Rogoff’s law – the opposite is usually true
Punning on Kenneth Rogoff’s surname is proving irresistible. He has just launched a new economics blog, which should prove rich in thought-provoking missives. Confronted by Rogoff’s economic ideas, I frequently find myself compelled to turn them upside down. His latest tome, The Curse of Cash, suggests that we should abolish physical cash, replacing it with a purely electronic version. This would allow central banks to pay interest on all money. Rogoff goes further: in recessions or deflations, interest rates could go sharply negative, because the option of holding ‘zero interest money’ – physical notes and coins – would not exist.
What I expect most non-economists reading The Curse of Cash are confounded by is not the idea of abolishing physical notes and coins – on many levels this is appealing, particularly its consequences for criminal activity. No, what’s bizarre is his insistence on charging negative interest rates on cash to stimulate demand under deflation. The obvious common-sense query is that replacing zero-interest cash with negative interest rate cash makes the holders of cash worse off.
Perhaps surprisingly, the non-economists’ concern is valid, and shared by none other than Mervyn King. The obvious way to stimulate demand in the current monetary system is to use dual interest rates. In fact, to raise deposit rates and cut lending rates. This is an unambiguous stimulus. Of course, the private banking system left to its own devices tries to do the opposite, in order to maximise profits. This is why the central bank should take the lead, and we have seen the first steps in this direction, with tiered reserves and a series of new central bank lending schemes. The sooner there is focus on the ability of the central banks to cut their lending rates further, leaving deposit rates unchanged, the better.
From this perspective, Rogoff’s central thesis can be up-ended. Simply cutting official interest rates in a world without physical cash has ambiguous consequences for demand. Setting a negative net interest margin on deposits relative to loans in the current system is an unambiguous stimulus. Furthermore, eliminating physical cash would in fact be incentivised.
Let’s think this through. In Rogoff’s futuristic world, we don’t have physical dollars, pounds, or euros in our wallets. Our digital wallets will contain digital cash. Now there are two options, this digital cash could simply be bank deposits – the current world without physical cash – or there could be a new category of deposit, created by the central bank and directly held by households, the quantity of which is determined by the central bank, analogous to bank reserves. This money could be fixed in quantity, would be credit risk free, fixed in nominal value and not convertible. The only substantive difference between this and physical cash, other than its electronic nature, is that bank deposits would not be convertible into electronic money.
In this world, reserves held by households and corporates held at the central bank would be a distinct category of base money. As we have seen with tiered reserves, these holdings could be remunerated at interest rates independent of those held by banks which are borrowed and lent into money markets and determine market interest rates. Surely if we want to boost spending we should set a sufficiently high positive interest rate on digital cash held by households in order to raise their spending? This indeed is a great reason to have digital cash – people would voluntarily swap physical for digital cash if it was remunerated at, say 5%.
The initial response to this suggestion is that raising interest rates in a recession would kill the economy. But I am not suggesting that we raise market interest rates at all. The stock of digital cash is fixed by the state. Payments, positive or negative, on this cash are not really interest rates at all. Money market rates are set by the availability of bank reserves and the rate of interest on ‘excess’ reserves. Why should the interest rate on bank reserves be the same as the rate on digital cash? In other words the distinction between physical cash and bank reserves, which exists when cash is physical could persist in the fully virtual world – the rate of remuneration would depend on the holder of these reserves. Central banks could set one interest rate on digital cash held by households and another on banks’ excess reserves, which determines money market rates and market lending rates.
This also deals with the basic flaw in Rogoff’s thesis – the assumption that negative policy rates would raise spending. This is a questionable, probably false, assumption. But Rogoff’s innovation remains profoundly valuable. Don’t abolish physical cash, drive it out of business by paying people to hold electronic cash. Oh, and deflation can always and everywhere be reversed with a stroke of the pen (or the click on a keyboard).
It is tempting to dismiss the case for abolishing cash with a trivialising ‘Bog off, Ken’. But that is childish. Keep blogging, Ken. This time is no different. Your ideas are always thought-provoking, and the (almost) opposite of what you suggest remains true.