Tag Archives: Zero lower bound

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.

I Would Like to Withdraw A Couple Billion Swiss Francs: Legal Aspects

On his blog, Urs Birchler offers different perspectives on the question whether the Swiss National Bank (SNB) is obliged to pay out banks’ reserves in cash.

  • One view: Reserves are legal tender. The SNB therefore is not obliged to exchange reserves against cash.
  • Another view: According to the law, the SNB is required to provide sufficient cash. Moreover, reserves and cash were meant to be perfect substitutes.
  • Yet another view: Lawmakers would have written a different law had they known that the SNB considers it necessary to impose negative interest rates.

Costs of Negative Interest Rates

James McAndrews of the Federal Reserve Bank of New York doubts the merits of negative interest rates. He lists the following types of complications:

  1. Avoidance
  2. Legal and operational frictions
  3. Economic frictions
  4. Pass-through to market rates, and retail v. wholesale
  5. Effects of negative rates on the health of financial intermediaries
  6. Signal of deflation
  7. Public acceptance

“Leben ohne Bargeld (Life without Cash),” SRF, 2015

SRF, Echo der Zeit, May 18, 2015. AUDIO, HTML.

  • The availability of cash has costs: It eases tax evasion and money laundering and obstructs monetary policy at the zero lower bound.
  • But it also has benefits.
  • And the zero lower bound constraint can be relaxed otherwise, using taxes or an exchange rate.

Removing the Zero Lower Bound on Interest Rates

Imperial College London (the business school’s Brevan Howard Centre), CEPR and the Swiss National Bank organized a conference on this topic in London.

Most of the speakers agreed that giving central banks the option to move interest rates much further into negative territory would be valuable; and that deposit rates lower than minus half a percent p.a. are difficult to sustain without triggering major cash withdrawals. There was less agreement on how to avoid such withdrawals. Some favored phasing out cash, as this would also render tax evasion and money laundering more difficult; others were unwilling to sacrifice the privacy benefits of cash. But many speakers emphasized that there are other possibilities to achieve the same objective. (See my earlier blog post.)

Limits on Cash Withdrawals?

Andreas Valda reports in Der Bund about speculation that the Swiss National Bank (SNB) and/or commercial banks may limit cash withdrawals in response to negative CHF interest rates. According to the report, SNB press officer Walter Meier clarified the instruments at the SNB’s disposal as follows:

Die Nationalbank hat sich gemäss Gesetz bei der Ausgabe von Banknoten nach den Bedürfnissen des Zahlungsverkehrs zu richten; sie kann dafür Vorschriften über die Art und Weise, Ort und Zeit von Notenbezügen erlassen. … [Solche Vorschriften] würden gegenüber Bargeldbezügern bei der SNB gelten, also typischerweise Banken und sogenannte Bargeld-Verarbeiter.

“Notenbankgeld für Alle? (Reserves for Everyone?),” NZZ, 2015

Neue Zürcher Zeitung, February 20, 2015. PDF, HTML. Ökonomenstimme, February 24, 2015. HTML.

  • Allowing the general public to hold reserves at the central bank could help reduce the risk of bank runs and the negative consequences of deposit insurance.
  • It would end the need to accept bank deposits as means of payment although they are not legal tender; this need arises due to prohibitions on cash payments, for tax reasons.
  • But it could also have negative consequences: Money and credit creation by banks would be undermined, with social costs and benefits.
  • Price stability and financial stability could be threatened during the transition period.
  • More technical questions would have to be addressed as well: They concern the payment system or the conduct of monetary policy.
  • Proposals to go further and to abolish cash are not convincing. One suggested benefit—more leeway for monetary policy makers—is over estimated: Negative rates can also be engineered (effectively) through fiscal policy, and they can fully be implemented with a flexible exchange rate between reserves and cash.
  • Another suggested benefit—better monitoring of tax dodgers and criminals—is also overrated; the fixed cost to circumvent the measure would deter minor illegal activity but not major one.
  • But abolishing cash would have severe negative consequences for privacy and could negatively affect financial literacy.
  • Enforcing an abolishment of cash would be difficult. In a free society, any reform to the monetary system is constrained by the requirement that money must remain attractive for its users.

