Stumbling toward Silvio Gesell

Silvio Gesell was famous in the 1930s for proposing negative interest rates on currency, as a solution to the liquidity trap.  In early 2009 I proposed negative rates on excess reserves, as a way of reducing the demand for base money.  Three years later there is movement in that direction:

European Central Bank President Mario Draghi is contemplating taking interest rates into a twilight zone shunned by the Federal Reserve

While cutting ECB rates may boost confidence, stimulate lending and foster growth, it could also involve reducing the bank’s deposit rate to zero or even lower. Once an obstacle for policy makers because it risks hurting the money markets they’re trying to revive, cutting the deposit rate from 0.25 percent is no longer a taboo, two euro-area central bank officials said on June 15.

“The European recession is worsening, the ECB has to do more,” said Julian Callow, chief European economist at Barclays Capital in London, who forecasts rates will be cut at the ECB’s next policy meeting on July 5. “A negative deposit rate is something they need to consider but taking it to zero as a first step is more likely.”

Should Draghi elect to cut the deposit rate to zero or lower, he’ll be entering territory few policy makers have dared to venture. Sweden’s Riksbank in July 2009 became the world’s first central bank to charge financial institutions for the money they deposited with it overnight.

.   .   .

“If you want to ease monetary policy, you won’t get it from cutting the main refinancing rate,” said Nick Kounis, head of macro research at ABN Amro Bank NV in Amsterdam. “Reducing it alone wouldn’t translate into lower market rates. Slashing the deposit rate makes more sense.”

The ECB isn’t the only central bank in Europe considering cutting interest rates below zero. Denmark’s central bank signaled last month that it is willing to let rates go negative to fight an appreciation of the krone, and the Swiss government has said it’s also assessing emergency measures such as negative rates to weaken the franc if Europe’s debt crisis escalates.

So why am I not happy?  Because it’s not being done as monetary stimulus, but rather a coping mechanism.  Central banks seem to be throwing in the towel, and saying; “We aren’t going to do anything to produce NGDP growth, so we’d better get interest rates to a level that is “equilibrium” in a zero growth society, a failed monetary regime.

PS.  That’s not to criticize Denmark and Switzerland, they are too small to change the dynamic—we need stimulus from the Fed and ECB.

Update:  Niklas Blanchard corrected my faulty memory:

A technical point, Gesell did not propose negative interest on currency as an escape from the “liquidity trap”, that was Keynes’ take on the idea.
He died in 1930.

 


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20 Responses to “Stumbling toward Silvio Gesell”

  1. Gravatar of OneEyedMan OneEyedMan
    6. July 2012 at 06:37

    Many have made the point that away from the zero lower bound, it doesn’t much matter if you follow a Taylor rule instead of some sort of level targeting. Therefore, if for whatever reason, this is part of undoing the magic powers of the zero lower bound then perhaps it could make continuing to follow a Taylor rule less harmful and therefore still unleash some major benefits.

  2. Gravatar of David Pearson David Pearson
    6. July 2012 at 07:05

    Scott,
    One of the following must be true:

    -the 25bp IOR is critically important
    -the 25bp IOR is unimportant except when a central bank means it to be

    If the second is true, then why should the IOR imposition have mattered in 2008? After all, the Fed clearly did not mean it to be contractionary. They imposed it specifically to address an operational problem with hitting the Fed Funds target, and they explicitly said so at the time. I don’t recall anyone saying then, “the IOR would be highly contractionary, except its clear the Fed didn’t mean it to be so.”

  3. Gravatar of ssumner ssumner
    6. July 2012 at 07:05

    Oneeyedman, Yes, That’s possible.

  4. Gravatar of Luis Pedro Coelho Luis Pedro Coelho
    6. July 2012 at 07:05

    You would be even more depressed if you lived in the Eurozone and spent all of yesterday reading and hearing about how the ECB is taking this “unprecedented step” and having “historically low rates” followed by comments saying that, if this isn’t enough, it just shows that monetary policy alone does not work.

  5. Gravatar of ssumner ssumner
    6. July 2012 at 07:30

    David, Robert Hall claimed the Fed’s IOR program clearly had a contractionary intent. I agree with him. Indeed the explanation they provided (to prevent interest rates from falling) basically confirms it had a contractionary intent. They were worried that monetary policy would be more expansionary in the absence of IOR.

    I’m not sure either statement is true, I’m not sure the 0.25% IOR is “critically important.”

    Luis, I guess it’s no surprise we are faced with these problems, given how clueless our policy pundits are.

