JP Koning Defends Electronic Money vis a vis Ashok Rao

Ashok Rao wrote a blog post questioning the importance of eliminating the zero lower bound: 

The Economy’s Not a Rock, and Paper Isn’t Killing It

Here is my pictorial reply: 

For a more serious answer to Ashok, I was delighted to see JP Koning’s answer to Ashok’s arguments in the comments section of Ashok’s blog. Thanks to JP for his permission to reprint those comments here.

Good stuff. Some comments:

“Michael Woodford or Paul Krugman’s preferred monetary policy – “credibly promising to be irresponsible” – might be better achieved under negative interest rates but, even then, that’s not a clear conclusion. ”

Actually, the whole point of being able to set negative interest rates is so you don’t have to credibly promise to be irresponsible. It allows a central banker to reduce the return on reserves in the present (to some negative amount) rather than having to promise a future reduction in returns. It’s just a continuation of the conventional policy of manipulating interest rates that we had during the Great Moderation, except with the possibility of going negative — Greenspan, for instance, never had to commit to being irresponsible, he just lowered the overnight rate.

“what exactly is the point of militating for the abolishment of paper money – which is a far more radical experiment altogether?”

Aren’t you focusing in on the wrong experiment? Remember, Miles’s plan isn’t necessarily about abolishing paper. It’s about introducing a variable conversion rate between paper and deposits. If you think about it, this strategy isn’t even an experiment, actually. It’s very similar in concept to policies adopted in the late 1800s to go off the bimetallic standard and onto a pure gold standard. Rather than enforce a fixed ratio between gold:silver, authorities let the ratio float. That way the economy needn’t revert between gold and silver every few decades. Doing the same with notes:deposits means that we won’t experience mass movements from deposits to notes when the ZLB becomes a problem.

“[there’s no reason why following a Taylor Rule when rates exceed zero ] and an ‘exponential growth of asset purchases’ when rates fall below zero is any more discretionary.”

But that’s the whole problem. Rates can’t get below 0 because of the existence of 0% cash. No amount of QE will ever be able to make rates fall below 0.

That isn’t to say that huge QE can’t have some effect on the price level. By promising to keep huge amounts of reserves outstanding in the future, a central bank can lower today’s return on reserves and inspire movements today out of reserves into other goods and assets. Near term bills will fall to 0%, and eventually mid-term bonds will hit 0%, and finally long term bonds will fall towards 0%. The problem here, as Miles points out, is that we lose any sort of term structure of interest rates. Reducing rates below 0%, on the other hand, preserves the existing term structure of interest rates. Insofar as the term structure provides important information to economic actors, we may desire to preserve it rather than distort it.