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Breaking Through the Zero Lower Bound Miles Kimball (joint work with Ruchir Agarwal) Presentation at IMF May 4th, 2015 Preface: Central Point The zero lower bound is a policy choice, not a law of nature. Preface: Where the Zero Lower Bound Comes From • The zero lower bound arises when a government issues pieces of paper (or coins) 1. guaranteeing a zero nominal interest rate 2. over all horizons 3. that can be obtained in unlimited quantities in exchange for money in the bank. • This acts as an interest rate floor, making people unwilling to lend at significantly lower rates. • Cf. milk-price supports in the United States. Preface: “Electronic Money” • Eliminating the zero lower bound involves distinguishing between paper currency and electronic money (which in the 1930’s, Robert Eisler called “bank money”). Electronic money would be “the real thing.” • The electronic dollar, euro, yen, pound, etc. would be the unit of account. • The central bank would define which accounts constituted electronic legal tender. Ideally, this would be the only legal tender. Preface: “Electronic Money” (cont.) • The government is a big enough market player that it should be able to establish the electronic dollar (e-$) as the unit of account if all its dealings were on that basis (taxes, accounting rules,..) • That the government can determine the equilibrium on daylight savings time suggests private firms and households would follow the government’s lead on this. • For public relations, the name “electronic money” for the policy has real advantages, because it can be described as a natural transition to a 21st century monetary system. The Fraction of Transactions Conducted with E-Money/Bank Money • The higher the fraction of transactions that are conducted by check, credit card, debit card, electronic transfer, or other electronic means, the easier the transition to an electronic dollar, euro, yen, pound etc. unit of account is. • The fraction of transactions conducted in electronic/bank money depends on – convenience, – electronic discount/cash discount – spread between paper currency interest rate and other interest rates. (e.g. Japan, Germany) Preface: The Urgency of Understanding How to Eliminate the Zero Lower Bound In large measure because of the zero lower bound, other means of stimulus are being employed that may have bad side effects: • Running up the national debt with traditional fiscal policy • The unusual spreads generated by QE • The danger of reigniting a home-price bubble with QE • A possible sense in the future that past forward guidance has precluded what would otherwise seem appropriate policy. Monetary policy has two key advantages over fiscal policy for stabilizing the economy: 1. “expansionary monetary policy does not raise the budget deficit” –Alan Blinder 2. There is a much stronger tradition of technocratic monetary policy than technocratic short-run fiscal policy for stabilization. a. Many countries have independent central banks, beyond automatic stabilizers, almost none have independent short-run fiscal stabilization authorities. b. There is a reason for this: it is hard for politicians and voters not to feel a resonance between short-run fiscal policies taken for stabilization and the long-run fiscal policy issues that are the main axis of the political spectrum in most advanced countries. The Fed Does Less Monetary Stimulus Than It Thinks Is Warranted Because It Is Afraid of the Side Effects of Unconventional Tools Ben Bernanke, January 14, 2013 at the University of Michigan: “… the short-term interest rate is close to zero and therefore we are now in the world of non-standard monetary policy…asset purchases and communications and so on.” The Fed Does Less Monetary Stimulus Than It Thinks Is Warranted Because It Is Afraid of the Side Effects of Unconventional Tools “And as we were discussing earlier, we have to pay very close attention to the costs and the risks and the efficacy of these non-standard policies as well as the potential economic benefits.” Ben Bernanke, January 14, 2013 at the University of Michigan: The Fed Does Less Monetary Stimulus Than It Thinks Is Warranted Because It Is Afraid of the Side Effects of Unconventional Tools “And to the extent that there are costs or risks associated with non-standard policies which do not appear or at least not to the same degree for standard policies then you would, you know, economics tells you when something is more costly, you do a little bit less of it.” Ben Bernanke, January 14, 2013 at the University of Michigan: Preface: History of Thought for Negative Rates and Electronic Money A. Non-unit-of-account “bills of credit” in the early United States. “Continentals” lost value without causing rampant inflation (see Hall and Sargent 2013) B. Silvio Gesell’s stamped currency (1906) C. Robert Eisler’s depreciating paper currency (1932) D. Marvin Goodfriend’s advocacy of a modern version of stamped money (2000) E. Marvin Goodfriend’s discussion of suspension of payment in paper currency (2000) Preface: History of Thought for Negative Rates and Electronic Money F. Willem Buiter’s discussion of a wide range of mechanisms for avoiding massive paper currency storage (2004, 2007, 2009) – Abolish paper currency – Tax currency and stamp it (like Silvio Gesell) – Depreciating paper currency (like Robert Eisler) G. Greg