The Brookings (Hutchins Center) conference last Monday was another milestone for negative interest rate policy. I thought every minute of the conference was illuminating. This one is really worth watching. Here is Leon Berkelman’s reaction to watching the video, which he was kind enough to write up as a guest post:
A few weeks ago I gave a talk to some economics undergraduate students at the University of New South Wales. I told them I was ridiculously envious of them. When I was an undergraduate in Australia, it was impossible to know what the giants of the profession were discussing. Without physically attending a conference in the US, you could only rely upon word of mouth, or until someone wrote a book, to ponder their thoughts. Now, it’s different. To channel the Australian Prime Minister, there has never been a more exciting time to be a student of economics.
But I can’t complain too much. I get to reap the benefits now. And so it was with a gold-plated conference that the Brookings Institution ran on the 6th of June on negative interest rates. Soon after the conference finished, several hours of video were posted featuring the musings of rock stars like Bernanke, Kohn, and Slok.
Of most interest to me was Miles Kimball’s presentation. Miles has been discussing methods for overcoming the difficulties in implementing deep negative rates for a while now. Basically, if monetary authorities try to implement rates too far below zero, which they may want to do if the economy is depressed, we think that people and institutions will move away from assets earning negative rates, like deposits, into cash, which earns a zero return. We’ve heard rumblings about this recently in Germany and Japan. Such a move will cause many problems. For example, banks may see their deposit base disappear, but that’s far from the only problem.
The root of the issue is that physical cash maintains its nominal value. That places a limit on how low rates can go. But what if physical cash did not maintain its value? For example, what if you could somehow tax it? Well, then physical cash would be costly to hold, and the incentive to pile into it is gone. Problem solved.
Miles and others have suggested that you could devalue physical currency by having it depreciate. At the moment, a physical dollar is worth one dollar in the bank. However, you could break that one-to-one link, and you could have, say, one dollar in physical cash worth 90 cents in the bank. In the circumstances of a time-varying exchange rate between the two monies, if physical money was expected to depreciate, then once again the allure of physical cash is gone. It is again costly to hold physical cash. Again, problem solved. For the interested reader Miles’s website is a wonderful resource discussing how this idea would work, and some of the challenges it faces.
I’ve written and spoken about this idea before. I like it. However, as mentioned many times in the Brookings conference, the idea is politically toxic. My response is that it is then up to economists to advocate and educate. If economists think that such an idea can be useful, then shrugging our shoulders and saying that politics renders the idea a non-starter is not good enough. Economists consistently butt their heads up against a brick wall when arguing for cuts in fossil fuel subsidies, which are popular, but are economically and environmentally absurd. With strong enough advocacy, economists have chipped away and have had victories in the fossil fuel realm. Why not the Kimball solution too?
There are precedents of previously unthinkable monetary regime shifts. Going off the gold standard is one. Don Kohn, in his discussion during the conference, noted that these shifts involved changes in the relationship between money and goods (for example gold), rather than the relationship between monies. But we have seen different monies trade at different values before. For example, in the United States, before the Civil War, banks issued their own distinct private banknotes that traded at different rates. People did not riot in the streets then. Are we less able to cope with a small degree of complexity than we were in the 1850’s? I don’t think so.
Miles made the comment during the conference that monetary historians can be very useful right now in helping us to think through debates about our monetary system. They know the way things have worked before, and so they know what was politically feasible before. I suspect political feasibility is a more elastic concept than many appreciate.