Escaping the zero lower bound: electronic money, or higher inflation?

Ken Rogoff wrote recently extolling the virtues of abolishing cash in favour of electronic money in order to escape the zero lower bound, which he prefers to the alternative of raising the inflation target.  Targeting higher inflation would ‘baffle’ the public, he thinks, and would mean that the inflation targets were no longer the ‘moral equivalent of zero’.

To recap.  If everyone uses electronic money, then balances in this money can be ‘taxed’ so that the market generates negative nominal interest rates, and thus the constraint on the ability of monetary policy to respond to contractionary shocks posed by the zero bound is alleviated.  Cash has to be abolished because if the option to hold cash is there then people will simply switch to holding it at zero interest rather than keeping their liquid balances in electronic money at negative interest rates.  The option of targeting higher inflation achieves the same end since higher long-term inflation generates a higher long-term nominal rate from which central banks could start cutting in the event of a recession.

A few points.

First, I think abolishing cash and instituting electronic payments for all would be pretty hard to grasp for many.  Some of the people I hang out with have trouble operating their 10-year-old Nokia phones to send a text message, let alone doing smartphone payments.  Many are excluded from the digital payments and information network entirely, and not for nefarious reasons.  Would people embrace electronic money, when there have been so many large-scale and well-publicised IT failures in major banks, and security failures in companies involved in online payments, like eBay, PayPal and so on?

Granted, raising the inflation target would take some explaining.  I can see the twitter storm from Andrew Sentance and the hawks coming already ‘Aha, they are finally coming clean on the high inflation they have doing by subterfuge for years!’  But to argue that electronic money would be preferable on these grounds seems peculiar to me.  It would be an unprecedented leap at a time when many have not yet mastered paying for stuff with bank deposits.

On this point of low inflation being the moral equivalent of zero.  Rogoff touches on something important here, that policy objectives have to be morally justified.  But moral equivalence to zero inflation doesn’t seem to me a useful comparison.  The moral equivalence we are looking for with policy is between the practical and the best policies.  And, in order to create the necessary room to smooth business cycles with interest rates, (which we could agree is morally justifiable without needing to drink the strong waters of normative ethical philosophy), it may mean that we need more inflation.

What Rogoff thinks would particularly ‘baffle’ central bankers’ constituents was that they had changed their minds about the benefits of price stability.  There’s something in this.  But it should not be the overriding concern.    And:  the profession has done a lot of changing of minds recently!  We would hardly decide against tightening prudential supervisory standards on the grounds that we would baffle everyone that we had changed our minds on it.  On the contrary, it would be perplexing if the authorities had not changed their minds in the light of the evidence about what constituted good policy.  So too with inflation.  For generations, the authorities wrestled with different metallic standards for monetary policy.  Finally, we ‘changed our minds’ about this being the right thing to do.  It was probably baffling at the beginning.  But slowly people got used to the meaninglessness of the ‘promise to pay the bearer on demand the sum of’ text.


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9 Responses to Escaping the zero lower bound: electronic money, or higher inflation?

  1. maruku says:

    I’m yet to be convinced that abolishing cash, even if you could do it, would be sufficient to kill the zero bound anyway. There are other fairly broadly accessible stores of wealth that give a nominal return of zero – on a small scale, stamps; on a larger scale, maybe something like deliberate overpayment of taxes. And more generally, there are lots of unindexed contracts about. Those are less convenient than cash, so the convenience yield of central bank reserves would be higher and the effective lower bound on the central bank policy rate lower, but not completely abolished. You could have a programme of rooting out all such possibilities – but you might wind up with a tiresome and intrusive body of regulation that needs regular updating and has significant distortative costs (on top of the distortative cost of getting rid of cash, which is still a useful payment technology).

    A different way of making the same point is that the central bank is the monopoly supplier of paper cash as well as central bank reserves, so could limit recourse to the option to hold cash without abolishing it altogether if they wanted to (by e.g. having limits on the amount of high value banknotes they issue). They don’t, because the costs of not meeting the demand for cash would also be significant.

    • Tony Yates says:

      These are very good points.