Mankiw’s discussion of random invalidation by serial number (2009) H. Matthew Yglesias’s advocacy of abolishing paper currency (December, 2011) Preface: History of Thought for Negative Rates and Electronic Money I. My own advocacy of a crawling-peg exchange rate between paper currency and electronic money, as here (November 2012). J. The Urbanization Project’s elucidation of a crawling peg as a way to elicit substantial seignorage without inflation (Miles Kimball, Paul Romer, etc. November 2012) K. Focus on the details of policy tools to inhibit paper currency storage (Frances Coppola January 2013 and Miles Kimball January 2013 to date) Outline I. The Zero Lower Bound is a Problem II. How to Eliminate the Zero Lower Bound A. The Best Place to Act Against the Massive Paper Currency Storage that Would Enforce the Zero Lower Bound. B. “A Minimalist Implementation of Electronic Money” C. “How to Set the Exchange Rate Between Paper Currency and Electronic Money” III. Discussion and Conclusion I. The Zero Lower Bound is a Problem A. The zero lower bound is a key motivation for steady state inflation above zero. Ben Bernanke, March 20, 2013 press conference: So historically, the argument for having inflation greater than zero—we define price stability as 2 percent inflation as do most central banks around the world. And one might ask, “Well, price stability should be zero inflation. Why do you choose 2 percent instead of zero?” And the answer to the question you’re raising which is that if you have zero inflation, you’re very close to the deflation zone and nominal interest rates will be so low that it would be very difficult to respond fully to recessions. I. The Zero Lower Bound is a Problem (continued) A. The zero lower bound is a key motivation for steady state inflation above zero. • Ben Bernanke, March 20, 2013 press conference: There is research, for example, which asks the question how often do you tend to hit the zero lower bound? And our belief few years ago was that it was a very rare event and now it has become more common. • Larry Ball “The Case for 4% Inflation”: A 4% target would ease the constraints on monetary policy arising from the zero bound on interest rates, with the result that economic downturns would be less severe. I. The Zero Lower Bound is a Problem (continued) B. Many central banks are up against the zero lower bound in macroeconomic situations indicating output less than the natural level C. In particular, in the absence of the zero lower bound, the world economy’s Great Recession might have been much shorter. D. To keep certain spreads from being too thin, many central banks are unwilling to go as low possible given storage costs of cash. Sources: Haver Analytics Jan-15 Jul-14 U.K. Jan-14 Jul-13 Jan-13 Jul-12 Japan Jan-12 Jul-11 Jan-11 Jul-10 Euro Area Jan-10 Jul-09 Jan-09 Jul-08 Jan-08 6 Jul-07 Jan-07 Jul-06 Jan-06 Policy Rates in Major Advanced Economies (2006-2015) 7 U.S. 5 4 3 2 1 0 -1 Policy Rates in Other Advanced Economies (2006-2015) 9 Australia Canada Denmark New Zealand Norway Sweden 8 7 6 5 4 3 2 1 0 -1 Jan-06 Feb-07 Mar-08 Apr-09 May-10 Jun-11 Sources: Haver Analytics Jul-12 Aug-13 Sep-14 I. The Zero Lower Bound is a Problem (continued) E. The Bank of Japan has been up against the zero lower bound for a long time. This could be an important factor behind the relatively poor macroeconomic performance of the Japanese economy in the last 20 years or so. Japanese Treasury Bill Rates Real GDP Per Capita in Japan Log of Real GDP Per Capita in Japan Japanese Price Level (Log of GDP Deflator for Japan) Log of Nominal GDP for Japan Nominal GDP for Japan Since 1994 I. The Zero Lower Bound is a Problem (continued) F. “The Great Moderation”: when not facing the zero lower bound, central banks of advanced countries have done well in shortrun stabilization in recent decades, freeing up fiscal policy to focus on long-run issues. “The Great Moderation” I. The Zero Lower Bound is a Problem (continued) G. The zero lower bound makes it hard to get the time path of monetary stimulus right. • The short-term interest rate is the intertemporal relative price between spending now and spending a little while (say a year or two) in the future. • To get considerably more stimulus now than a year or two in the future, it is important to have a low short-term interest rate that makes goods now look inexpensive compared to goods a year or two from now. The Constraint the Zero Lower Bound Puts on the Time Path of Stimulus The zero lower bound creates a constraint between amount of stimulus now and amount of stimulus later. Typically, when below the natural rate, with a binding ZLB, • To get enough stimulus now, there would have to be too much stimulus later. • To get the right amount of stimulus later, there would have to be too little stimulus now. • This creates two problems: 1. Too little now or too much later 2. Credibility problems for enough now. Removing the Constraint and Restoring Credibility • If the zero lower bound is eliminated, the constraint between stimulus now and stimulus later is also removed. • This means it is possible to stimulate the economy now without convincing people the central bank will overstimulate the economy in the future. • As Krugman says about fiscal policy, low enough negative short-term interest rates will work, regardless of what people believe about the future. • If beliefs about the future reduce the stimulus from monetary policy, in the absence of the zero lower bound, the short-term interest rate can simply be lowered further to compensate. II. How to Eliminate the Zero Lower Bound A. The Best Place to Act Against the Massive Paper Currency Storage that Would Enforce the Zero Lower Bound. B. A Minimalist Implementation of Electronic Money C. How to Set the [Effective] Exchange Rate Between Paper Currency and Electronic Money [in Banks] A. The Best Place to Act Against the Massive Paper Currency Storage that Would Enforce the Zero Lower Bound 1. Restrictions or fees on paper currency withdrawals have the disadvantage of preventing withdrawals for spending as well as withdrawals for storage. Also the ability to withdraw has great option-value for people. 