Tyler Cowen has a new post criticizing the idea that we should eliminate hand-to-hand currency so that the Fed could cut interest rates below zero. He’s right that it’s a bad idea, but not all of his objections are sound:
Furthermore, under some views, this proposal would in essence put monetary policy in the hands of the drug trade. Cracking down on drug lords, or easing up on them, would become major monetary policy instruments, at least if you take the Fama-Sumner view that currency has special potency over the price level.
4. I do not myself believe that currency per se has such extreme power over aggregate demand, at least not in such a credit-intensive economy as ours. That means this proposal doesn’t get at the heart of the AD problem, which is closely linked to credit creation.
This is a very common mistake, so it’s important to explain what’s wrong with this reasoning. Money is not special because it is a big part of wealth, or a big part of credit. Indeed it’s not even special because it’s the medium of exchange. It’s special because it’s the medium of account. All prices (including the price of credit) is measured in money terms, not credit terms. If everything was measured in apple terms, then the apple market would drive the nominal economy (even though apples would continue to have only trivial impact on long term RGDP growth.)
Even if there is no change in the real demand for credit, a doubling of the money supply will lead to a doubling of the nominal credit stock in the long run. That’s true even if the stock of credit is 100 times larger than the stock of currency. The reverse is not true. Base money is special because we price things in terms of base money. If someone could show me that the previous sentence was wrong, I would disavow everything I’ve written on this blog from day one. It’s the rock on which all of monetary
history theory is built.
Also note that drug dealers would not cause any problem for monetary policy, for the simple reason that they did not do so before 2008, when 95% of the base was already currency. The Fed can easily accommodate changes in the demand for currency, and does so. That’s why the big increase in currency demand in the 1990s and 2000s did not put us in a depression. On the other hand if we had been following a 4% constant MB growth rule, we probably would have fallen into depression as foreign demand for our currency soared.
6. I don’t see how this proposal could work unless it is applied globally, which seems implausible. If your dollars are being taxed some extra amount, just put them in a foreign bank to earn zero or do some kind of funny quasi-repurchase agreement, with a foreign bank, to avoid having formal ownership of the dollars on the days of the tax.
If I’m not mistaken the electronic money proposal would eliminate hand-to-hand currency, and all other base money would be electronic accounts at the Fed or money embedded in debit cards representing electronic accounts at the Fed. Continual positive or negative interest would occur via adjustments in those money balances up or down. Other foreign “dollar bank accounts” could pay positive or negative interest. So I think it would be feasible, but I’m far less confident on this point than on my previous point.
Currency will obviously be eliminated at some point, but I agree with Tyler that it would be a mistake to rush this solution into effect anytime soon. For now a much easier solution to our problems is monetary stimulus. Remember, Bernanke does not say the Fed can’t give us 3% inflation; he says it would be a bad idea.
PS. The “Sumner-Fama view” is not all that special. During the Great Moderation the standard view was that the Fed could target NGDP or inflation via adjustments in the fed funds rate. And those adjustments occurred only because the Fed was able to adjust the base (not via a magic wand.) And the base was 95% currency. Furthermore, the vast majority of monetary economists believe the policy could have been implemented without reserve requirements, which is simply a tax. In that case the base would have been over 99% currency. Currency seems unimportant because actual operating procedures make the base change first, and then currency endogenously adjusts to a change in the base. But prior to 1914 the base was 100% currency, and we could easily return to that system and still run monetary policy essentially the same way. The only difference would be that the Fed would give banks ten $100,000 bills for a $1 million T-bond, not credit their Fed account for $1,000,000. That’s a trivial difference.
Monetary policy is all about adjusting the stock of currency.