Non-Neutral Helicopter Drops

In an August 2014 Economics article, Willem Buiter discussed the conditions for a Friedman-type helicopter drop of money to be effective.

First, there must be benefits from holding fiat base money other than its pecuniary rate of return. Only then will base money be willingly held despite being dominated as a store of value … Second, fiat base money is irredeemable: it is view[ed] as an asset by the holder but not as a liability by the issuer. … Third, the price of money is positive.

Deflation … are therefore unnecessary. They are policy choices. This effectiveness result holds when the economy is away from the zero lower bound (ZLB), at the ZLB for a limited time period or at the ZLB forever.

The feature of irredeemable base money that is key … is that the acceptance of payment in base money by the government to a private agent constitutes a final settlement … It leaves the private agent without any further claim on the government, now or in the future. The helicopter money drop effectiveness issue is closely related to the question as to whether State-issued fiat money is net wealth for the private sector, despite being technically an ‘inside asset’ …

… because of its irredeemability, state-issued fiat money is indeed net wealth to the private sector … even after the intertemporal budget constraint of the State (which includes the Central Bank) has been consolidated with that of the household sector.

“Reserves For Everyone—Towards a New Monetary Regime?,” VoxEU, 2015

VoxEU, January 21, 2015. HTML.

New proposals to phase out cash are set to revive an old debate. Contributions to this debate focus on two related but independent issues: granting the general public access to central bank reserves; and phasing out cash.

Abolishing cash is neither necessary nor sufficient. But allowing the public to hold reserves at the central bank could have substantial benefits. Technical questions need careful consideration.

1.20 No Longer—Buiter Critique

In a Citi research note, Willem Buiter discusses the SNB’s decision to discontinue the exchange rate floor of the Swiss Franc vis-a-vis the Euro. His main points are:

  • The removal of the 1.20 floor on the CHF-euro exchange rate was a mistake.
  • Superior policy alternatives existed.
  • The old regime was indefinitely sustainable.
  • Removing the lower bound on nominal interest rates would have been the best choice. This can be done one of three ways.
  • The economic damage can be limited by restoring the exchange rate floor at a level not below the old one, and/or by eliminating the lower bound on nominal interest rates.
  • The rest of the world can learn from the SNB’s experience with a -0.75% deposit rate.

Buiter refers to his earlier work on removing the lower bound on nominal interest rates that I have discussed elsewhere (here and here).

Fed and Treasury Maturity Policies

In a recent paper, Robin Greenwood, Sam Hanson, Josh Rudolph and Larry Summers discuss the joint effect of Fed and Treasury policy on the maturity structure of government liabilities in the hands of the private sector. John Cochrane commends the paper in a blog post.

Greenwood, Hanson, Rudolph and Summers make several points. First, “monetary and fiscal policies have been pushing in opposite directions in recent years.” In spite of QE, long-term government debt held by the private sector increased, mostly due to government deficits but also because the government lengthened the maturity of its debt. Second, Fed and Treasury policies largely are uncoordinated. They argue that this is suboptimal, in particular when the Fed strongly intervenes as it did in the recent QE episodes.

The Federal Reserve has focused purely on the effects that its bond purchases were expected to have on long-term interest rates and, by extension, the economy more broadly. … it completely ignored any possible impact on government fiscal risk, even though the Federal Reserve’s profits and losses are remitted to the Treasury. Conversely, Treasury’s debt management announcements and the advice of the Treasury Borrowing Advisory Committee (TBAC) have focused on the assumed benefits of extending the average debt maturity from a fiscal risk perspective, and largely ignored the impact of policy changes on long-term yields. To the extent that the Federal Reserve and Treasury ever publicly mention the other institution’s mandate, it is usually in the context of avoiding the perception that one institution might be helping the other achieve an objective. Specifically, the Fed does not want to be seen as monetizing deficits, while the Treasury has been reluctant to acknowledge the Fed as anything more than a large investor.

