Negative rates, abolishing cash, nominal illusion and neurosurgery

Miles Kimball’s preferred solution to the current predicament, in which the zero, or quite near zero bound to central bank interest rates constrains the amount of stimulus that can be imparted, is to reform monetary institutions so that negative rates can be applied, with no more limit to how low they can go than there is with positive rates.

One option to permit this is to abolish cash.  With this done, negative interest rates can be applied to digital deposits in banks, with no risk that they will be out-competed by cash, which earns a higher interest rate of zero.

However, it’s possible that banks are affected by nominal illusion on the part of some of their customers.   One reason put forward for the woes of bank shares has been that while the banks’ asset side has rates that are competed, or even indexed down as bank rate falls, bank deposit rates cannot fall so much, nor be replaced by charges.  A reason being some psychological reaction to negative nominal rates akin to the disproportionate response to nominal wage cuts versus nominal wage rises that is discussed by labour economists.

If there is this kind of nominal illusion, abolishing cash isn’t going to allow seamless transmission of negative nominal rates that matches those nominal interest rate rises the older generation remember fondly.  In fact, nothing will do it, short of some not yet thought of neurosurgery, except perhaps a rather painful learning process where circumstances slowly accustom depositors to the new reality.

In the meantime, however, negative rates would not guarantee regaining control of inflation.


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One Response to Negative rates, abolishing cash, nominal illusion and neurosurgery

  1. t. says:

    Dr. Kimball claims that negative short term rates will produce higher long term rates.

    now because the causation is tricky, lets allow him to define whatever terms he wants in order to rescue this claim from its empirical failure up to now. what level of overnight rates will produce a higher level of 30yr rates? if short term rates are negative 10 will long term rates be positive 10? if so what is the level of negative rates needed to create a discontinuity and why? Dr. Kimball has a rental cost of capital model of the IS curve, why should this relationship be non-linear? ie, negative rates have so far caused much lower long term rates but past some point would cause higher long term rates.

    (maybe this spread is not long enough). notice how if one says that its only forward rates that will rise (like 10y10y rates), but that nonetheless all spot rates, even 20,30,40y tenors will fall, this is the equivalent of saying monetary policy can influence the level of yields at any maturity. pretty odd claim. in fact i think its not long now until we experience a government bond curve where every extant maturity trades below zero. what a victory for NIRP! (sarcasm)

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