Like me, Peter Sands and Larry Summers are not currently advocating negative interest rates for the United States. But they make a remarkable statement about the technical feasibility of the deep negative rates–not just the mild negative rates now seen in the eurozone, Japan, Switzerland, Sweden and Denmark. They write:
We take no position on the desirability of negative interest rates but are convinced by the arguments of JPMorgan, Miles Kimball and others that significantly negative rates can, if desired, be maintained without any limitation on currency through bank withdrawal fees. And we believe that for the foreseeable future there will be a role for cash in modern economies, though we would not be surprised if in many contexts its transactions costs come to exceed those of various electronic payment schemes.
Larry Summers was one of my professors as a graduate student at Harvard, so I take great pleasure in this affirmation. I sent him the link to my bibliographic post “How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide” not long ago, and am pleased that he has read some of what I have written on negative interest rate policy. Larry would not have agreed to have the op-ed say what it says unless he had thought carefully about my proposal from a technical point of view, within whatever time constraints he faced.
I should note, though, that Peter and Larry’s emphasis on withdrawal fees is based on a desire to talk about JPMorgan and me in the same sentence. I have primarily talked about withdrawal fees in order to argue that time-varying deposit fees at the cash window of the central bank are better. On pages 6 and 7 of “Breaking Through the Zero Lower Bound,” Ruchir Agarwal and I write:
Short of stamped currency or the abolition of paper currency, the government can discourage paper currency storage in essentially three ways, corresponding to the three steps needed to earn an interest rate of zero minus storage costs from paper currency: it can attack withdrawal of paper currency, storage of paper currency, or redeposit of paper currency.
To attack withdrawal of paper currency, the government could implement a restriction or fee on paper currency withdrawals from bank accounts (or in the extreme, end the printing of new paper currency, forcing people to make do with the existing stock). There are several disadvantages to this approach. First, it prevents withdrawal for spending as well as withdrawal for storage. Second, the ability to withdraw paper currency has great option value for people, which restrictions or fees on withdrawal would damage. Third, whether a withdrawal fee of a given size is adequate to prevent massive paper currency storage depends crucially not only on how negative interest rates are, but for how long they will be negative, which is difficult to know in advance. Fourth, with quantity restrictions on withdrawals—or fees high enough that the corner solution of withdrawing zero is often attractive—the effective price of paper currency would likely follow a jagged diffusion process as information and expectations evolved. Finally, people would still have an incentive to hoard the paper currency already in their possession, and to withdraw as much as possible in advance of the imposition of a withdrawal fee. This makes it more difficult to openly discuss and debate the imposition of a withdrawal fee.
To attack storage, the government could attempt to make storage of paper currency costly by taxing or prohibiting storage. There is a limit to how effective this can be, since storage of paper currency can be done in low-tech ways by anyone. Moreover, criminals already have experience in secret storage of paper currency. Thus, while storage of paper currency can be driven underground, it is hard to fully prevent. The ease of small-scale storage of paper currency by households, in particular, could lead to fewer funds left in demand deposits or savings accounts and hence to significant disintermediation even if commercial-scale paper currency storage could be successfully blocked.
The third option for the government is to implement a temporary fee on deposit or re-deposit of paper currency at the cash window of the central bank. Such a fee, when implemented in a time-varying manner on net deposits, creates an effective exchange rate between paper currency and electronic money, and allows the government to avoid the disadvantages of the first two options discussed above. The next section describes this mechanism in further detail.
In the next version of the paper, we will also need to talk about the Bank of Japan’s inadequately detailed but fascinating potential policy of using the interest on reserves policy to charge interest on paper currency that I discussed in “The Bank of Japan’s New Tool to Block Massive Paper Currency Storage.”
One other thing I should mention is that, unfortunately, Peter and Larry link to website for “Negative Interest Rate Policy as Conventional Monetary Policy” where readers will hit a paywall if they try to download the paper itself. Here is a link to the paper itself, which, as part of my deal with the National Institute Economic Review, I have full permission to post in full on my own websites.
In “Going Off the Paper Standard” I wrote that the first of 18 steps toward a smooth implementation of an electronic money policy was
- Announce that eliminating the zero lower bound is possible from a technical point of view.
Progress on this first step has been considerably faster than I expected.