Wednesday, April 22, 2009

More on Negative Interest Rates

Commentary on my negative interest rate piece in the NY Times (and the follow-up here) continues to pour in. To answer the most common queries: Yes, the serial-number-lottery plan was tongue-in-cheek. The goal of mentioning it was to get people thinking about whether, as a matter of first principles, zero is really an unavoidable lower bound for interest rates. And no, I am not the devil incarnate, at least as far as I know. Thank you for asking.

As to the Fed announcing a commitment to a moderate amount of inflation, let me point out that according to many macroeconomic historians, the abandonment of the gold standard was the most useful thing that the federal government did to get the country out of the Great Depression. A commitment to producing a moderate amount of inflation would be the modern equivalent of that act.

I should note that I am not alone among economists in thinking along these lines lately. Several prominent economists have been musing about the possibility of levying a fee on reserves (either total or excess reserves) held by banks. See, for example, Hall and Woodward, Edlin and Jaffee, and Scott Sumner. That fee could be described as a negative interest rate for holdings of reserves. Because this proposal does not affect the return on currency, however, it does not generate the kind of heated reaction my Times piece did.

But for precisely that reason, I am doubtful that this plan by itself would work. If reserves earned a negative return at the margin, banks would have more incentive to lend (which is the motivation for these proposals). But more lending might not be the outcome. Banks could instead discourage deposits by, for example, passing the reserve fee on to depositors. Deposits would then earn a negative return, which would give households an incentive to hold currency rather than bank deposits. Moving the monetary base from excess reserves to currency holdings, however, would yield no macroeconomic benefits. The only thing you would end up stimulating is sales of home safes.