2. Storage of paper currency can be done in a very lowtech way by anyone. Also, criminals already have experience in secret storage of paper currency. 3. A temporary, time-varying fee on the deposit or redeposit of paper currency can effectively stop massive paper currency storage. See below on the timevariation (including why it can be temporary). B. The 3 Elements of a Minimalist Implementation of Electronic Money 1. Levying a time-varying deposit charge when banks deposit paper currency with the central bank. For example, with a 5% deposit charge, a deposit by a bank of 100 € of paper currency would yield 95 € in additional electronic reserves. 2. Discounting vault cash applied to reserve requirements by the same percentage as the deposit charge. 3. Establishing a legal right for any individual, business, government agency, or creditor to refuse payment in paper currency at par. (That is, paper currency would no longer be legal tender.) An Ultra-Minimalist Implementation of Electronic Money Time-Varying Deposit Fee • Only between the central bank and privatesector banks. No regulations related to the deposit fee are needed beyond that. • Must grow over time during the period the target interest rate is negative • Can shrink when the interest rate is positive. • Two-way: the other direction is equivalent to getting paper currency at a discount. The Deposit Fee Creates an Effective Exchange Rate Between Paper Currency and Electronic Money 1. Even if only one-way, to avoid the deposit fee, banks would offer paper currency to customers at a discount. Hence, if banks were making any deposits with the central bank, the deposit fee would establish an exchange rate between paper currency and electronic money. 2. (1-deposit fee) = exchange rate = X at which paper currency trades for electronic money. (Ignoring transactions costs.) 3. Ideally, to encourage this, the central bank would charge the deposit fee on net deposits, thereby effectively allowing withdrawals of paper currency at a discount. 4. While this exchange rate would probably hold for all dealings with banks, it need not hold at retail shops. For a while, shops would accept money at par (a) to avoid credit & debit card fees, and (b) to be nice to customers. The Nominal Interest Rate on Paper Currency • Remember that electronic money is the unit of account, so “nominal” means relative to an electronic dollar, euro, pound or yen, NOT relative to a paper dollar, euro, pound or yen. • X = electronic euros per paper euro. • Paper currency interest rate = (dX/dt)/X. • At every meeting of the monetary policy committee, four interest rates chosen until next meeting. – – – – Target rate Interest rate on reserves Lending rate Paper currency interest rate • Starting at par plus track of (dX/dt)/X mechanically determines X. C. The Log Exchange Rate Between Paper Currency and Electronic Money is the Integral of the MPC’s Chosen Interest Rate for Paper Currency What Having a Non-Zero Interest Rate on Paper Currency Means • Whatever the interest path chosen for paper currency implies that, say, 100€ should cumulate has to be the exchange rate for paper currency vis a vis electronic money at that point times 100€. • Thus, starting from par at the inception of an electronic money system, the principles of compound interest (with some combination of positive and negative interest rates) determine what the exchange rate between paper currency and electronic money must be. If, Given Recovery, the Average Nominal Rate Over Time is Positive, the Exchange Rate Can Return to Par. Four Options for the Time Path of the Effective Interest Rate on Paper Currency 1. Return to par swiftly. Serious mistake because high LB 2. Return to par gradually, but as quickly as possible consistent with keeping the zero lower bound nonbinding at all times: – Paper currency interest rate = monetary policy target interest rate (or maybe a little lower) during times of economic emergency. 