Tag Archives: Negative interest rate

Does CBDC Increase Run Risk?

Central bankers often argue that CBDC would increase the risk of bank runs. On his blog, JP Koning rejects this notion. After all, he retorts, during a confidence crisis bank customers would no longer have to queue to withdraw cash; lender of last resort support would be provided much more quickly; and “large” cash holders would continue to shift funds into treasury bills, not into CBDC.

Koning writes:

The general criticism here is that during a crisis, households and businesses will desperately shift their deposits into the ultimate risk-free asset: central bank money. Presumably when deposits were only redeemable in banknotes (as is currently the case) and one had to trudge to an ATM to get them, this afforded people time for sober contemplation, thus rendering runs less damaging. But if small depositors can withdraw money from their accounts while in their pajamas, this makes banks more susceptible to sudden shifts in sentiment, goes the Carney critique.

I don’t buy it. … even in jurisdictions without deposit insurance, I still don’t think that shifts into digital currency in times of stress would exceed shifts into banknotes. A bank will quickly run out of banknotes during a panic as it meets client redemption requests, and will have to make arrangements with the central bank to get more cash. Thanks to the logistics of shipping cash, refilling the ATMs and tellers will take time. In the meantime a highly visible lineup will grow in front of the bank, exacerbating the original panic. Now imagine a world with digital currency. In the event of a panic, customer redemption requests will be instantaneously granted by the bank facing the run. But that same speed also works in favor of the bank, since a request to the central bank for a top-up of digital currency could be filled in just a few seconds. Since all depositors gets what they want when they want, no lineups are created. And so the viral nature of the panic is reduced.

But what about large depositors like corporations and the rich … ? During a crisis, won’t these sophisticated actors be more likely to pull uninsured funds from a bank, which have a small possibility of failure, and put them into risk-free central bank digital currency?

I disagree. In a traditional economy where banknotes circulate, CFOs and the rich don’t generally flee into paper money during a crisis, but into short-term t-bills. Paper money and t-bills are government-issued and thus have the same risk profile, t-bills having the advantage of paying positive interest whereas banknotes are barren. The rush out of deposits into t-bills is a digital one, since it only requires a few clicks of the button to effect. Likewise, in an economy where digital currency circulates, CFOs are unlikely to convert deposits into barren digital currency during stress, but will shift into t-bills. The upshot is that banks are not more susceptible to large deposit shifts thanks to the introduction of digital currency—they always were susceptible to digital bank runs thanks to the presence of short-term government debt.

Of course, depending on the type of CBDC, central banks might also choose to pay negative interest on CBDC in order to depress demand for it.

Marvin Goodfriend, the Fed’s Board of Governors, and Negative Rates

In the FT, Sam Fleming and Demetri Sevastopulo report that the White House considers Marvin Goodfriend for the Federal Reserve’s Board of Governors.

He has criticised the Fed’s crisis-era balance sheet expansion, saying the central bank should generally not purchase mortgage-backed securities, and has advocated the use of monetary policy rules to guide policy, as has Mr Quarles. …

At the same time, however, Mr Goodfriend has been willing to contemplate the use of deeply negative rates to stimulate growth — something that the Fed has thus far not embarked upon. In 1999 he wrote that negative rates were a feasible option, years before central banks started actually experimenting with them.

To implement negative rates while preserving cash, Goodfriend has advocated a flexible exchange rate between deposits and cash. On Alphaville, Matthew Klein quotes from a recent paper of Goodfriend’s:

The zero bound encumbrance on interest rate policy could be eliminated completely and expeditiously by discontinuing the central bank defense of the par deposit price of paper currency. … the central bank would no longer let the outstanding stock of paper currency vary elastically to accommodate the deposit demand for paper currency at par. …

The reason to abandon the pegged par deposit price of paper currency is analogous to the … reasons for abandoning the gold standard and fixed exchange rate: it is to let fluctuations in the deposit demand for paper currency be reflected in the deposit price of paper currency so as not to destabilize the general price level … the flexible deposit price of paper currency would behave as it actually did when the payment of paper currency for deposits was restricted in the United States during the banking crises of 1873, 1893, and 1907.

Negative Interest Rates vs. Higher Inflation

On his blog, Ben Bernanke weighs the pros and cons of negative (nominal) interest rates vs. a higher inflation target to create monetary “policy space.” His main points are:

  • Lower rates work immediately. In contrast, a higher inflation target only works once agents’ expectations adjust. A higher target may not be politically tenable a thus, not be credible. In contrast, “institutional changes … [such] as eliminating or restricting the issuance of large-denomination currency, could expand the scope for negative rates.”
  • Both negative rates and higher inflation have negative side effects. But the side effects of negative rates would materialize only during bad recessions.
  • There are reasons to expect that higher inflation would impose a relatively larger burden on the “poor” while negative interest rates would impose a relatively larger burden on the “rich.”
  • The political risks for the Fed associated with a higher inflation target may be substantial.

Monetary Policy When Interest Rates are Near Zero

In the 18th Geneva Report on the World Economy, Laurence Ball, Joseph Gagnon, Patrick Honohan and Signe Krogstrup ask whether “central banks can do [more] to provide stimulus when rates are near zero; and … whether policies exist that would lessen future constraints from the lower bound.”

They are optimistic and argue that the unconventional policies of recent years can be extended: “[I]t is likely that rates could go somewhat further than what has been done so far without adverse consequences” and “[m]ore stimulus can be provided if policymakers increase the scale of quantitative easing, and if they expand the range of assets they purchase to include risky assets such as equity.” While the authors concede that QE might have negative side effects they argue that the benefits are worth the costs.

To relax the zero lower bound constraint in the future, Ball, Gagnon, Honohan and Krogstrup argue in favor of a higher inflation target. They view cashless societies as not imminent but possible.

Tax Treatment of Negative Interest Rates in Germany

The German Ministry of Finance has decided (p. 55, nr. 129a) that for tax purposes, negative interest rates are not to be treated as the opposite of positive interest rates. Instead they are considered fees. This treatment lowers taxable income to a lesser extent than would be the case under a symmetric treatment.