Bank of England Chief Economist Andrew Haldane Explains How to Break Through the Zero Lower Bound

Some of the reporting of Andrew Haldane’s September 18 speech “How low can you go?” skipped over key things he said. Here is the part of his speech where he explains how to break through the zero lower bound:

Negative interest rates on currency

That brings me to the third, and perhaps most radical and durable, option.  It is one which brings together issues of currency and monetary policy.  It involves finding a technological means either of levying a negative interest rate on currency, or of breaking the constraint physical currency imposes on setting such a rate (Buiter (2009)).

These options are not new.  Over a century ago, Silvio Gesell proposed levying a stamp tax on currency to generate a negative interest rate (Gesell (1916)).  Keynes discussed this scheme, approvingly, in the General Theory.  More recently, a number of modern-day variants of the stamp tax on currency have been proposed – for example, by randomly invalidating banknotes by serial number (Mankiw (2009), Goodfriend (2000)).

A more radical proposal still would be to remove the ZLB constraint entirely by abolishing paper currency.  This, too, has recently had its supporters (for example, Rogoff (2014)).  As well as solving the ZLB problem, it has the added advantage of taxing illicit activities undertaken using paper currency, such as drug-dealing, at source.

A third option is to set an explicit exchange rate between paper currency and electronic (or bank) money.  Having paper currency steadily depreciate relative to digital money effectively generates a negative interest rate on currency, provided electronic money is accepted by the public as the unit of account rather than currency.  This again is an old idea (Eisler (1932)), recently revitalised and updated (for example, Kimball (2015)).

All of these options could, in principle, solve the ZLB problem.  In practice, each of them faces a significant behavioural constraint.  Government-backed currency is a social convention, certainly as the unit of account and to lesser extent as a medium of exchange.  These social conventions are not easily shifted, whether by taxing, switching or abolishing them.  That is why, despite its seeming unattractiveness, currency demand has continued to rise faster than money GDP in a number of countries (Fish and Whymark (2015)).

One interesting solution, then, would be to maintain the principle of a government-backed currency, but have it issued in an electronic rather than paper form.  This would preserve the social convention of a state-issued unit of account and medium of exchange, albeit with currency now held in digital rather than physical wallets.  But it would allow negative interest rates to be levied on currency easily and speedily, so relaxing the ZLB constraint.

Would such a monetary technology be feasible?  In one sense, there is nothing new about digital, state-issued money.  Bank deposits at the central bank are precisely that.