Breaking Through the
Zero Lower Bound
Miles Kimball
(joint work with Ruchir Agarwal)
Presentation at IMF
May 4th, 2015
Preface: Central Point
The zero lower
bound is a policy
choice, not a law
of nature.
Preface: Where the Zero Lower Bound
Comes From
• The zero lower bound arises when a
government issues pieces of paper (or coins)
1. guaranteeing a zero nominal interest rate
2. over all horizons
3. that can be obtained in unlimited quantities in
exchange for money in the bank.
• This acts as an interest rate floor, making
people unwilling to lend at significantly lower
rates.
• Cf. milk-price supports in the United States.
Preface: “Electronic Money”
• Eliminating the zero lower bound involves
distinguishing between paper currency and
electronic money (which in the 1930’s, Robert
Eisler called “bank money”). Electronic money
would be “the real thing.”
• The electronic dollar, euro, yen, pound, etc.
would be the unit of account.
• The central bank would define which accounts
constituted electronic legal tender. Ideally, this
would be the only legal tender.
Preface: “Electronic Money” (cont.)
• The government is a big enough market player
that it should be able to establish the electronic
dollar (e-$) as the unit of account if all its dealings
were on that basis (taxes, accounting rules,..)
• That the government can determine the
equilibrium on daylight savings time suggests
private firms and households would follow the
government’s lead on this.
• For public relations, the name “electronic money”
for the policy has real advantages, because it can
be described as a natural transition to a 21st
century monetary system.
The Fraction of Transactions
Conducted with E-Money/Bank Money
• The higher the fraction of transactions that are
conducted by check, credit card, debit card,
electronic transfer, or other electronic means, the
easier the transition to an electronic dollar, euro,
yen, pound etc. unit of account is.
• The fraction of transactions conducted in
electronic/bank money depends on
– convenience,
– electronic discount/cash discount
– spread between paper currency interest rate and
other interest rates. (e.g. Japan, Germany)
Preface: The Urgency of
Understanding How to
Eliminate the Zero Lower Bound
In large measure because of the zero lower bound,
other means of stimulus are being employed that
may have bad side effects:
• Running up the national debt with traditional
fiscal policy
• The unusual spreads generated by QE
• The danger of reigniting a home-price bubble
with QE
• A possible sense in the future that past forward
guidance has precluded what would otherwise
seem appropriate policy.
Monetary policy has two key advantages over
fiscal policy for stabilizing the economy:
1. “expansionary monetary policy does not raise
the budget deficit” –Alan Blinder
2. There is a much stronger tradition of
technocratic monetary policy than technocratic
short-run fiscal policy for stabilization.
a. Many countries have independent central banks,
beyond automatic stabilizers, almost none have
independent short-run fiscal stabilization authorities.
b. There is a reason for this: it is hard for politicians and
voters not to feel a resonance between short-run
fiscal policies taken for stabilization and the long-run
fiscal policy issues that are the main axis of the
political spectrum in most advanced countries.
The Fed Does Less Monetary Stimulus Than
It Thinks Is Warranted Because It Is Afraid
of the Side Effects of Unconventional Tools
Ben Bernanke, January 14, 2013 at the
University of Michigan:
“… the short-term interest rate is close to
zero and therefore we are now in the
world of non-standard monetary
policy…asset purchases and
communications and so on.”
The Fed Does Less Monetary Stimulus Than
It Thinks Is Warranted Because It Is Afraid
of the Side Effects of Unconventional Tools
“And as we were discussing earlier, we
have to pay very close attention to the
costs and the risks and the efficacy of
these non-standard policies as well as
the potential economic benefits.”
Ben Bernanke, January 14, 2013 at the University of Michigan:
The Fed Does Less Monetary Stimulus Than
It Thinks Is Warranted Because It Is Afraid
of the Side Effects of Unconventional Tools
“And to the extent that there are costs or
risks associated with non-standard
policies which do not appear or at least
not to the same degree for standard
policies then you would, you know,
economics tells you when something is
more costly, you do a little bit less of it.”
Ben Bernanke, January 14, 2013 at the University of Michigan:
Preface: History of Thought for
Negative Rates and Electronic Money
A. Non-unit-of-account “bills of credit” in the early
United States. “Continentals” lost value without
causing rampant inflation (see Hall and Sargent
2013)
B. Silvio Gesell’s stamped currency (1906)
C. Robert Eisler’s depreciating paper currency
(1932)
D. Marvin Goodfriend’s advocacy of a modern
version of stamped money (2000)
E. Marvin Goodfriend’s discussion of suspension of
payment in paper currency (2000)
Preface: History of Thought for
Negative Rates and Electronic Money
F. Willem Buiter’s discussion of a wide range of
mechanisms for avoiding massive paper
currency storage (2004, 2007, 2009)
– Abolish paper currency
– Tax currency and stamp it (like Silvio Gesell)
– Depreciating paper currency (like Robert Eisler)
G. Greg Mankiw’s discussion of random
invalidation by serial number (2009)
H. Matthew Yglesias’s advocacy of abolishing
paper currency (December, 2011)
Preface: History of Thought for
Negative Rates and Electronic Money
I. My own advocacy of a crawling-peg exchange
rate between paper currency and electronic
money, as here (November 2012).