      • maruku says:

        Underlying idea I guess is that zero is actually special, because contracting is cheaper at a zero interest rate (e.g. it’s the rate I use when I lend someone a tenner to buy lunch).

    • Buying stamps, or prepaying taxes, is not a problem. In fact, it’s exactly what we want under this scheme! The goal is to increase the velocity of money, and if someone “buys” their “tax-paid-up status” early, then velocity has increased and the government can choose to spend that money early.

      And buying stamps early is similar to buying gift cards. The store isn’t going to want to sell a “50 pound sterling gift card” at par if they foresee falling prices, as this would imply that the real size of the debt they owe to the customer would increase. Therefore, they would put a time limit on the gift card. This is exactly what we want, because purchasing the gift card effectively commits you to make a “real world” purchase in a certain timeframe. As the gift card approaches its expiry date, it effectively loses value (negative interest).

      We can assume (hope?) that the post office would do something similar with stamps.

      An alternative strategy might be for the store to issue time-unlimited gift cards, but to charge more than par to issue them. That implies the negative interest being paid in advance. But I’m not sure how to value this.

      Either way, the issuers of gift cards and stamps aren’t going to issue money-like bonds at par and without time limits. It would be a mistake for them to do so.

  2. Best way to escape the ZLB is to conduct monetary policy more effectively. Directly expanding money to the broad public when pursuing targets instead of a few banks through open market operations should markedly increase policy effectiveness.

    Direct expansions to people will increase net wealth and consumption. Instead of purchasing something to expand base money just place it into circulation that way wealth increases directly. Banks don’t really consume much as a result of money expansions but people do.

  3. I think the politics of the government telling people that they can’t have cash anymore because the government needs to be able to credibly threaten to confiscate money at the drop of a hat for macroeconomic reasons will be a hard lift. Also, it’s one thing to punish, say, big businesses sitting on millions, quite another to penalise small savers who won’t see why macroeconomic problems should prevent them from saving as they wish. And this is before you get into the really sinister aspects:

  4. Dan Davies says:

    “What Rogoff thinks would particularly ‘baffle’ central bankers’ constituents was that they had changed their minds about the benefits of price stability.”

    I think you were right to identify this as the daftest part of the Rogoff article. People have got their heads around gay marriage, the Atkins Diet, the changes to the offside law and dubstep, all of which were greater departures from the status quo ante than a decision to find and replace the value “2%” with “4%”. It’s not exactly consistent with a rational expectations view of the world to claim that there’s some special significance to the ad hoc decisions which caused policymakers to settle on 2% in the first place.

    I seem to remember that there were some people trying to push this kind of argument over the change from RPIX to CPI. It was daft then too. The vast majority of people who don’t know what inflation means beyond “bad economic thing” didn’t care, and the minority who do know are surely capable of seeing that 4% is only a bit more than 2%, and even understanding the economic arguments that Rogoff doesn’t think they can handle.

  5. Dan Davies says:

    actually I am wrong – the sentence immediately after it is the daftest in the Rogoff piece:

    “Just recall the market’s “taper tantrums” in May 2013, when then-Fed Chairman Ben Bernanke suggested a far more modest turn in monetary policy”

    Yes, who among us can forget those horrible days in May 2013 when it was feared that civilisation itself would end. The bond market went down a bit, then went up again, while the equity market went down a bit, then went up again. It’s hardly “the living envied the dead and the rubbish rotted in the streets” territory. If Rogoff genuinely thinks this is something his readers would recognise as a disastrous adverse consequence, he’s been spending too much time with hedge funds.

  6. maruku says:

    By my count we’ve had something like 8 different combinations of monetary policy target, instrument, and institutions since WWII – Bretton Woods, the Snake, monetary aggregate targeting, shadowing the DM, the ERM, two forms of inflation-targeting with the interest rate as instrument (Ken-and-Eddie & BoE independence) and for the last few years flexible inflation targeting with QE as the main instrument. And I’ve probably forgotten a couple of other big changes (getting rid of credit control?). Compared to that history tweaking the inflation target is a pretty small change!

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