3. Implement the Friedman rule: – Paper currency interest rate = target rate all the time 4. Constantly depreciate paper currency to earn seignorage without inflation. (e-yen=unit of account) – Attractive if it is otherwise hard to tax the shadow economy. Case 1: Swift Return to Par (Percent) 5 4 3 2 1 0 -1 Target Rate -2 PCIR -3 ln(X) -4 -5 2009 2010 2011 2012 2013 2014 Case 2: Gradual Return to Par (Percent) 5 4 3 2 1 0 -1 Target Rate -2 PCIR -3 ln(X) -4 -5 2009 2010 2011 2012 2013 2014 Case 3: Friedman Rule (Percent) 5 4 3 2 1 0 -1 -2 Target Rate -3 PCIR -4 ln(X) -5 2009 2010 2011 2012 2013 2014 Case 4: Never Return to Par (Seignorage) (Percent) 5 4 3 2 1 0 Target Rate -1 -2 PCIR -3 ln(X) -4 -5 2009 2010 2011 2012 2013 2014 The Spread Between the Monetary Policy Target Rate and the Paper Currency Interest Rate • The Central Bank should move the target rate (e.g., fed funds rate in the US) in tandem with the interest on reserves (when negative not just excess reserves), the discount rate and the paper currency interest rate. • The spread between other rates and the paper currency interest rate will matter to financial firms. This can be a separate policy choice with electronic money. • Currently, negative nominal interest rates yield a very low (negative) spread of other rates over the paper currency rate of zero. An electronic money system can avoid the resultant side-effects of negative rates that occur under current paper currency policies, since the paper currency interest rate would be a policy variable. Spread Between Target Rate and PCIR (Percent) 8 6 4 2 0 Case 1: Swift Return to Par -2 Case 2: Gradual Return to Par -4 Case 3: Friedman Rule Case 4: Seignorage without Inflation -6 2009 2010 2011 2012 2013 2014 Effect of Negative Interest Rates on Debt Contracts 1. Like any decline in interest rates, negative interest rates raise the price of non-callable debt contracts over horizons over which interest rates definitely fall (as long as the current numeraire-e-euro--value of the payments is unchanged.) 2. If negative interest rates bring quicker recovery, they can raise medium-term real interest rates and therefore lower medium-term nominal bond prices. 3. If then end of the zero lower leads to a reduction in the long-run inflation target, then very long-term nominal bond prices may increase. Effects of Paper Currency Below Par on Debt Contracts 1. Treating the e-euro as the unit of account means that an option to pay off in paper currency when paper currency is cheaper than par reduces would be an unintended quirk of typical debt contracts that are ambiguous about how payments must be made. 2. Ideally, legislation would clarify that debt contracts should be interpreted as referring to an e-euro numeraire. 3. The alternative is to give lawyers as much warning as possible that they should clarify what should happen in a debt contract when paper currency is away from par. How to Make Electronic Money De Facto Legal Tender: Gold Clauses as a Precedent for Electronic Payment Clauses in Debt Contracts From Wikipedia “Gold clause”: Gold clauses specified within business contracts allow the creditor the option to receive payment in gold or gold equivalent. A gold clause may prove valuable to the creditor in long term contracts, wherein questions may arise as to whether a currency in use at the time the contract was entered into would still have the same value when payment is due. Creditor concerns in respect to inflation, war, changes in government, and any other uncertainty about the future value of currency would be common reasons for adopting a gold clause within a contract. (Continued on next slide) How to Make Electronic Money De Facto Legal Tender: Gold Clauses as a Precedent for Electronic Payment Clauses in Debt Contracts (cont.) • These clauses were common at the beginning of the 20th century. However, their use in the United States was invalidated by the Gold Reserve Act of 1934. Congress later reinstated their use for obligations (new contracts) issued after October 1977 in accordance with 31 U.S.C. § 5118(d)(2).[1] • On August 27, 2008, the United States Court of Appeals for the Sixth Circuit affirmed the enforceability of such clauses in the decision Jamaica Avenue, LLC vs S&R Playhouse Realty Co..[2] Unintended Effects on Debt Contracts Do Not Create a Zero Lower Bound • Paper Currency under the current monetary system creates a zero lower bound because of the option to get a zero interest rate over any horizon for any amount of funds. • By contrast, pre-existing debt contracts are fixed in number. There is no unlimited option to get more debt contracts like that on the same terms. • Unlike paper currency in the current monetary system, the price of debt contracts and most other assets can adjust relative to the e-euro unit of account. “How Governments Can and Should Beat Bitcoin at Its Own Game” (Slate) “… in our current monetary system we take for granted an interest rate of zero on paper currency. That interest rate of zero can falsely signal to households and firms that it is OK for them to hold back on spending—even at times when businesses desperately need the customers and people desperately need the jobs that extra spending would provide”. “How Governments Can and Should Beat Bitcoin at Its Own Game” (Slate) “Yesterday’s paper currency is not only a barrier to speedy recovery from deep recessions—it is also a barrier to ending inflation. … Take paper currency off its pedestal, and inflation is no longer necessary to provide this space for monetary policy, since interest rates can go down, instead of inflation having to go up. Then there is nothing standing in the way of ending inflation forever.” “How Governments Can and Should Beat Bitcoin at Its Own Game” (Slate) Step 1 Establish official government-sanctioned electronic money in a way that makes the use of electronic money as convenient and seamless as possible. This involves setting the stage for private innovation in electronic payment systems by giving full legal