J. The Urbanization Project’s elucidation of a
crawling peg as a way to elicit substantial
seignorage without inflation (Miles Kimball,
Paul Romer, etc. November 2012)
K. Focus on the details of policy tools to inhibit
paper currency storage (Frances Coppola
January 2013 and Miles Kimball January 2013
to date)
Outline
I. The Zero Lower Bound is a Problem
II. How to Eliminate the Zero Lower Bound
A. The Best Place to Act Against the Massive Paper
Currency Storage that Would Enforce the Zero
Lower Bound.
B. “A Minimalist Implementation of Electronic
Money”
C. “How to Set the Exchange Rate Between Paper
Currency and Electronic Money”
III. Discussion and Conclusion
I. The Zero Lower Bound is a Problem
A. The zero lower bound is a key motivation for
steady state inflation above zero.
Ben Bernanke, March 20, 2013 press conference:
So historically, the argument for having inflation greater
than zero—we define price stability as 2 percent
inflation as do most central banks around the world. And
one might ask, “Well, price stability should be zero
inflation. Why do you choose 2 percent instead of zero?”
And the answer to the question you’re raising which is
that if you have zero inflation, you’re very close to the
deflation zone and nominal interest rates will be so low
that it would be very difficult to respond fully to
recessions.
I. The Zero Lower Bound is a Problem
(continued)
A. The zero lower bound is a key motivation for
steady state inflation above zero.
• Ben Bernanke, March 20, 2013 press conference:
There is research, for example, which asks the question how
often do you tend to hit the zero lower bound? And our belief
few years ago was that it was a very rare event and now it has
become more common.
• Larry Ball “The Case for 4% Inflation”:
A 4% target would ease the constraints on monetary
policy arising from the zero bound on interest rates, with
the result that economic downturns would be less
severe.
I. The Zero Lower Bound is a Problem
(continued)
B. Many central banks are up against the zero
lower bound in macroeconomic situations
indicating output less than the natural level
C. In particular, in the absence of the zero lower
bound, the world economy’s Great Recession
might have been much shorter.
D. To keep certain spreads from being too thin,
many central banks are unwilling to go as low
possible given storage costs of cash.
Sources: Haver Analytics
Jan-15
Jul-14
U.K.
Jan-14
Jul-13
Jan-13
Jul-12
Japan
Jan-12
Jul-11
Jan-11
Jul-10
Euro Area
Jan-10
Jul-09
Jan-09
Jul-08
Jan-08
6
Jul-07
Jan-07
Jul-06
Jan-06
Policy Rates in Major Advanced Economies (2006-2015)
7
U.S.
5
4
3
2
1
0
-1
Policy Rates in Other Advanced Economies (2006-2015)
9
Australia
Canada
Denmark
New Zealand
Norway
Sweden
8
7
6
5
4
3
2
1
0
-1
Jan-06 Feb-07 Mar-08 Apr-09 May-10 Jun-11
Sources: Haver Analytics
Jul-12 Aug-13 Sep-14
I. The Zero Lower Bound is a Problem
(continued)
E. The Bank of Japan has been up against the
zero lower bound for a long time. This could
be an important factor behind the relatively
poor macroeconomic performance of the
Japanese economy in the last 20 years or so.
Japanese Treasury Bill Rates
Real GDP Per Capita in Japan
Log of Real GDP Per
Capita in Japan
Japanese Price Level
(Log of GDP Deflator for Japan)
Log of Nominal GDP for Japan
Nominal GDP for Japan Since 1994
I. The Zero Lower Bound is a Problem
(continued)
F. “The Great Moderation”: when not facing
the zero lower bound, central banks of
advanced countries have done well in shortrun stabilization in recent decades, freeing up
fiscal policy to focus on long-run issues.
“The Great Moderation”
I. The Zero Lower Bound is a Problem
(continued)
G. The zero lower bound makes it hard to get
the time path of monetary stimulus right.
• The short-term interest rate is the
intertemporal relative price between spending
now and spending a little while (say a year or
two) in the future.
• To get considerably more stimulus now than a
year or two in the future, it is important to
have a low short-term interest rate that makes
goods now look inexpensive compared to
goods a year or two from now.
The Constraint the Zero Lower Bound
Puts on the Time Path of Stimulus
The zero lower bound creates a constraint between
amount of stimulus now and amount of stimulus
later. Typically, when below the natural rate, with a
binding ZLB,
• To get enough stimulus now, there would have to
be too much stimulus later.
• To get the right amount of stimulus later, there
would have to be too little stimulus now.
• This creates two problems:
1. Too little now or too much later
2. Credibility problems for enough now.
Removing the Constraint and Restoring
Credibility
• If the zero lower bound is eliminated, the constraint
between stimulus now and stimulus later is also
removed.