Third, they argue that from a consolidated government policy perspective, the optimal debt maturity structure is rather short. This saves on interest payments to the private sector (on average) and reduces “liquidity transformation” by the financial sector with dangerous consequences for financial stability. They downplay the risk sharing benefits of longer-term debt and argue that short-term debt has additional advantages at the zero lower bound.

Pages 11-12 contain the following figure, among others:


Phasing out Cash

In the first and third of his Munich Lectures in Economics, Kenneth Rogoff argued in favour of phasing out cash, at least high denominations and in some developed economies. (His second lecture covered financial crises, see my post.)

Rogoff is well aware that cash preserves privacy and he acknowledges that one should have very good reasons to advocate phasing it out. He believes that there are two: Tax evasion and the black economy on the one hand, and the zero lower bound on nominal interest rates on the other.

Based on earlier research (Rogoff 1998) he argues that withdrawing bank notes with high denominations (e.g., USD 100 bills, EUR 500 bills etc.) would increase the cost of evading taxes or engaging in the black economy sufficiently strongly as to raise tax revenues, and that increased tax revenues would more than compensate for any loss of seignorage.

The (close to) zero lower bound on nominal interest rates and the resulting constraints for monetary policy derive from the fact that cash pays a zero nominal interest rate. Rogoff emphasised the seminal contribution of Lebow (1993 Fed working paper) in identifying the problems connected with the zero lower bound as well as possible ways to address them. Rogoff added that earlier writers (e.g., Gesell, Goodfriend, Mankiw or Buiter) who suggested to relax the constraint by subjecting cash to depreciation missed the point. Rather than forcing a negative nominal interest rate upon cash one should eliminate it altogether. He also dismissed shifting to a higher inflation target to avoid the zero lower bound problem, pointing to the huge loss of credibility that central banks would suffer as a consequence. Among factors for the trend towards lower real interest rates, Rogoff emphasised demographics and the asset pricing consequences of rare disasters; he dismissed secular stagnation. He also discussed forward guidance in the form of price level targeting.

Rogoff suggests to replace cash by universal debit cards. He does not expect significant technical difficulties in the process and proposes to subsidise debit cards for low income households.

Ken Rogoff on Martin Wolf’s “The Shifts and the Shocks”

In Prospect Magazine, Ken Rogoff reviews Martin Wolf’s account of the financial and European debt crises as well as his policy conclusions. Along the way, he offers his own views. Some excerpts:

Wolf rightly believes that one needs to look at the entire global economic system to understand what happened.

… he essentially concludes that there will be no long-run financial stability without kicking banks out of the money creation business, leaving it as a government monopoly, much as leading “Chicago Plan” economists first suggested in the 1930s.

Although Wolf makes a coherent case for considering this radical reform [the Chicago plan], he is rather circumspect on just how bad things will be if we don’t do it. For one thing, he seems to agree with Chicago economist Robert Lucas (whom he otherwise sharply critiques) that if the US financial firm Lehman Brothers had not been allowed to fail, the financial crisis would have been far less acute.

But if one really believes this, then why take all the risks of radical change? Anyone advocating a radical fix, as Wolf does, needs to convert the many politicians, financiers, regulators and even academics who conclude that the real lesson of the crisis should be to never let big banks fail. (This is certainly not my position.)

… By mulling whether the crisis could have been mitigated simply through better tactics during the weekend of 13th-14th September 2008, Wolf undermines his own case for radical reform. To be clear, I think that a major financial collapse would have been very difficult to avoid regardless of how Lehman was handled. Thus Wolf is fundamentally right: radical change is needed. Turning to the eurozone, … He is right that Germany bears its share of responsibility. But he emphasises the potential role of German fiscal stimulus far too much, and correspondingly underestimates the importance of regulatory failures, the rigidity of the 2 per cent inflation target and, above all, northern recalcitrance to restructure and write down southern debts.

… The first problem with Wolf’s simple arithmetic is that Europe is not a closed economy, and indeed Germany depends vastly more on exports to China and the US than exports to the periphery.

… If the capital flows to the eurozone periphery had been mainly in the form of direct foreign investment or equity (instead of short-term debt), they would have been far less problematic. … Germany’s biggest mistakes, by far, were in financial regulation that produced instability.