  6. Gravatar of Niklas Blanchard Niklas Blanchard
    6. July 2012 at 07:35

    A technical point, Gesell did not propose negative interest on currency as an escape from the “liquidity trap”, that was Keynes’ take on the idea.

    He died in 1930.

  7. Gravatar of David Pearson David Pearson
    6. July 2012 at 08:00

    If the following paragraph holds, what would be the expected effect of the elimination of the IOR?

    “If you pay people to hold on to ERs, there’ll be a greater demand for ERs. And when the demand for any good rises its value rises. But when the value of the medium of account rises, its nominal price cannot change, by assumption. Instead, the only way for the medium of account to become more valuable is for all other prices to fall.”

  8. Gravatar of Nick Rowe Nick Rowe
    6. July 2012 at 08:26

    Wasn’t “stamped money” Silvio Gessel’s idea? You had to pay a monthly(?) fee to have the government put a stamp on notes so they stayed valid? If so, isn’t that exactly the same as negative interest on money? It’s just like a negative coupon, where you have to pay the government to attach a coupon rather than have the government pay you when you detach a coupon.

    From what little I know of Gessell, I think he understood the point that Keynes misunderstood. It’s an excess of saving in the form of money, rather than an excess of saving per se, that causes the problem.

  9. Gravatar of Jim Glass Jim Glass
    6. July 2012 at 09:19

    The Fed initiated interest on reserves to keep the federal funds rate from falling as a result of the reserves it was pumping into the system. I read that as contractionary intent. To quote the NY Fed:

    Recently the Desk has encountered difficulty achieving the operating target for the federal funds rate set by the FOMC, because the expansion of the Federal Reserve’s various liquidity facilities has caused a large increase in excess balances. The expansion of excess reserves in turn has placed extraordinary downward pressure on the overnight federal funds rate.

    Paying interest on excess reserves will better enable the Desk to achieve the target for the federal funds rate, even if further use of Federal Reserve liquidity facilities, such as the recently announced increases in the amounts being offered through the Term Auction Facility, results in higher levels of excess balances.

    The initial IOR rate was well over .25%, tied to the FFR and fell with the FFR.

    Or, as Jim Hamilton explained it:

    The Fed has never wanted to see the huge volume of reserves it created end up as currency held by the public, for fear this would be inflationary … the Fed started paying interest on reserves in October 2008, and by November had increased that rate to the target fed funds rate itself. This created a very strong incentive for banks to simply hold reserves idle at the end of each day rather than lend them out on the overnight fed funds market.

    In effect, by paying interest on reserves, the Fed is borrowing directly from banks and using the proceeds for the various asset expansions detailed above.

    “If you pay people to hold on to ERs, there’ll be a greater demand for ERs. And when the demand for any good rises its value rises. But when the value of the medium of account rises, its nominal price cannot change, by assumption. Instead, the only way for the medium of account to become more valuable is for all other prices to fall.”

    Paying IOR effectively converts them to short-term interest-bearing T-securities, distinguishing them from currency, which is the medium of account. Banks certainly do treat them dramatically differently.

    Removing IOR would remove that trait that distinguishes them from currency, with corresponding effect on inflation, and get banks back to treating them much more as they did during the pre-2008 part of that line.

  10. Gravatar of David Pearson David Pearson
    6. July 2012 at 09:55

    @Jim Glass,

    “Removing IOR would remove that trait that distinguishes them from currency, with corresponding effect on inflation, and get banks back to treating them much more as they did during the pre-2008 part of that line.”

    Given the above, what is the likely effect of the ECB Deposit Rate (rate on excess reserves) cut to zero?

  11. Gravatar of David Pearson David Pearson
    6. July 2012 at 10:04

    @Jim Glass,
    BTW, from the NY Fed statement you cite:
    ——
    5. Does paying interest on excess balances constitute a change in monetary policy?

    No. The stance of monetary policy continues to be set by the target for the overnight federal funds rate established by the FOMC. Paying interest on excess balances just makes it easier for the Desk to implement the target federal funds rate chosen by the FOMC.
    ——

    Its obvious that markets understood the FFR to be the Fed’s main policy instrument. Excess balances were making it difficult for the Fed to hit their publicly-announced policy target without exhausting its supply of s.t. Treasuries. This is simply a function of the way the FFR/OMO regime operates. To say the initial IOR was “contractionary” is to claim that the Fed had abandoned the FFR as the policy target as soon as its various liquidity facilities began to produce excess balances. From my memory, I can’t think of anyone that argued this was the case.