• This means it is possible to stimulate the economy now
without convincing people the central bank will
overstimulate the economy in the future.
• As Krugman says about fiscal policy, low enough
negative short-term interest rates will work, regardless
of what people believe about the future.
• If beliefs about the future reduce the stimulus from
monetary policy, in the absence of the zero lower
bound, the short-term interest rate can simply be
lowered further to compensate.
II. How to Eliminate the
Zero Lower Bound
A. The Best Place to Act Against the Massive
Paper Currency Storage that Would Enforce
the Zero Lower Bound.
B. A Minimalist Implementation of Electronic
Money
C. How to Set the [Effective] Exchange Rate
Between Paper Currency and Electronic
Money [in Banks]
A. The Best Place to Act Against the
Massive Paper Currency Storage that
Would Enforce the Zero Lower Bound
1. Restrictions or fees on paper currency withdrawals
have the disadvantage of preventing withdrawals for
spending as well as withdrawals for storage. Also the
ability to withdraw has great option-value for people.
2. Storage of paper currency can be done in a very lowtech way by anyone. Also, criminals already have
experience in secret storage of paper currency.
3. A temporary, time-varying fee on the deposit or redeposit of paper currency can effectively stop massive
paper currency storage. See below on the timevariation (including why it can be temporary).
B. The 3 Elements of a Minimalist
Implementation of Electronic Money
1. Levying a time-varying deposit charge when banks
deposit paper currency with the central bank. For
example, with a 5% deposit charge, a deposit by a
bank of 100 € of paper currency would yield 95 € in
additional electronic reserves.
2. Discounting vault cash applied to reserve
requirements by the same percentage as the deposit
charge.
3. Establishing a legal right for any individual, business,
government agency, or creditor to refuse payment in
paper currency at par. (That is, paper currency would
no longer be legal tender.)
An Ultra-Minimalist Implementation of
Electronic Money
Time-Varying Deposit Fee
• Only between the central bank and privatesector banks. No regulations related to the
deposit fee are needed beyond that.
• Must grow over time during the period the
target interest rate is negative
• Can shrink when the interest rate is positive.
• Two-way: the other direction is equivalent to
getting paper currency at a discount.
The Deposit Fee Creates an Effective
Exchange Rate Between Paper
Currency and Electronic Money
1. Even if only one-way, to avoid the deposit fee, banks
would offer paper currency to customers at a discount.
Hence, if banks were making any deposits with the central
bank, the deposit fee would establish an exchange rate
between paper currency and electronic money.
2. (1-deposit fee) = exchange rate = X at which paper
currency trades for electronic money. (Ignoring
transactions costs.)
3. Ideally, to encourage this, the central bank would charge
the deposit fee on net deposits, thereby effectively
allowing withdrawals of paper currency at a discount.
4. While this exchange rate would probably hold for all
dealings with banks, it need not hold at retail shops. For a
while, shops would accept money at par (a) to avoid credit
& debit card fees, and (b) to be nice to customers.
The Nominal Interest Rate on Paper
Currency
• Remember that electronic money is the unit of
account, so “nominal” means relative to an electronic
dollar, euro, pound or yen, NOT relative to a paper
dollar, euro, pound or yen.
• X = electronic euros per paper euro.
• Paper currency interest rate = (dX/dt)/X.
• At every meeting of the monetary policy committee,
four interest rates chosen until next meeting.
–
–
–
–
Target rate
Interest rate on reserves
Lending rate
Paper currency interest rate
• Starting at par plus track of (dX/dt)/X mechanically
determines X.
C. The Log Exchange Rate Between
Paper Currency and Electronic Money
is the Integral of the MPC’s Chosen
Interest Rate for Paper Currency
What Having a Non-Zero Interest Rate
on Paper Currency Means
• Whatever the interest path chosen for paper
currency implies that, say, 100€ should cumulate
has to be the exchange rate for paper currency vis
a vis electronic money at that point times 100€.
• Thus, starting from par at the inception of an
electronic money system, the principles of
compound interest (with some combination of
positive and negative interest rates) determine
what the exchange rate between paper currency
and electronic money must be.
If, Given Recovery, the Average
Nominal Rate Over Time is Positive,
the Exchange Rate Can Return to Par.
Four Options for the Time Path of the
Effective Interest Rate on Paper
Currency
1. Return to par swiftly. Serious mistake because high LB
2. Return to par gradually, but as quickly as possible
consistent with keeping the zero lower bound nonbinding at all times:
– Paper currency interest rate = monetary policy target
interest rate (or maybe a little lower) during times of
economic emergency.
3. Implement the Friedman rule:
–
Paper currency interest rate = target rate all the time
4. Constantly depreciate paper currency to earn
seignorage without inflation. (e-yen=unit of account)
–
Attractive if it is otherwise hard to tax the shadow
economy.
