central bank does not want to use paper money, couldn’t it just stop printing money?
That could be a fallback position, if that were the only legal authority a central bank had. Paper currency would become an exotic security with a zero interest rate. The price of bank notes would then run at a premium to electronic money, because of the scarcity of cash. There would a big jump in the price of paper currency, which would be quite disruptive to the economy. By contrast, the paper currency deposit fee starts at zero and increases only very gradually over time during the period when there is a negative interest rate. There would never be a big jump.
You propose to introduce electronic money as a legal tender instead of banknotes. In Switzerland, the Vollgeld movement rallies for a monetary reform in which electronic money would be created by the Swiss National Bank, rather than by commercial bank money creation at the moment of making a loan. It is similar to the idea of full-reserve banking. What is your opinion on this?
Anything that raises the prestige of electronic money–such as making electronic money legal tender–is helpful in making people comfortable with electronic money as the unit of account and putting paper money in a subsidiary role. To make electronic money legal tender, it is important to have accounts for which the central bank certifies that this money is really there.
I don’t see a 100% reserve requirement as a problem. In the olden days, people worried that a higher reserve requirement would reduce the money supply. But we know how to deal with that: the central bank can just increase the amount of the monetary base through open market operations enough to cancel out any effects changes in the reserve requirement on the money supply. In any case, it is possible to have some accounts which are 100% covered by reserves. Fractional reserve banking is mainly a way to let commercial banks have some of the seignorage revenue that would otherwise go to the government through the central bank.
Could electronic money be legal tender in the current world of fractional reserve banking?
Electronic money is all money that is just numbers in a computer. To make it legal tender might take some time. The important thing is that the Swiss National Bank could introduce the paper currency deposit fee I propose tomorrow. There is no reason to wait until we can do everything perfectly. If the Swiss economy is being hurt by overly high interest rates and a Franc that is too strong, then you should institute this fee tomorrow. This is what I advised the Swiss National Bank. I think they are seriously considering it.
Wouldn’t a transition to electronic money and a fee on paper money cause people to lose faith in currency?
They would know that the government can do whatever it wanted with their cash, devaluing it with a single keystroke.It matters how you explain it to people. I don’t think people would be that alarmed if you explained how gradual everything is. If the interest rate on bank deposits was -2% per year, the corresponding fall in the value of paper money each day would be tiny. It would take three months for the paper currency deposit fee to get as big as .5%. Moreover, retail shops would probably continue to accept paper currency at par for quite some time, they already pay a much bigger fee to credit card companies on credit and debit card transactions than the likely size of the paper currency deposit fee. The only exception would be in the case of a recession or secular stagnation so severe that deeper, more persistent negative interest rates were needed than what I believe would have been sufficient to cut short the Great Recession.
But how would you deal with the strong emotional attachment to paper currency?
Our societies have been through this before. There was a strong attachment to gold and silver. We went off the gold standard; that was a big deal for people. It is worth remembering that making paper money legal tender was hugely controversial. This was done to raise the prestige of paper money vis-à-vis gold. In that longer historical perspective, paper money was only a way station towards electronic money. If you want to be very traditional, you can use gold; but that will mess up your economy even more than paper money. When people cling to paper money it is like clinging to gold.
In Switzerland and Germany the attachment to paper money seems to be especially strong. Wouldn’t that make your proposal especially controversial there?
It is precisely because of the feelings of the Germans that the Swiss National Bank needs to blaze the trail rather than the ECB. Once Switzerland does it–and I am hopeful also that Sweden might have that kind of courage–there is a huge benefit to other countries by showing the way. One advantage of having Switzerland lead the way is its sophisticated level of banking. There are many practical questions for commercial practices in a negative interest rate environment; Switzerland would be an excellent place to work out such details. Fpr example, in a positive interest rate environment you want people to pay you as soon as possible; in a negative rate environment, you want people to pay you slowly. If negative interest rates are used elsewhere, people around the world would take standard practice from what is done in Switzerland.
As you mentioned, commercial details of doing transactions in a negative interest rate environment would still need to be worked out. Isn’t there a point where there is a structural transformation of how the economy works after introducing deep negative rates?
The funny thing is that for economists it is not a big deal whether interest rates are positive or negative. In terms of real interest rates–that is, interest rates adjusted for inflation–we have had negative rates before. For the most part, negative real rates due to high inflation have the same effect as explicitly negative rates when inflation is zero. We understand the effects of negative rates much better than the effects of Quantitative Easing. And as for the effects on business practices, firms have to adapt their business practices even when interest rates change within the positive range. Even with positive interest rates, investment decisions need to be made in a much different way when a quick payback is needed because of high interest rates than when a firm can afford to wait a long time for a payback because interest rates are low.