  12. Gravatar of David Pearson David Pearson
    6. July 2012 at 10:12

    The European IOR monetary experiment is producing some early results, with implications for velocity (i.e. contracting shadow bank liabilities):

    Goldman:
    GOLDMAN HALTS INVESTMENTS IN EURO GOV MONEY FUND AFTER ECB CUT
    GOLDMAN SAYS MARKET CONDITIONS WILL DETERMINE WHEN FUND REOPENS
    GOLDMAN DECISION AFFECTS EURO GOVERNMENT LIQUID RESERVES FUND

    JPMorgan:

    The cut in the deposit facility rate to zero will almost certainly move cash bids in short-dated instruments into negative territory, and so we have taken the step to restrict subscriptions and switches in to the Funds in order to protect existing shareholders from yield dilution…

    Blackrock:

    BlackRock Inc. (BLK) (BLK) said it restricted new money into two European money-market funds after the European Central bank cut deposit rates to zero.

  13. Gravatar of John John
    6. July 2012 at 10:57

    I was pretty sure Gesell and Keynes thought that interest should be abolished in general. Gesell wanted to print enough money to make this happen. Unfortunately this is impossible since eventually you can’t drive rates to 0 permanently due to inflation. It is surprising to hear one of the dumbest economists in history mentioned on this site.

  14. Gravatar of marcus nunes marcus nunes
    6. July 2012 at 13:25

    “So why am I not happy? Because it’s not being done as monetary stimulus, but rather a coping mechanism. Central banks seem to be throwing in the towel, and saying; “We aren’t going to do anything to produce NGDP growth, so we’d better get interest rates to a level that is “equilibrium” in a zero growth society, a failed monetary regime”.

    That´s how I should have ended this post:
    http://thefaintofheart.wordpress.com/2012/07/06/policymakers-in-japan-must-have-a-pretty-sick-mind/

  15. Gravatar of ssumner ssumner
    6. July 2012 at 18:14

    Niklas, Thanks, I added an update.

    David, Ceteris Paribus, NGDP would rise.

    I’m not surprised that banks aren’t happy, they are losing a subsidy.

    Will NGDP rise? I doubt it, the eurozone has too many other things going against it, which was the point of this post.

  16. Gravatar of Saturos Saturos
    6. July 2012 at 18:54

    Whoops, should have posted it here:

    How to abolish the liquidity trap: http://marginalrevolution.com/marginalrevolution/2012/07/markets-in-everything-durable-goods-monopoly-edition-add-urgency-to-your-reading.html

  17. Gravatar of Saturos Saturos
    6. July 2012 at 18:57

    Lower rates aren’t easier money! Shout it from the rooftops!

  18. Gravatar of Jim Glass Jim Glass
    6. July 2012 at 18:57

    @Jim Glass … To say the initial IOR was “contractionary” is to claim that the Fed had abandoned the FFR as the policy target as soon as its various liquidity facilities began to produce excess balances.

    Not at all. It means they used IOR to produce a contractionary effect relative to if they hadn’t used IOR.

    Creating all the new reserves as it was doing at the time was an expansionary step that would have driven the FFR below target. Paying IOR was an offsetting contractionary step that pushed rates back up to the target — it is what enabled the Fed to continue using its FFR as a policy target.

    As Hamilton said above, “The Fed has never wanted to see the huge volume of reserves it created end up as currency held by the public, for fear this would be inflationary”. Actions to to counter inflation are contractionary.

    Bernanke himself has explained that paying IOR is just such a step…

    “By increasing the interest rate on reserves, the Federal Reserve will be able to put significant upward pressure on all short-term interest rates. Actual and prospective increases in short-term interest rates will be reflected in turn in longer-term interest rates and in financial conditions more generally.”

    Increasing IOR –> increasing interest rates generally = contractionary policy.

  19. Gravatar of David Pearson David Pearson
    6. July 2012 at 19:36

    @Jim Glass,
    “…Creating all the new reserves as it was doing at the time was an expansionary step that would have driven the FFR below target.”

    Your comment is like saying that if the FFR falls below target unintentionally, then OMO to bring it back to target is “contractionary”. If you are arguing that correcting unintended deviations from policy constitutes a change in policy stance, then yes, by that definition the Fed’s move was contractionary. I don’t think you would get much sympathy for that view, except perhaps in this precinct.

  20. Gravatar of Sumner Unimpressed With ECB Cutting IOR to Zero | Last Men and OverMen Sumner Unimpressed With ECB Cutting IOR to Zero | Last Men and OverMen
    27. March 2017 at 02:01

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