Case 1: Swift Return to Par
(Percent)
5
4
3
2
1
0
-1
Target Rate
-2
PCIR
-3
ln(X)
-4
-5
2009
2010
2011
2012
2013
2014
Case 2: Gradual Return to Par
(Percent)
5
4
3
2
1
0
-1
Target Rate
-2
PCIR
-3
ln(X)
-4
-5
2009
2010
2011
2012
2013
2014
Case 3: Friedman Rule
(Percent)
5
4
3
2
1
0
-1
-2
Target Rate
-3
PCIR
-4
ln(X)
-5
2009
2010
2011
2012
2013
2014
Case 4: Never Return to Par (Seignorage)
(Percent)
5
4
3
2
1
0
Target Rate
-1
-2
PCIR
-3
ln(X)
-4
-5
2009
2010
2011
2012
2013
2014
The Spread Between the Monetary Policy Target
Rate and the Paper Currency Interest Rate
• The Central Bank should move the target rate (e.g., fed
funds rate in the US) in tandem with the interest on
reserves (when negative not just excess reserves), the
discount rate and the paper currency interest rate.
• The spread between other rates and the paper
currency interest rate will matter to financial firms. This
can be a separate policy choice with electronic money.
• Currently, negative nominal interest rates yield a very
low (negative) spread of other rates over the paper
currency rate of zero. An electronic money system can
avoid the resultant side-effects of negative rates that
occur under current paper currency policies, since the
paper currency interest rate would be a policy variable.
Spread Between Target Rate and PCIR
(Percent)
8
6
4
2
0
Case 1: Swift Return to Par
-2
Case 2: Gradual Return to Par
-4
Case 3: Friedman Rule
Case 4: Seignorage without Inflation
-6
2009
2010
2011
2012
2013
2014
Effect of Negative Interest Rates on
Debt Contracts
1. Like any decline in interest rates, negative
interest rates raise the price of non-callable debt
contracts over horizons over which interest rates
definitely fall (as long as the current numeraire-e-euro--value of the payments is unchanged.)
2. If negative interest rates bring quicker recovery,
they can raise medium-term real interest rates
and therefore lower medium-term nominal
bond prices.
3. If then end of the zero lower leads to a
reduction in the long-run inflation target, then
very long-term nominal bond prices may
increase.
Effects of Paper Currency Below Par on
Debt Contracts
1. Treating the e-euro as the unit of account means
that an option to pay off in paper currency when
paper currency is cheaper than par reduces
would be an unintended quirk of typical debt
contracts that are ambiguous about how
payments must be made.
2. Ideally, legislation would clarify that debt
contracts should be interpreted as referring to
an e-euro numeraire.
3. The alternative is to give lawyers as much
warning as possible that they should clarify what
should happen in a debt contract when paper
currency is away from par.
How to Make Electronic Money De
Facto Legal Tender: Gold Clauses as a
Precedent for Electronic Payment
Clauses in Debt Contracts
From Wikipedia “Gold clause”:
Gold clauses specified within business contracts allow
the creditor the option to receive payment in gold or gold
equivalent. A gold clause may prove valuable to the
creditor in long term contracts, wherein questions may
arise as to whether a currency in use at the time the
contract was entered into would still have the same value
when payment is due. Creditor concerns in respect
to inflation, war, changes in government, and any other
uncertainty about the future value of currency would be
common reasons for adopting a gold clause within a
contract. (Continued on next slide)
How to Make Electronic Money De
Facto Legal Tender: Gold Clauses as a
Precedent for Electronic Payment
Clauses in Debt Contracts (cont.)
• These clauses were common at the beginning of the
20th century. However, their use in the United
States was invalidated by the Gold Reserve Act of 1934.
Congress later reinstated their use for obligations (new
contracts) issued after October 1977 in accordance
with 31 U.S.C. § 5118(d)(2).[1]
• On August 27, 2008, the United States Court of Appeals
for the Sixth Circuit affirmed the enforceability of such
clauses in the decision Jamaica Avenue, LLC vs S&R
Playhouse Realty Co..[2]
Unintended Effects on Debt Contracts
Do Not Create a Zero Lower Bound
• Paper Currency under the current monetary
system creates a zero lower bound because of the
option to get a zero interest rate over any horizon
for any amount of funds.
• By contrast, pre-existing debt contracts are fixed
in number. There is no unlimited option to get
more debt contracts like that on the same terms.
• Unlike paper currency in the current monetary
system, the price of debt contracts and most
other assets can adjust relative to the e-euro unit
of account.
“How Governments Can and Should
Beat Bitcoin at Its Own Game” (Slate)
“… in our current monetary system we take for
granted an interest rate of zero on paper
currency. That interest rate of zero can falsely
signal to households and firms that it is OK for
them to hold back on spending—even at times
when businesses desperately need the
customers and people desperately need the jobs
that extra spending would provide”.
