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.