Monday, December 19, 2011

The history of negative nominal interest rates

There is much talk about the zero bound on nominal interest rates and how this is constraining the policy options of many central banks. How can of course ask oneself why there would be such a restriction on nominal interest rates. Would it be possible to tax (nominal) money holdings? It is certainly conceivable to have negative interest rates on some bank accounts, and it has happened before. Switzerland and Germany imposed negative rates on non-resident account holders in the 1970's, and the Swiss National Bank is currently contemplating doing this again (New York Times). Sweden imposed them recently on mandatory reserve holdings of commercial banks. There is, however, very little theory on this.

Cordelius Ilgmann and Martin Menner try to make sense of the existing literature on the topic. There are essentially two strands, according to them: the first is started with Silvio Gesell in the 19th century and proposes taxing money, the second lies within the very recent money-search literature.

Gesell was the proponent of an anarchist free-market utopia, the free-economy movement. He proposed that bank notes would need to have a weekly stamp affixed to remain valid, amounting to a 5% tax every year. The stated reason is that while other goods depreciate naturally, money does not and may be withheld from circulation. The tax alleviates that, and should in particular be used in times of crisis, because it increases the velocity of money and prevents its hoarding. That argument can be made for today, but it neglects the influence of inflation on all this, and that is crucial.

The recent money-search literature uses taxes on money holding as a proxy for inflation. My understanding that this is really for analytic convenience but in no way a policy proposal. Indeed, what this literature cares about is the real return on money, not the nominal one. But Ilgmann and Menner run with it and believe there is an endorsement of a Gesell tax.

PS: a third way is discussed in the paper, recently proposed by Willem Buiter. It is based on the silly idea that the various function of money are taken over by separate currencies and backed up by equally silly arguments with money in the utility function.


Martin Menner said...

I am happy to have our paper discussed in this blog. But I think there are two misunderstandings.

First, with respect to the search literature.
To make the point, let me first cite the author of this economiclogig blog (sorry, I feel very uncomfortable that I cannot call the author by his name!) in his recent blog 'The best solution: carbon taxes':
"When there is some externality, the best way to deal it is with a tax (for a negative externality like pollution) or a subsidy (for a positive externality like education). Yet, I am continuously amazed how this policy using the market mechanism has found little reception in the United States. And economists are also very fond of it..."

The early search literature found that in sufficiently productive economies a search-externality might arise, and it proposed a 'tax on non-search', i.e. a tax on hoarding money to overcome this externality. Seems that the blogger is also one of the economists that are 'not very fond of it' - or he just didn't read our paper well.
All this has nothing to do with the real vs. nominal value of money but with a 'hot potato'-effect of Gesell taxes that are similar to the one of inflation.
The blogger is right: in the early search literature this tax has mainly been seen as a proxy for inflation since technical reasons made the analysis of inflation in these models impossible. But in latest generation models you can study both: inflation and Gesell taxes and both can have 'hot potato' effects and overcome the search-externality. Our paper thus closes the gap between these literatures: 'taxes on money' to improve efficiency and 'Gesell taxes' as policy instrument to get negative nominal interest rates.
This does not mean that the authors of the early search-literature would endorse a Gesell tax, but that such a tax has a theoretical fundament in its role to overcome an externality.

Second, with respect to the role of inflation: As stated above, inflation can have similar effects on velocity but in contrast to a Gesell tax it increases the price level and distorts the price system and the wealth of debtors vs. creditors... In contrast, you can run a zero inflation regime and have a similar "hot potato" effect with Gesell taxes and avoid thereby the distortions of inflation.
So, I wouldn't agree that our paper neglects the influence of inflation on hoarding etc. We argue that it is not a perfect substitute for a Gesell tax (especially if you cannot generate inflation or inflation expectations in a liquidity trap at the zero lower bound).

Finally, the Buiter proposal of Eichner's scheme is discussed for sake of completeness. I agree that money in the utility function arguments are silly, and therefore I work with search-theoretic micro-foundations.

The reader of our article may judge whether it deserves the label 'bad research' or whether this label better suits this (anonymous!) blog.


Economic Logician said...

While some money search papers have addressed the search externality with a tax, most take it as a given. This is why I do not consider it a general result from this literature.

And I still think your paper several underplays, if not ignores, the role of inflation when velocity increases.

Finally, I thought those working in money search theory were big fans of anonymity, as it is crucial to their models...

Anonymous said...

Monetary search theorist here. Yes, we are well aware of the search externality and that it can be alleviated with a tax on holding money. But I do not think anybody is advocating such a tax and it is impossible to enforce. Inflation does that much more easily.