“How Governments Can and Should
Beat Bitcoin at Its Own Game” (Slate)
“Yesterday’s paper currency is not only a barrier
to speedy recovery from deep recessions—it is
also a barrier to ending inflation. …
Take paper currency off its pedestal, and
inflation is no longer necessary to provide this
space for monetary policy, since interest rates
can go down, instead of inflation having to go
up. Then there is nothing standing in the way of
ending inflation forever.”
“How Governments Can and Should
Beat Bitcoin at Its Own Game” (Slate)
Step 1
Establish official government-sanctioned
electronic money in a way that makes the use of
electronic money as convenient and seamless as
possible. This involves setting the stage for
private innovation in electronic payment
systems by giving full legal tender status to
electronic money in all government-insured
bank accounts and in other accounts that are
officially certified as backed 100 percent by
reserves held at the central bank.
Corollaries to Step 1
• Entrepreneurs who are tying to develop
revolutionary payments technologies that can
upend the Visa/American
Express/Mastercard/.. Oligopoly and lower
electronic payment transactions costs are on
the side of the angels, and should be
encouraged.
• The Fed should be pressed to do its duty
under Dodd-Frank to set maximum
interchange fees in line with marginal cost as
“How Governments Can and Should
Beat Bitcoin at Its Own Game” (Slate)
Step 2
Dethrone paper currency from the exalted legal
status it was given (very controversially) in the late
19th century, by giving anyone, at any time, the
right to refuse payment in paper currency, unless a
contract explicitly calls for payment in paper
currency. Further demote paper currency by
abolishing the guarantee that a paper dollar (or
euro, or yen, or pound) will always be worth the
same amount as an electronic dollar. But make sure
that it is easy for people to convert paper currency
into electronic form and vice versa.
Corollaries to Step 2
• Going forward, standard debt contracts should
specify what the required payment will be if
paper currency is away from par. If 100 paper
dollars are worth 98 electronic dollars, does the
debt contract effectively permit paying the
interest or principal at a discount by paying in
paper, or is the equivalent of 100 electronic
dollars required? The answer should be explicit in
the debt contract.
• Commercial codes should encourage the
development of standard debt contracts
clarifying this issue.
“How Governments Can and Should
Beat Bitcoin at Its Own Game” (Slate)
Step 3
“Search in the nooks and crannies of the legal code
and government agency regulations and policies for
places where it is assumed that interest rates are
always zero or positive or where it is assumed that
paper currency has a special status—and root those
assumptions out. (For example, make it clear that
people can’t show up with suitcases full of
hundred-dollar bills to settle their taxes.) Encourage
businesses to do the same with their business plans
and their accounting.”
Corollaries to Step 3
• The law should be clarified to expressly prohibit
payment of taxes in paper currency.
• The option of prepaying taxes at an implicit
interest rate of zero needs to be foreclosed. The
natural alternative is to have nbenchmark
interest rates for tax purposes that are tied to the
Fed’s target rate.
• Tax accounting standards should be adjusted to
specify an electronic dollar standard should paper
currency ever be away from par.
• It needs to clarified when interest earned or paid
on paper currency should affects taxes and when
not.
“How Governments Can and Should
Beat Bitcoin at Its Own Game” (Slate)
Step 4
Give the central bank the authority to
make interest rates negative, including
making the interest rate on paper currency
negative when necessary, by using the fact
that a paper dollar is no longer guaranteed
to be worth the same amount as an
electronic dollar.
Corollaries to Step 4
• It is important for legal teams at Treasury to
clarify the legal authority of the Fed. For example
– Is the Fed allowed to make interest on excess reserves
negative? (The Fed is afraid to ask its own counsel for
a legal opinion on this, for fear that such a legal
opinion will then be determinative.)
– Is the Fed allowed to impose a deposit fee when
banks seek to deposit paper currency into their
reserve accounts?
• If Treasury’s view of the legal authority of the Fed
is more expansive than the view of the Fed itself,
that should be hashed out.
“How Governments Can and Should
Beat Bitcoin at Its Own Game” (Slate)
Step 5
Require the central bank to bring its inflation
target down to zero over the course of 15 years
and to forever afterward keep the value of a
dollar in terms of goods and services within an
unchanging narrow band. This should be revised
only when necessary to take into account
improved ways of measuring the value of a
dollar (or euro or yen or pound).
Corollaries to Step 5
• In making choices about debt maturities,
Treasury should take seriously the possibility
of lower inflation in the future. Without
worries about the zero lower bound, there is
likely to be a policy tendency toward lower
inflation.
• 30-year nominal government bonds with
interest rates determined by a market
assuming at least 2% inflation could in the end
be a very expensive form of government
finance.
“How Governments Can and Should
Beat Bitcoin at Its Own Game” (Slate)
It has become traditional for U.S. Treasury
secretaries to periodically repeat the mantra
that “A strong dollar is in our nation’s interest.”
I would add one word to the mantra: “A strong
electronic dollar is in our nation’s interest.” A
strong electronic dollar is one that works
smoothly in transactions, empowers monetary
policy to bring a speedy end to recessions, and
keeps its value over time with no concessions to
inflation.”
