[p2p-research] negative interest at NYT

[Michel Bauwens]

Very interesting article in the NYT by N. Gregory Mankiw a professor of
economics at Harvard.

He reminds us that Keynes was a supporter of negative interest rates as well
(I knew this, but had forgotten it).

The ideal interest rate for the US economy in current conditions would be
minus 5 per cent, according to internal analysis prepared for the Federal
Reserve's last policy meeting. (
http://www.ft.com/cms/s/0/23b62bfc-338b-11de-8f1b-00144feabdc0.html)

Via http://www.nytimes.com/2009/04/19/business/economy/19view.html



text:


The problem today, it seems, is that the Federal
Reserve<http://topics.nytimes.com/top/reference/timestopics/organizations/f/federal_reserve_system/index.html?inline=nyt-org>has
done just about as much interest rate cutting as it can. Its target
for
the federal funds rate is about zero, so it has turned to other tools, such
as buying longer-term debt securities, to get the economy going again. But
the efficacy of those tools is uncertain, and there are risks associated
with them.

In many ways today, the Fed is in uncharted waters.

So why shouldn’t the Fed just keep cutting interest rates? Why not lower the
target interest rate to, say, negative 3 percent?

At that interest rate, you could borrow and spend $100 and repay $97 next
year. This opportunity would surely generate more borrowing and aggregate
demand.

The problem with negative interest rates, however, is quickly apparent:
nobody would lend on those terms. Rather than giving your money to a
borrower who promises a negative return, it would be better to stick the
cash in your mattress. Because holding money promises a return of exactly
zero, lenders cannot offer less.

Unless, that is, we figure out a way to make holding money less attractive.

At one of my recent Harvard seminars, a graduate student proposed a clever
scheme to do exactly that. (I will let the student remain anonymous. In case
he ever wants to pursue a career as a central banker, having his name
associated with this idea probably won’t help.)

Imagine that the Fed were to announce that, a year from today, it would pick
a digit from zero to 9 out of a hat. All currency with a serial number
ending in that digit would no longer be legal tender. Suddenly, the expected
return to holding currency would become negative 10 percent.

That move would free the Fed to cut interest rates below zero. People would
be delighted to lend money at negative 3 percent, since losing 3 percent is
better than losing 10.

Of course, some people might decide that at those rates, they would rather
spend the money — for example, by buying a new car. But because expanding
aggregate demand is precisely the goal of the interest rate cut, such an
incentive isn’t a flaw — it’s a benefit.

The idea of making money earn a negative return is not entirely new. In the
late 19th century, the German economist Silvio Gesell argued for a tax on
holding money. He was concerned that during times of financial stress,
people hoard money rather than lend it. John Maynard
Keynes<http://topics.nytimes.com/top/reference/timestopics/people/k/john_maynard_keynes/index.html?inline=nyt-per>approvingly
cited the idea of a carrying tax on money. With banks now
holding substantial excess reserves, Gesell’s concern about cash hoarding
suddenly seems very modern.

If all of this seems too outlandish, there is a more prosaic way of
obtaining negative interest rates: through inflation. Suppose that, looking
ahead, the Fed commits itself to producing significant inflation. In this
case, while nominal interest rates could remain at zero, real interest rates
— interest rates measured in purchasing power — could become negative. If
people were confident that they could repay their zero-interest loans in
devalued dollars, they would have significant incentive to borrow and spend.


Having the central bank embrace inflation would shock economists and Fed
watchers who view price stability as the foremost goal of monetary policy.
But there are worse things than inflation. And guess what? We have them
today. A little more inflation might be preferable to rising unemployment or
a series of fiscal measures that pile on debt bequeathed to future
generations.

Ben S. Bernanke<http://topics.nytimes.com/top/reference/timestopics/people/b/ben_s_bernanke/index.html?inline=nyt-per>,
the Fed chairman, is the perfect person to make this commitment to higher
inflation. Mr. Bernanke has long been an advocate of inflation targeting. In
the past, advocates of inflation targeting have stressed the need to keep
inflation from getting out of hand. But in the current environment, the goal
could be to produce enough inflation to ensure that the real interest rate
is sufficiently negative.

The idea of negative interest rates may strike some people as absurd, the
concoction of some impractical theorist. Perhaps it is. But remember this:
Early mathematicians thought that the idea of negative numbers was absurd.
Today, these numbers are commonplace. Even children can be taught that some
problems (such as 2x + 6 = 0) have no solution unless you are ready to
invoke negative numbers.

Maybe some economic problems require the same trick.


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