In truth, the southern Mediterranean countries in Europe are a place where there really is secular stagnation … But secular stagnation in the periphery would have been happening with or without the financial crisis … what could Germany have done? … First, it should have acted earlier to take a euro break-up off the table. Second, it should have found a way to restructure periphery debts at lower interest rates and with more time to repay. Third, it should have moved earlier to endorse a looser monetary policy at the European Central Bank (ECB). Fourth, and more for itself, it should have expanded infrastructure investment at home and abroad.

… rather than pouring fiscal stimulus into a German economy that has for some time arguably been overheated, it would have been far better to give periphery countries more help. … The point that periphery countries suffer from debt overhang should be an obvious one by now …

Wolf finds convincing the comparison between Spain and the UK made by the Belgian economist Paul De Grauwe, who argues that Spain would have been in much less trouble if it had had its own currency. True, but misleading. The claim overlooks the fact that, in many ways, Spain has still not completed the transition from being an emerging market to being an advanced economy. … But governance and institutional development can take many generations to unfold. My overwhelming presumption is that these countries would still have had problems containing their debts. … It is ludicrous to think the periphery has a mere liquidity problem. That is why the debts needed to be written down, or more likely stretched out at lower interest rates, which amounts to the same thing.

… So Germany could have done more to alleviate the crisis in the periphery. But the best way was not to increase spending in Germany, but to help increase spending in the periphery. Even the IMF has finally reached this epiphany, arguing that it should have insisted on “bailing in” private creditors in Europe; that is, making lenders take losses. Instead, too much of its lending effectively just helped to pay off private creditors, and did not provide meaningful budget relief.

Anyone worried about austerity in the periphery should have been first and foremost focused on writing down debt. The idea that arguing for such policies, and that worrying about the effects of debt overhang on growth, amounted to favouring “austerity” is simply ludicrous.

… Austerity in the periphery eurozone is an entirely different animal to that seen in the US and UK. The eurozone periphery suffered a classic sudden stop in private lending, and although the “troika” of the IMF, European Commission and the ECB did step in to help, they were too limited in their willingness to write down debt. Facing a sudden withdrawal of financing, periphery countries had to reduce expenditures.

For the US and UK, the decision to expand and then gradually reduce deficits gave policymakers considerable discretion over the exit strategy. For these countries, one can meaningfully speak about the trade-off between stability and stimulus….

Another key pillar in recovering from a financial crisis should be to boost infrastructure investment. Virtually every economist of every stripe agrees with this recommendation. … Administration officials privately expressed concern that infrastructure projects would take too long to get off the ground, and by the time they did, the spending would no longer be needed. My book with Carmen Reinhart, This Time Is Different, suggested that the recession was likely to be around for a long time, and that infrastructure spending would be extremely helpful.

… In fact, the ostensible argument over debt has nothing to do with progressive and conservative differences. It is about the size of government.

… The financial crisis does create an additional and very important argument in favour of fiscal stimulus, and Wolf is absolutely correct to highlight it. When an economy is at the zero bound on interest rates, and the central bank is unable or unwilling to stimulate inflation, fiscal policy is more effective in raising output. … However, the empirical size of the “fiscal multiplier” (how much output rises relative to increased government spending) is widely debated, and the evidence is very thin. … The fact the UK and US both achieved solid growth in the face of fiscal cuts would seem to contradict the view that multipliers are always and everywhere very large.

… Wolf, in line with Krugman, appears to believe that even wasteful government spending would raise welfare, a claim that is at best debatable.

… As for the resulting debt burden not being an issue, it is far from obvious that governments were wrong to worry about the fiscal burden, as debt more than doubled within a very short time. The ability to issue large amounts of debt in response to crises is a valuable option for governments. But if a country’s debt starts to reach a situation that is perceived as risky, the option might not be as available when needed most.

… Wolf now argues that of course we all knew there would eventually be a vigorous recovery in the UK. I can only say this was not obvious from reading either the Financial Times or the New York Times. Again, this is a matter of calibration, and the awful forecasts of those who focused excessively on fiscal policy and nothing else, underscores how difficult real-world policymaking can be.