III. “The Costs and Benefits of
Repealing the Zero Lower Bound …
and Then Lowering the Long-Run
Inflation Target”
A. Costs of eliminating the ZLB
– Computational costs of the exchange rate: like sales
taxes and applies to a smaller and smaller fraction of
goods as electronic transactions become more
common
– Effects of lower real interest rates, like any reduction
in interest rates.
– Nominal illusion effects. E.g., new strategies for
financial hucksters and bubble-mongers.
– Possible redistributions from soft-money transition
Benefits of Eliminating the ZLB
• Direct benefits
• Benefits of being able to lower the long-run
inflation target
• Analogy: direct benefits of raising equity
requirements for financial firms + benefits of
being able to pursue more vigorous monetary
given fewer macro-prudential worries
Costs of Inflation in the Absence of the
ZLB: Must Answer “Inflation Relative
to What?”
1. Messing up price signals




Varieties of final goods
Varieties of intermediate goods
Varieties of labor inputs
Leisure over time
2. Menu costs
Unit in which prices and wages are specified
(Should be e-$ with minor exceptions)
Costs of Inflation in the Absence of the
ZLB
3. Confusion
 Making people blame “inflation” for real wages lower than they
would like
 Causing unintended distortions in the tax code, particular higher
capital taxation than intended.
 Making people misunderstand economic data, for example income
distribution including inflation component of capital gains and interest
 Leading people to mistake nominal rates for real rates of return when
doing retirement planning.
 Muddling intertemporal comparisons more generally (yardstick)
4. Unpredictability of Inflation goes up with level of inflation (zero
inflation is focal, so less unpredictability when inflation is near zero)
Unit of Account
Costs of Inflation in the Absence of the
ZLB
5. People using too little paper currency (shoeleather costs, etc.)
• Not about inflation per se, at all.
• Rather about the spread between the checking
account interest rate etc. and the paper currency
interest rate.
• In an electronic money system, the key shortterm spread is under the central bank’s control
as a distinct instrument.
• Tradeoff between various effects of this spread,
regardless of the level of inflation.
• Lower inflation helps during periods at par.
Will Having Paper Currency Away from
Par at Some Points Discourage Its Use?
• Extra computations costs make paper
currency use less attractive.
• Retailers likely to, in effect, give a cash
discount when they must have a conversion
factor in any case. This encourage paper
currency use.
• Stickiness of conversion factor at par may lead
to an especially big cash discount early on.
Possible Benefits of Inflation: SecondBest Effects Relative to a Preexisting
Suboptimality
1. Raising the effective rate of capital taxation,
if that is a good thing rather than a bad thing.
(Unit of account)
2. Making it easier for firms to lower the real
wages of particular employees. (Unit of
stickiness)
3. Leading firms to lower their markups of price
over marginal cost and wage setters to lower
their markups of the wage over the
opportunity cost of time. (Unit of stickiness)
Conclusion
• The zero lower bound is a policy choice.
• The zero lower bound is costly.
– ZLB interferes with stabilization policy
– ZLB is a big enough problem it motivates higher inflation than
would otherwise be optimal
• The zero lower bound can be eliminated through
– A time-varying charge for depositing paper currency at the
central bank
– A discount for vault-cash as applied to reserve requirements
– The ability to specify terms for acceptance of paper currency in
new debt contracts
• Electronic money would be “the real thing”: the unit of
account and the effective legal tender.
• Other measures can make the electronic money system
work better, and make the transition easier.
APPENDIX SLIDES
Transition to Electronic Money as a
Monetary System
“The Transition to Electronic Money as
a Monetary System”/ “Going Off the
Paper Standard”—The Long Version
1. Announce technical feasibility of eliminating
the ZLB.
2. Strengthen macro-prudential regulation by
raising equity requirements substantially
above Basel III.
3. Ask banks and other financial firms to make
contingency plans for negative interest rates.
D. “The Transition to Electronic Money
as a Monetary System”/ “Going Off the
Paper Standard”
4. Develop accounting standards for negative
interest rates that take electronic money as the
unit of account, and give to paper money then
value it is worth in the market relative to
electronic money.
5. Ask government agencies to prepare
contingency plans for negative interest rates and
non-par valuation of paper money.
D. “The Transition to Electronic Money
as a Monetary System”/ “Going Off the
Paper Standard”
6. Make it clear no one has the right to pay off
large debts to the government in contexts where
transactions are now routinely conducted with
bank money.
7. Establish by law that debgtors do not have the
right to pay off large debts with paper currency
at par when the market value of paper currency
is below par.
D. “The Transition to Electronic Money
as a Monetary System”/ “Going Off the
Paper Standard”
8. Formally make money in central-bank
certified bank accounts legal tender.
9. Announce the intent to introduce an
electronic money system.
10. Lower the central bank’s interest rate on
reserves to zero or slightly below zero.
