Follow-Up on Eliminating Paper Currency
Some lengthy responses to comments on my BloombergView post on eliminating US government-provided paper currency …
Comment 1: Scott Sumner (among others) asked, “Why not just raise the inflation target?” I think that this represents a misunderstanding of the problem that I’m trying to solve. My hypothetical was that there had been a large adverse shock to the economy. In that scenario, the equilibrium real interest rate could be -6% or even lower. (Take a look at some of the optimal control pictures from the FOMC meetings in 2009 or from Chair Yellen’s latest speech.) Even with an inflation target of 4%, the appropriate nominal interest rate has to be well below zero.
To sum up: The premise of my post is that (1) the central bank won’t and probably shouldn’t set the inflation target high enough to avoid the zero lower bound after quite plausible shocks and (2) the central bank cannot or will not raise the medium-term inflation target on a temporary basis to deliver appropriate outcomes.
Comment 2: Why not use nominal GDP level targeting?
Perhaps not surprisingly, this comment also came from Scott. As I understand it, the key benefit of level targeting is that, given a period of slower-than-desired growth in nominal GDP, people will expected faster-than-desired growth in nominal GDP. This will damp the needed fall in the real interest rate, and also deliver part of the needed fall in the real interest rate (because of higher inflation expectations).
But would people’s expectations actually work that way? It’s worth noting that, over the past thirty years, annual nominal GDP growth has been highly positively autocorrelated. To be effective, a nominal GDP level target would require people to significantly downweight that data in forming their expectations of future nominal GDP growth. It would be desirable to have some evidence - maybe from laboratory experiments? - to support this claim.
To sum up: the idea in my post is that the central bank can lower the real interest rate in the conventional way: by lowering the nominal interest rate a lot while expected inflation stays relatively stable. I’m not convinced that nominal GDP level targeting would lead to the kind of “automatic stabilizer” expectations adjustment that is often claimed, although I’m certainly open to evidence along those lines.
Comment 3: Asset purchases and forward guidance will already do the trick - central banks don’t need negative rates.
Perhaps tellingly, nobody actually made this comment. But I took it to be an important message of Chair Yellen’s speech in Jackson Hole. I agree with her that forward guidance can be powerful (I remain considerably less convinced about asset purchases). But I’ll note that she presumes in her speech that, after the shock hits, the central bank is able to commit to delivering an unemployment rate well below its long-run level. As I listen to current Fed communication, I just don’t think that kind of commitment would (or should) be seen as all that credible.
Comment 4: Government-provided paper currency means that nominal interest rates can’t go negative. That’s a good thing, because negative nominal interest rates are a tax on Americans’ hard-earned wealth.
Many on Twitter made this comment and more than a few in fairly strongly terms. The thrust of my post is that I disagree with the characterization of negative nominal interest rates as a tax. In my view, a negative nominal interest should be understood as simply representing a high price for the desirable attributes of US government liabilities. We can see that price became artificially low during the recession and recovery because people and businesses held cheap financial assets rather than spending enough to utilize existing economic capacity.
Eliminating US government-provided paper currency would not alter in any way Americans’ ability to store their wealth in stocks, in corporate bonds, in gold, in silver or in other countries’ currencies. Of course, the prices of these assets too might rise in response to a reduction in the nominal interest below zero. That’s what happens when central banks ease.
As I discuss below, I support the US government allowing the development of private currencies (digital or possibly otherwise).
This comment is generally what is meant by the political opposition to negative nominal interest rates. As I noted in my post, similar opposition exists in poorer countries to removing price ceilings on bread or other staples. One way to deal with this opposition is to make transfers to those who are most affected by the removal of the distortion - in this case, retirees or near-retirees.
Comment 5: Eliminating government-provided paper currency will allow the government too much power to monitor (and tax) our activities.
Unlike some other economists, I’m highly sympathetic to this concern. People value anonymity, even from (and some especially from) the state. In my post, I suggest that the government should allow the development of private anonymous digital currencies as a substitute for the anonymity currently provided by government-issued paper currency. In a very nice blogpost, J. P. Koning suggested that private banknotes could serve the same function.
However, would the government be willing to allow such private means of payment to flourish? Quite possibly not. The federal government has been moving in the opposite direction in the past few years by significantly upping its tracking of non-cash payments. This regulation is designed to curtail the activities of terrorists and criminals. But, whatever its intent, it does not speak to a desire to facilitate privacy in transactions.
In my view, this last comment sets up what I see as the key public policy trade-off. If big shocks hit, government-provided paper currency creates significant underutilization of resources But, if paper currency were to disappear, would the government actually allow Americans to develop the private sector means of accomplishing anonymous transactions that they desire?
N. Kocherlakota
Rochester, NY
September 3, 2016