tender status to electronic money in all government-insured bank accounts and in other accounts that are officially certified as backed 100 percent by reserves held at the central bank. Corollaries to Step 1 • Entrepreneurs who are tying to develop revolutionary payments technologies that can upend the Visa/American Express/Mastercard/.. Oligopoly and lower electronic payment transactions costs are on the side of the angels, and should be encouraged. • The Fed should be pressed to do its duty under Dodd-Frank to set maximum interchange fees in line with marginal cost as “How Governments Can and Should Beat Bitcoin at Its Own Game” (Slate) Step 2 Dethrone paper currency from the exalted legal status it was given (very controversially) in the late 19th century, by giving anyone, at any time, the right to refuse payment in paper currency, unless a contract explicitly calls for payment in paper currency. Further demote paper currency by abolishing the guarantee that a paper dollar (or euro, or yen, or pound) will always be worth the same amount as an electronic dollar. But make sure that it is easy for people to convert paper currency into electronic form and vice versa. Corollaries to Step 2 • Going forward, standard debt contracts should specify what the required payment will be if paper currency is away from par. If 100 paper dollars are worth 98 electronic dollars, does the debt contract effectively permit paying the interest or principal at a discount by paying in paper, or is the equivalent of 100 electronic dollars required? The answer should be explicit in the debt contract. • Commercial codes should encourage the development of standard debt contracts clarifying this issue. “How Governments Can and Should Beat Bitcoin at Its Own Game” (Slate) Step 3 “Search in the nooks and crannies of the legal code and government agency regulations and policies for places where it is assumed that interest rates are always zero or positive or where it is assumed that paper currency has a special status—and root those assumptions out. (For example, make it clear that people can’t show up with suitcases full of hundred-dollar bills to settle their taxes.) Encourage businesses to do the same with their business plans and their accounting.” Corollaries to Step 3 • The law should be clarified to expressly prohibit payment of taxes in paper currency. • The option of prepaying taxes at an implicit interest rate of zero needs to be foreclosed. The natural alternative is to have nbenchmark interest rates for tax purposes that are tied to the Fed’s target rate. • Tax accounting standards should be adjusted to specify an electronic dollar standard should paper currency ever be away from par. • It needs to clarified when interest earned or paid on paper currency should affects taxes and when not. “How Governments Can and Should Beat Bitcoin at Its Own Game” (Slate) Step 4 Give the central bank the authority to make interest rates negative, including making the interest rate on paper currency negative when necessary, by using the fact that a paper dollar is no longer guaranteed to be worth the same amount as an electronic dollar. Corollaries to Step 4 • It is important for legal teams at Treasury to clarify the legal authority of the Fed. For example – Is the Fed allowed to make interest on excess reserves negative? (The Fed is afraid to ask its own counsel for a legal opinion on this, for fear that such a legal opinion will then be determinative.) – Is the Fed allowed to impose a deposit fee when banks seek to deposit paper currency into their reserve accounts? • If Treasury’s view of the legal authority of the Fed is more expansive than the view of the Fed itself, that should be hashed out. “How Governments Can and Should Beat Bitcoin at Its Own Game” (Slate) Step 5 Require the central bank to bring its inflation target down to zero over the course of 15 years and to forever afterward keep the value of a dollar in terms of goods and services within an unchanging narrow band. This should be revised only when necessary to take into account improved ways of measuring the value of a dollar (or euro or yen or pound). Corollaries to Step 5 • In making choices about debt maturities, Treasury should take seriously the possibility of lower inflation in the future. Without worries about the zero lower bound, there is likely to be a policy tendency toward lower inflation. • 30-year nominal government bonds with interest rates determined by a market assuming at least 2% inflation could in the end be a very expensive form of government finance. “How Governments Can and Should Beat Bitcoin at Its Own Game” (Slate) It has become traditional for U.S. Treasury secretaries to periodically repeat the mantra that “A strong dollar is in our nation’s interest.” I would add one word to the mantra: “A strong electronic dollar is in our nation’s interest.” A strong electronic dollar is one that works smoothly in transactions, empowers monetary policy to bring a speedy end to recessions, and keeps its value over time with no concessions to inflation.” III. “The Costs and Benefits of Repealing the Zero Lower Bound … and Then Lowering the Long-Run Inflation Target” A. Costs of eliminating the ZLB – Computational costs of the exchange rate: like sales taxes and applies to a smaller and smaller fraction of goods as electronic transactions become more common – Effects