11. Lower the central bank’s target interest rate,
interest rate on reserves, and the central bank’s
lending rate substantially below zero.
D. “The Transition to Electronic Money
as a Monetary System”/ “Going Off the
Paper Standard”
12. If there is any sign of large increases in paper
currency withdrawal, institute a time-varying
deposit charge when banks deposit paper
currency with the central bank in exchange for
reserves. (Since the deposit charge starts at
zero, there will be plenty of time for people to
get used to the deposit charge as it grows. It
only grows as required by a negative target rate,
and shrinks when the target rate is positive.)
D. “The Transition to Electronic Money
as a Monetary System”/ “Going Off the
Paper Standard”
13. Discount vault cash applied to reserve
requirements by the factor (1-deposit charge)
14. Implement the accounting standards
appropriate for negative interest rates and nonpar valuations of paper currency.
15. Require payment of taxes and other
substantial debts to the government in
electronic form.
D. “The Transition to Electronic Money
as a Monetary System”/ “Going Off the
Paper Standard”
16. Implement the contingency plans for
government agencies.
17. Ask all firms to post prices in terms of electronic
money. (This could be in addition to prices posted
in terms of paper currency. It also may not be
necessary.)
18. Make it clear that firms are allowed to specify in
contracts (including loan contracts) and in retail sale
the terms under which they will accept paper
currency.
Hard-Money Transition vs.
Soft-Money Transition
• Having pre-existing debt contracts interpreted as
applying to e-$ amounts probably keeps to the
intent of those contracts better than letting them
be paid in below-par paper currency. If this
principle can be established in law, I call it a
“hard-money transition.”
• If old debt contracts can be paid in below-par
paper currency, I call it a “soft-money transition.”
• I prefer the hard-money transition, but old debt
contracts cannot create a zero lower bound if
new debt contracts are effectively in terms of emoney.
Other Issues
A. Political constraints
B. Can things other than government-issued paper
currency generate a zero lower bound?
C. Could the ZLB be eliminated without a change in
current law, if key elements of the government
were tacitly backing the central bank in such an
action?
D. Helping financial firms adjust
E. Comparing negative rates to QE
F. Answer to miscellaneous possible objections
G. Options for exchange rates with e-money
A. Dealing With Political Constraints:
Negative Nominal Rates Themselves
1. People are not used to negative nominal interest rates

Both the reasons and the mechanics will require a great deal
of explanation
2. The usual complaints that expansionary monetary policy
hurts virtuous savers will be magnified when rates are
negative. As part of communication, it needs to be
emphasized that
 Low rates help borrower in the economic hard times
 Low rates help the economy
 Interest rates should reflect the social benefit of saving; saving is
not what society needs when the economy is in a slump.
 Low rates for a short time will bring higher rates later by
fostering economic recovery:
“Negative rates for a few quarters are better than zero rates
for years and years.”
B. Which of These Things Could
Generate a ZLB
Even if Paper Currency Doesn’t?
• Postal Savings system in Japan pays a zero
interest rate on unlimited deposits. Yes.
• A zero interest rate on a limit amount of
deposits. No.
– A transfer program. Does not creat a ZLB.
• Bitcoin. No. (Unless it became the unit of
account.)
– Not freely convertible at a set price.
– Announcement of negative rates should cause
Bitcoin to appreciate instantly and then have a
gradual price decline thereafter.
– The government has plenty of tools to maintain its
near-monopoly on money.
C. Could the ZLB Be Eliminated
Without Any Change in Current Law If
Key Elements of the Government
Tacitly Backed That Action?
1. Time-varying deposit fee when banks deposit paper
currency with the central bank is probably within current
authority of most central banks.
2. Discounting vault cash should be within current authority
of most central banks.
3. Future debt contracts can probably be written with a
clause with conditions on paper currency payment.
4. The deposit fee for paper currency implicitly treats
electronic money as the unit of account.
5. The details of the law may matter. Legal teams at central
banks should examine the issues.
D. Helping Financial Firms Adjust
Prudently to a New World of Negative
Interest Rates Safely.
1. Go big or go home? Would -3% or -5% help financial firms
realize they need to adjust their business models (and
explain the changes to customers) better than -.5%?
2. Money market mutual fund reform needed to push
money market mutual funds away from any implicit
promise not to “break the buck.” (Proposals already on
the table.)
3. No real downside to high bank (& shadow bank) equity
(“capital”) requirements to ensure financial firms aren’t
causing macroeconomic risk.


See The Banker’s New Clothes by Anat Admati and Martin
Hellwig
The higher equity requirements can be implemented without
disruption for existing firms simply by prohibiting dividends
and share purchases until the requirements are met.
E. Comparing Negative Nominal
Interest Rates to QE (Overview)
• Negative nominal interest rates are powerful
enough that they can be used as a substitute
for QE, not just as an adjunct. Indeed, I would
recommend explicitly saying nominal interest
rates are a way to avoid having to use QE.
• QE is better than nothing, but how does QE
compare to negative interest rates in the
absence of a zero lower bound?
