Breaking Through the Zero Lower Bound

Abstract

There has been much discussion about eliminating the "zero lower bound" by eliminating paper currency. But such a radical and difficult approach as eliminating paper currency is not necessary. Much as during the Great Depression-when countries were able to revive their economies by going off the gold standard-all that is needed to empower monetary policy to cut interest rates as much as needed for economic stimulus now is to change from a paper standard to an electronic money standard, and to be willing to have paper currency go away from par. This paper develops the idea further and shows how such a mechanism can be implemented in a minimalist way by using a time-varying paper currency deposit fee between private banks and the central bank. This allows the central bank to create a crawling-peg exchange rate between paper currency and electronic money; the paper currency interest rate can be either lowered below zero or raised above zero. Such an ability to vary the paper currency interest rate along with other key interest rates, makes it possible to stimulate investment and net exports as much as needed to revive the economy, even when inflation, interest rates, and economic activity are quite low, as they are currently in many countries. The paper also examines different options available to the central bank to return to par when negative interest rates are no longer needed, and the associated implications for the financial sector and debt contracts. Finally, the paper discusses various legal, political, and economic challenges of putting in place such a framework and how policymakers could address them.

Enabling Deep Negative Rates to Fight Recessions: A Guide

“…(1) Eisler (1932) (2) Buiter (2009) (3) Tax Approach (Feldstein 2002;Correia et. al, 2013) Clean Approach (Agarwal and Kimball, 2015)…”

“…Among the approaches that emphasize bank (or financial-sector) transmission, the clean approach is developed in Agarwal and Kimball (2015). The rest of the bank-transmission-based approaches are developed in this paper, with the exception of the "withdrawal limit approach," which was presented by Marvin Goodfriend (2016) in his Jackson Hole speech "The Case for Unencumbering Interest Rate Policy at the Zero Lower Bound."…”

“…( 1) Thus, if the central bank can affect the dividend yield or appreciation rate (or capital gains rate) of paper currency it can create a non-zero rate of return for holding paper currency. Proposals in the spirit of Eisler (1932), Buiter (2009), and Agarwal and Kimball (2015) are about targeting the capital gains rate (appreciation rate), while proposals in the spirit of Gesell (1916) and Goodfriend (2000) are in the spirit of targeting the dividend yield to create a non-zero rate of return for holding cash.…”

Cryptocurrencies and Digital Fiat Currencies

“…The potential cost savings of digital fiat currency appears to be a substantial part of the interest in Sweden where declining use of cash has made handling it more expensive relative to transactions volume . A final rationale for replacing cash with digital fiat currency is to make it easier to set negative interest rates; although this could likely be achieved simply using digital fiat currency alongside cash (Agarwal and Kimball ).…”

Negative Interest Rate Policies: Sources and Implications

“…The feasibility of a tax on money has also been subject to debate in academic circles as a way to overcome the zero bound on interest rates (Goodfriend 2000 andBuiter and Panigirtzoglou 2003;Ilgmann and Menner 2011). Some studies also analyze the costs and benefits of phasing out paper currency as one way to eliminate the zero bound in interest rates (Agarwal and Kimball 2015). Rogoff (2014), for instance, suggests that the phasing-out procedure could begin with large-denomination notes, extended to others except small coins and bills, and finally abolishing the smallest ones.…”