of lower real interest rates, like any reduction in interest rates. – Nominal illusion effects. E.g., new strategies for financial hucksters and bubble-mongers. – Possible redistributions from soft-money transition Benefits of Eliminating the ZLB • Direct benefits • Benefits of being able to lower the long-run inflation target • Analogy: direct benefits of raising equity requirements for financial firms + benefits of being able to pursue more vigorous monetary given fewer macro-prudential worries Costs of Inflation in the Absence of the ZLB: Must Answer “Inflation Relative to What?” 1. Messing up price signals Varieties of final goods Varieties of intermediate goods Varieties of labor inputs Leisure over time 2. Menu costs Unit in which prices and wages are specified (Should be e-$ with minor exceptions) Costs of Inflation in the Absence of the ZLB 3. Confusion Making people blame “inflation” for real wages lower than they would like Causing unintended distortions in the tax code, particular higher capital taxation than intended. Making people misunderstand economic data, for example income distribution including inflation component of capital gains and interest Leading people to mistake nominal rates for real rates of return when doing retirement planning. Muddling intertemporal comparisons more generally (yardstick) 4. Unpredictability of Inflation goes up with level of inflation (zero inflation is focal, so less unpredictability when inflation is near zero) Unit of Account Costs of Inflation in the Absence of the ZLB 5. People using too little paper currency (shoeleather costs, etc.) • Not about inflation per se, at all. • Rather about the spread between the checking account interest rate etc. and the paper currency interest rate. • In an electronic money system, the key shortterm spread is under the central bank’s control as a distinct instrument. • Tradeoff between various effects of this spread, regardless of the level of inflation. • Lower inflation helps during periods at par. Will Having Paper Currency Away from Par at Some Points Discourage Its Use? • Extra computations costs make paper currency use less attractive. • Retailers likely to, in effect, give a cash discount when they must have a conversion factor in any case. This encourage paper currency use. • Stickiness of conversion factor at par may lead to an especially big cash discount early on. Possible Benefits of Inflation: SecondBest Effects Relative to a Preexisting Suboptimality 1. Raising the effective rate of capital taxation, if that is a good thing rather than a bad thing. (Unit of account) 2. Making it easier for firms to lower the real wages of particular employees. (Unit of stickiness) 3. Leading firms to lower their markups of price over marginal cost and wage setters to lower their markups of the wage over the opportunity cost of time. (Unit of stickiness) Conclusion • The zero lower bound is a policy choice. • The zero lower bound is costly. – ZLB interferes with stabilization policy – ZLB is a big enough problem it motivates higher inflation than would otherwise be optimal • The zero lower bound can be eliminated through – A time-varying charge for depositing paper currency at the central bank – A discount for vault-cash as applied to reserve requirements – The ability to specify terms for acceptance of paper currency in new debt contracts • Electronic money would be “the real thing”: the unit of account and the effective legal tender. • Other measures can make the electronic money system work better, and make the transition easier. APPENDIX SLIDES Transition to Electronic Money as a Monetary System “The Transition to Electronic Money as a Monetary System”/ “Going Off the Paper Standard”—The Long Version 1. Announce technical feasibility of eliminating the ZLB. 2. Strengthen macro-prudential regulation by raising equity requirements substantially above Basel III. 3. Ask banks and other financial firms to make contingency plans for negative interest rates. D. “The Transition to Electronic Money as a Monetary System”/ “Going Off the Paper Standard” 4. Develop accounting standards for negative interest rates that take electronic money as the unit of account, and give to paper money then value it is worth in the market relative to electronic money. 5. Ask government agencies to prepare contingency plans for negative interest rates and non-par valuation of paper money. D. “The Transition to Electronic Money as a Monetary System”/ “Going Off the Paper Standard” 6. Make it clear no one has the right to pay off large debts to the government in contexts where transactions are now routinely conducted with bank money. 7. Establish by law that debgtors do not have the right to pay off large debts with paper currency at par when the market value of paper currency is below par. D. “The Transition to Electronic Money as a Monetary System”/ “Going Off the Paper Standard” 8. Formally make money in central-bank certified bank accounts legal tender. 9. Announce the intent to introduce an electronic money system. 