E. Comparing Negative Nominal
Interest Rates to QE
A.
Large purchases and later sales of long-term government bonds can be
costly because of a buy high/sell low problem. Using IOR instead of
unwinding would just delay the recognition of this problem.
 Another way of looking at the same problem is that buying up long-term
government bonds goes against the government as a whole locking in low
long-term rates.
 The losses to the private sector from buy high/sell low tend to benefit those
who are relatively wealthy.
 This problems with QE can be avoided by focusing on risky asset purchases.
B.
C.
D.
QE, like all methods that face the zero lower bound, has a constraint
making it hard to stimulate enough now without committing to stimulate
too much later. This may be the biggest problem.
QE squeezes spreads abnormally. It would be surprising if that did not
cause some distortions. In any case, those squeezed spreads push the
economy into unknown territory.
By contrast, we already have plenty of experience with negative real
rates, so the only unknowns with negative interest rates have to do with
nominal illusion.
F. Answering Potential Objections
1. “People will just use a foreign currency.”
 But people now use domestic paper currency
even when foreign paper currency has a higher
expected return. (For example, why don’t
Americans now have big piles of yen notes?)
 If people did turn to foreign currency, that would
just one more example of a low domestic interest
rate causing capital outflows and therefore
raising net exports, with stimulative effects. (In
this case the fact that paper currency interest
rates fall in tandem with other interest rates
makes it a bit more powerful.)
F. Answering Potential Objections
2. “People will store commodities”
 The production of anything can stimulate the
economy. And storage of useful goods is actually
socially optimal if other investments have a lower
return. (There is nothing wrong with people buying
canned goods in advance, when rates are low, for
example.)
 The production of money-like goods (e.g. gold)
beyond their non-monetary social usefulness can be
discouraged by taxing the storage of those goods.
 Buying foreign-produced gold creates export
demand for goods produced locally. Domestic
production of gold can be tracked.
What About a “Paperification
Equilibrium” Where To Avoid the
Deposit Fee, People Just Use Paper
Currency and Non Electronic Money?
• For those taking paper as a numeraire, target rate
– paper currency interest rate (or IOR – PCIR) is
the approximate return to putting funds into the
bank.
• Thus, a low enough paper currency interest rate
relative to the target rate or IOR will induce
people to put money in the bank, even if paper
currency is being accepted at par in shops.
• So the paper currency deposit fee remains
relevant.
What If a Sub-Par Future Exchange
Rate for Paper Currency is Not Fully
Credible?
• A fair amount of credibility is indeed needed.
• However, perfect credibility is not needed.
– Even if the intended exchange rate peg is broken (& 2-way
is shut down to avoid money pump), the actual exchange
rate will be between that and 1, since paper currency is
still handicapped somewhat by the deposit fee.
– We need E(PCIR) < target rate and E(PCIR) < IOR
– While the peg holds,
E(PCIR) < [θ (1-x)/x] + ([dx/dt)/x] = [θ (1-x)/x] + PCIR*
– So as long as the perceived probability θ of going into a
messy “endgame” where the peg is broken is not too high,
there will be no massive paper currency storage and the
peg can hold.
G. Options for International Exchange
Rates and Paper Currency Exchange Rates
• Robert Eisler wanted a fixed international exchange
rate in the bank money, with a flexible paper currency
exchange rate.
• My basic plan has flexible international exchange rates
and a crawling-peg paper currency exchange rate.
• For the euro-zone, I proposed a “one-central bank,
multiple currencies” model with an electronic
Deutsche mark, with the euro serving as the paper
currency for Germany as well as for the rest of the
zone. So in effect,
 Electronic euro = paper euro = paper mark,
 But the electronic mark (which would be the unit of
account in Germany) is distinct and has a crawling-peg
exchange rate with the others.
Assessing Japanese Monetary Policy:
Has NGDP (the Velocity-Adjusted
Money Supply) Been Smooth?
1. Quartz 21—>Optimal Monetary Policy: Could
the Next Big Idea Come from the
Blogosphere?
2. http://blog.supplysideliberal.com/post/5064
6128943/quartz-21-optimal-monetarypolicy-could-the-next-big
3. Influenced by Market Monetarism.
4. Focuses on the behavior of NGDP, the
velocity adjusted money supply (MV=PY)
Why NGDP (the Velocity-Adjusted
Money Supply) Should be Smooth
1. To a first approximation, optimal monetary
policy is to keep the economy at the natural
level of output.
2. Inflation data only gradually reveal where the
natural level of output is.
3. Therefore, a good approach in absence of ZLB is:
a. Very-short-run interest rate target
b. Medium-run NGDP target with steady growth at a
rate that factors in estimates of of what tech
progress, pop, capital stock, etc. mean for growth in
natural output. (Choice of the estimated growth rate
for natural output is a key task of the central bank.)
c. Long-run inflation target at zero.
Log of Nominal GDP for Japan
Nominal GDP for Japan Since 1994