With interest rates not far from the zero floor in many parts of the industrial
world, can central banks do anything more to stimulate demand? Writing in
the October 2003 Economic Journal, Willem Buiter and Nikolaos
Panigirtzoglou argue that there is still one unconventional monetary policy
instrument left: to lower the zero floor by paying a negative nominal interest
rate on base money – in other words, by taxing currency.
The authors note that the industrial world is experiencing the first serious
deflationary episode since the 1930s. In Japan and Switzerland, short riskfree
nominal interest rates are effectively zero and conventional monetary
policy has exhausted its potential for stimulating demand.
With the Federal Funds rate at 1%, the United States faces the real risk that
short nominal interest rates would hit the zero floor if the economy were to
encounter further contractionary shocks. In euroland, with the ECB's repo rate
at 2%, the risk of hitting the 'zero bound' is lower but still non-negligible, while
in the UK, where the repo rate has just gone up to 3.75%, a visit to the zero
floor remains a rather distant prospect.
The authors note that even with the short nominal interest rate at zero,
monetary policy is not completely emasculated. Central banks can relax the
collateral requirements for their repo operations or widen the range of eligible
counterparties. They can engage in 'open market purchases' of longermaturity
public debt. In principle, this can be taken to the point that all public
debt held outside the central bank has been monetised. As long as the
nominal interest rate on any government debt instrument is positive, monetary
policy has not been emasculated.
Central banks could also engage in foreign exchange market intervention,
sterilised or non-sterilised. More generally, they could expand the stock of
base money by purchasing foreign-currency denominated liabilities of foreign
governments and foreign private agents. There may be legal, regulatory or
conventional practice obstacles to expanding the scope of central bank open
market operations to include a much wider spectrum of collateralised or
uncollateralised financial instruments, but from a technical point of view they
are perfectly feasible.
What’s more, textbook economic analysis teaches that precisely when riskfree
nominal interest rates at all maturities are stuck at their zero floor – that
is, in a 'liquidity trap' – expansionary fiscal policy is at its most effective. Even
when the entire stock of public debt has been monetised, current and future
government deficits can be monetised. Financing government deficits by
printing base money does not, of course, add to the burden of the public debt.
But if all else fails, the central banks on their own still have one
unconventional monetary policy instrument left: to lower the zero floor on
nominal interest rates and to achieve negative nominal interest rates by
paying a negative nominal interest rate on base money.
Part of that job is trivially easy. Commercial bank balances (reserves) held
with the central bank are entries in an electronic ledger, no different from an
individual account held with a commercial bank. It is equally easy to apply a
negative interest rate to such balances as a zero or positive nominal interest
rate. More difficult is taxing the second component of the stock of base
money: currency or bank notes, which are examples of bearer securities, but
there are ways by which these could be made gradually to lose their nominal
value.
This paper reviews the analytics and the intellectual history of negative
nominal interest rates on bearer securities and of the ‘carry tax’ on currency.
The idea goes back at least to Silvio Gesell (1862-1930), a German/Argentine
businessman and economist with a reputation as a bit of a crank but admired
by Keynes. Distinguished ‘conventional’ economists like Irving Fisher for a
while supported the issuance of notes that would gradually lose their nominal
value according to some pre-announced schedule (also called stamp scrip)
and wrote a sympathetic account of it.
The authors demonstrate that if negative interest can be paid on base money,
then the lower bound on nominal interest rates is removed completely and it
becomes possible again to drive current and expected future real interest to
levels that will boost demand.
No monetary authority today has the stamp scrip arrow in its quiver. Without
minimising the administrative and enforcement costs of implementing
negative interest rates on currency, the authors believe that it may be
worthwhile to add the carry tax on base money to the conventional monetary
policy arsenal.
If the alternatives are either persistent deflation (if the zero floor has become
binding) or the implementation of a high inflation strategy (to minimise the risk
of the zero floor becoming binding) even a proposal originated by a crank may
be worth considering.
ENDS
Notes for Editors: ‘Overcoming the Zero Bound on Nominal Interest Rates
with Negative Interest on Currency: Gesell’s Solution’ by Willem Buiter and
Nikolaos Panigirtzoglou is published in the October 2003 issue of the
Economic Journal.
Buiter is Chief Economist and Special Counsellor to the President at the
European Bank for Reconstruction and Development; Panigirtzoglou is at the
Bank of England.
For Further Information: contact RES Media Consultant Romesh Vaitilingam
on 0117-983-9770 or 07768-661095 (email: romesh@compuserve.com); or
Willem Buiter on 020-7338-6805 (email: buiterw@ebrd.com).