10. Lower the central bank’s interest rate on reserves to zero or slightly below zero. 11. Lower the central bank’s target interest rate, interest rate on reserves, and the central bank’s lending rate substantially below zero. D. “The Transition to Electronic Money as a Monetary System”/ “Going Off the Paper Standard” 12. If there is any sign of large increases in paper currency withdrawal, institute a time-varying deposit charge when banks deposit paper currency with the central bank in exchange for reserves. (Since the deposit charge starts at zero, there will be plenty of time for people to get used to the deposit charge as it grows. It only grows as required by a negative target rate, and shrinks when the target rate is positive.) D. “The Transition to Electronic Money as a Monetary System”/ “Going Off the Paper Standard” 13. Discount vault cash applied to reserve requirements by the factor (1-deposit charge) 14. Implement the accounting standards appropriate for negative interest rates and nonpar valuations of paper currency. 15. Require payment of taxes and other substantial debts to the government in electronic form. D. “The Transition to Electronic Money as a Monetary System”/ “Going Off the Paper Standard” 16. Implement the contingency plans for government agencies. 17. Ask all firms to post prices in terms of electronic money. (This could be in addition to prices posted in terms of paper currency. It also may not be necessary.) 18. Make it clear that firms are allowed to specify in contracts (including loan contracts) and in retail sale the terms under which they will accept paper currency. Hard-Money Transition vs. Soft-Money Transition • Having pre-existing debt contracts interpreted as applying to e-$ amounts probably keeps to the intent of those contracts better than letting them be paid in below-par paper currency. If this principle can be established in law, I call it a “hard-money transition.” • If old debt contracts can be paid in below-par paper currency, I call it a “soft-money transition.” • I prefer the hard-money transition, but old debt contracts cannot create a zero lower bound if new debt contracts are effectively in terms of emoney. Other Issues A. Political constraints B. Can things other than government-issued paper currency generate a zero lower bound? C. Could the ZLB be eliminated without a change in current law, if key elements of the government were tacitly backing the central bank in such an action? D. Helping financial firms adjust E. Comparing negative rates to QE F. Answer to miscellaneous possible objections G. Options for exchange rates with e-money A. Dealing With Political Constraints: Negative Nominal Rates Themselves 1. People are not used to negative nominal interest rates Both the reasons and the mechanics will require a great deal of explanation 2. The usual complaints that expansionary monetary policy hurts virtuous savers will be magnified when rates are negative. As part of communication, it needs to be emphasized that Low rates help borrower in the economic hard times Low rates help the economy Interest rates should reflect the social benefit of saving; saving is not what society needs when the economy is in a slump. Low rates for a short time will bring higher rates later by fostering economic recovery: “Negative rates for a few quarters are better than zero rates for years and years.” B. Which of These Things Could Generate a ZLB Even if Paper Currency Doesn’t? • Postal Savings system in Japan pays a zero interest rate on unlimited deposits. Yes. • A zero interest rate on a limit amount of deposits. No. – A transfer program. Does not creat a ZLB. • Bitcoin. No. (Unless it became the unit of account.) – Not freely convertible at a set price. – Announcement of negative rates should cause Bitcoin to appreciate instantly and then have a gradual price decline thereafter. – The government has plenty of tools to maintain its near-monopoly on money. C. Could the ZLB Be Eliminated Without Any Change in Current Law If Key Elements of the Government Tacitly Backed That Action? 1. Time-varying deposit fee when banks deposit paper currency with the central bank is probably within current authority of most central banks. 2. Discounting vault cash should be within current authority of most central banks. 3. Future debt contracts can probably be written with a clause with conditions on paper currency payment. 4. The deposit fee for paper currency implicitly treats electronic money as the unit of account. 5. The details of the law may matter. Legal teams at central banks should examine the issues. D. Helping Financial Firms Adjust Prudently to a New World of Negative Interest Rates Safely. 1. Go big or go home? Would -3% or -5% help financial firms realize they need to adjust their business models (and explain the changes to customers) better than -.5%? 2. Money market mutual fund reform needed to push money market mutual funds away from any implicit promise not to “break the buck.” (Proposals already on the table.) 