Show Me the E-Money

Q: Would negative nominal rates effectively act as a flat tax indiscriminately hitting those who can afford to pay it and those who would struggle to?

A: I really think you would see short rates go down but long rates go up because people would see that there was going to be an economic recovery. Those long-term rates should matter more for retirees, for example.

Even if the worse off are impacted in the short run you’re not going to touch social security or benefits. You’re not hitting the people at the very bottom. So we’re really just talking about relatively better off people who have something more than the state pension to retire on anyway.

Q: Given that we already have negative real returns on cash holdings and there is little evidence that it is causing firms or individuals to spend heavily, why should we expect them to respond differently to negative nominal rates?

A: Theoretically you shouldn’t have much of a response until you get the interest rate below the net rental rate. If you take a very simple model you get very little investment until you get to that point but once it is crossed you get a large amount of investment.

Things are more complicated in the real world because you have a variety of different investment projects. Nevertheless the simple model has a message that there is a critical interest rate at which investment takes off.

Suppose the net rental rate is around -2%. The message from the simple model is that there are lots of investment projects that have an internal rate of return of -2%. You might see some difference if you reduce rates from 0.5% to around zero but you shouldn’t expect to see much activity before you get below that level.

Q: Are you suggesting that at present the weakness in private sector spending is that they in effect expect a negative return on investment?

A: Absolutely. The internal rate of return companies expect, which I call the net rental rate, is currently below the natural rate of interest partly because the economy is doing badly.

This doesn’t mean that an investment will earn a negative rate of return. Investment projects may still be making positive returns on average but after adjusting for risk they might not look so appealing.

What you need to do is make it so that there is no way of getting a safe return of more than -2% anywhere and then people will take the risk of buying a new factory or building new equipment. That is why electronic money is crucial.

Q: How do you prevent huge capital flight in the interim?

A: I would use the more neutral term of a net capital outflows and there’s nothing wrong with that. The way this thing works is that the first adopter country gets a big trade surplus as a weakening currency stimulates exports.

So the first mover gets a big boost to their economy but of course other countries may complain. There are two possible answers for them:

The first is that they bring in electronic money and negative interest rates too so that the world can get the monetary stimulus it needs.

The second answer is to invite other countries to do a currency intervention. You have government debt yielding -2% and if other countries purchase it the UK gets paid handsomely for exporting some of the stimulus it’s providing to the world.

Any major country that adopted electronic money and negative rates would do the service of quickly making it happen in other countries. Although it might seem like there is a big political barrier to doing it initially the fact that any country doing it makes it politically necessary for other countries to do it makes it much more likely to happen than people realise.

Q: There was an implicit assumption behind the current policy mix in the UK that a weaker pound would boost exports. Despite falls in the value of sterling the export boom failed to materialise. Why should people expect a different result with negative nominal rates?

A: If you lower rates into negative territory at some point you are going to get more investment or more exports. It does depend on the balance of investment opportunities in the UK, for example, compared to elsewhere but you’re going to get one or the other.

Quantitative easing is a relatively weak tool and in simple models it doesn’t work at all. So I’m not surprised that it hasn’t been able to weaken sterling more and boost exports. Lowering interest rates is a much more powerful tool.

Q: But if an export boom fails to materialise could you become trapped in negative rates?

A: There’s no way you’re not going to recover. At some point you’re going to get production just for storage.

Even in the worse possible case where there were no factories or equipment that could possibly be a worthwhile investment you would still have some uplift to production from people stocking up on canned goods. So you will eventually get a recovery.

Q: From a more philosophical perspective, could the effect of the combination of electronic money and negative rates prize the commodity aspect of money from its value as a means of exchange?

A: What I would say is that electronic money represents the logical completion of the process of governments taking charge of monetary policy. It’s demoting the store of value aspect of currency, although it’s still important for it to be a decent short-term store of value between the time you get it out of the ATM and when you spend it.

Under the system of electronic money I’m talking about, where you still have paper currency around, you will still need that short-term store of value but you’ve totally demoted money as a long-term store of value. We want people to be funnelling money into building factories, buying new equipment and funding research and development. We don’t want them doing things that are not advancing the world around them.

Q: What are the implications of this for fiscal policy?

A: The zero lower bound does get in the way of monetary policy dominance. Once you get rid of it with electronic money then you really do get monetary policy dominance, and actually we’ve been there before. We didn’t have big discussions about how fiscal policy needed to stabilise the economy in the 1990s or even in the early 2000s. It’s only because we’ve run into the zero lower bound that fiscal policy has been a part of the discussion.

With fiscal policy, however, you really do have a problem as you have to deal with short run stabilisation and long run debt sustainability problems all at once. If you could get the former done through monetary policy then you only have to deal with the debt problem.