Paper Currency Policy: A Primer →
The title is a link to storified tweets. I have transcribed them below as well. The last tweet is a link to what will be tomorrow’s post. So you can get a sneak peak.
- Let me explain paper currency policy a little more. Our current paper currency policy is that 1 paper $ = 1 electronic $ always.
- Let’s treat the electronic $ (e-$) as our yardstick–the unit of account. We want to encourage people to state prices in terms of the e-$.
- With 1 paper $ = 1 electronic $ all the time, paper currency earns a zero rate of interest. So people won’t lend at a worse negative rate.
- So a paper currency policy of pegging paper currency at par (1 p-$ = 1 e-$) puts a floor of zero under interest rates.
- Like other price floors, a floor of 0 on interest rates messes up markets big time when the equilibrium interest rate would otherwise be <0.
- We see the messed up markets from the floor of 0 on interest rates all around us these days in the troubled world economy.
- The alternative paper currency policy looks like this: In January 2013, 1 paper $ = 1 e-$. In January 2014, 1 paper $ = .95 e-$.
- If 1 paper $ = 1 e-$ now, but 1 paper-$ = .95 e-$ a year from now (95 e-cents), then paper currency effectively earns a -5% interest rate.
- Call our current paper currency policy “pegging at par.” (Par: 1 p-$=1 e-$) The alternative paper currency policy is called a crawling peg
- With a crawling peg that allows paper currency to depreciate relative to electronic money, paper money earns a negative interest rate.
- If the crawling peg makes paper money earn -5%, there is no reason the Fed can’t choose any interest rate above -5%.
- Institutionally, the Fed should be given control of paper currency policy and have the target rate and ROR on paper money move together.
- ROR = rate of return = effective interest rate in a case like this, when the ROR is a fixed, certain number.
- The Fed should move the effective interest rate on paper money in tandem with the fed funds rate and the interest rate on excess reserves.
- For those just tuning in, here is my first column on electronic money and a followup column: http://qz.com/21797/the-case-for-electric-money-the-end-of-inflation-and-recessions-as-we-know-it/ http://qz.com/35991/could-the-uk-be-the-first-country-to-adopt-electronic-money/
- Twitter Round Table on Our Disastrous Policy of Pegging Paper Currency at Par: http://storify.com/mileskimball/twitter-round-table-on-our-disastrous-policy-of-pe