3. No real downside to high bank (& shadow bank) equity (“capital”) requirements to ensure financial firms aren’t causing macroeconomic risk. See The Banker’s New Clothes by Anat Admati and Martin Hellwig The higher equity requirements can be implemented without disruption for existing firms simply by prohibiting dividends and share purchases until the requirements are met. E. Comparing Negative Nominal Interest Rates to QE (Overview) • Negative nominal interest rates are powerful enough that they can be used as a substitute for QE, not just as an adjunct. Indeed, I would recommend explicitly saying nominal interest rates are a way to avoid having to use QE. • QE is better than nothing, but how does QE compare to negative interest rates in the absence of a zero lower bound? E. Comparing Negative Nominal Interest Rates to QE A. Large purchases and later sales of long-term government bonds can be costly because of a buy high/sell low problem. Using IOR instead of unwinding would just delay the recognition of this problem. Another way of looking at the same problem is that buying up long-term government bonds goes against the government as a whole locking in low long-term rates. The losses to the private sector from buy high/sell low tend to benefit those who are relatively wealthy. This problems with QE can be avoided by focusing on risky asset purchases. B. C. D. QE, like all methods that face the zero lower bound, has a constraint making it hard to stimulate enough now without committing to stimulate too much later. This may be the biggest problem. QE squeezes spreads abnormally. It would be surprising if that did not cause some distortions. In any case, those squeezed spreads push the economy into unknown territory. By contrast, we already have plenty of experience with negative real rates, so the only unknowns with negative interest rates have to do with nominal illusion. F. Answering Potential Objections 1. “People will just use a foreign currency.” But people now use domestic paper currency even when foreign paper currency has a higher expected return. (For example, why don’t Americans now have big piles of yen notes?) If people did turn to foreign currency, that would just one more example of a low domestic interest rate causing capital outflows and therefore raising net exports, with stimulative effects. (In this case the fact that paper currency interest rates fall in tandem with other interest rates makes it a bit more powerful.) F. Answering Potential Objections 2. “People will store commodities” The production of anything can stimulate the economy. And storage of useful goods is actually socially optimal if other investments have a lower return. (There is nothing wrong with people buying canned goods in advance, when rates are low, for example.) The production of money-like goods (e.g. gold) beyond their non-monetary social usefulness can be discouraged by taxing the storage of those goods. Buying foreign-produced gold creates export demand for goods produced locally. Domestic production of gold can be tracked. What About a “Paperification Equilibrium” Where To Avoid the Deposit Fee, People Just Use Paper Currency and Non Electronic Money? • For those taking paper as a numeraire, target rate – paper currency interest rate (or IOR – PCIR) is the approximate return to putting funds into the bank. • Thus, a low enough paper currency interest rate relative to the target rate or IOR will induce people to put money in the bank, even if paper currency is being accepted at par in shops. • So the paper currency deposit fee remains relevant. What If a Sub-Par Future Exchange Rate for Paper Currency is Not Fully Credible? • A fair amount of credibility is indeed needed. • However, perfect credibility is not needed. – Even if the intended exchange rate peg is broken (& 2-way is shut down to avoid money pump), the actual exchange rate will be between that and 1, since paper currency is still handicapped somewhat by the deposit fee. – We need E(PCIR) < target rate and E(PCIR) < IOR – While the peg holds, E(PCIR) < [θ (1-x)/x] + ([dx/dt)/x] = [θ (1-x)/x] + PCIR* – So as long as the perceived probability θ of going into a messy “endgame” where the peg is broken is not too high, there will be no massive paper currency storage and the peg can hold. G. Options for International Exchange Rates and Paper Currency Exchange Rates • Robert Eisler wanted a fixed international exchange rate in the bank money, with a flexible paper currency exchange rate. • My basic plan has flexible international exchange rates and a crawling-peg paper currency exchange rate. • For the euro-zone, I proposed a “one-central bank, multiple currencies” model with an electronic Deutsche mark, with the euro serving as the paper currency for Germany as well as for the rest of the zone. So in effect, Electronic euro = paper euro = paper mark, But the electronic mark (which would be the unit of account in Germany) is distinct and has a crawling-peg exchange rate with the others. Assessing Japanese Monetary Policy: Has NGDP (the Velocity-Adjusted Money Supply) Been Smooth? 1. Quartz 21—>Optimal Monetary Policy: Could the Next Big Idea Come from the Blogosphere? 2. http://blog.supplysideliberal.com/post/5064 6128943/quartz-21-optimal-monetarypolicy-could-the-next-big 3. Influenced by Market Monetarism. 4. Focuses on the behavior of NGDP, the velocity adjusted money supply (MV=PY) Why NGDP (the Velocity-Adjusted Money Supply) Should be Smooth 1. To a first approximation, optimal monetary policy is to keep the economy at the natural level of output. 2. Inflation data only gradually reveal where the natural level of output is. 3. Therefore, a good approach in absence of ZLB is: a. Very-short-run interest rate target b. Medium-run NGDP target with steady growth at a rate that factors in estimates of of what tech progress, pop, capital stock, etc. mean for growth in natural output. (Choice of the estimated growth rate for natural output is a key task of the central bank.) c. Long-run inflation target at zero. Log of Nominal GDP for Japan Nominal GDP for Japan Since 1994