Part 1: Pieria Debate on Electronic Money & Negative Rates
Miles Kimball, Jonathan Portes, Frances Coppola and Tomas Hirst discuss the case for electronic money and negative interest rates.
Miles Kimball: I summarised the core of my presentation to the Bank of England in my post earlier this week – “A Minimalist Implementation of Electronic Money”. A lot of economic discussion in recent years has been about the zero lower bound so it’s important to start there.
I was trying to think about how you achieve electronic money legally as I think it sounds a little less radical if you look at it from that perspective. In general the public don’t understand the zero lower bound but negative rates on savings seem too crazy. So the real issue politically is going to negative nominal interest rates in the first instance but once you’re there eliminating the zero lower bound is not such a big step.
Cash storage is the issue but you’ve got three parts to that – taking electronic money out of cashpoints as paper money, storing it and putting it back into accounts. You don’t want to attack it at the withdrawal stage as then you’re blocking people from spending it, which is what you’re trying to avoid. Moreover, the storage stage is difficult to attack as we know that people are already hoarding lots of paper currency. So the number one thing you need for electronic money is for the central bank to have a deposit charge that varies over time.
Conceptually, you just set the interest rate on paper currency. That then determines what the exchange rate with electronic money is in a very simple way. Imagine say £1 earning that interest rate over a given period of time, then on any particular date I can work out its value. You could just set the interest rate on paper currency to be equal to the bank rate.
Jonathan Portes: Suppose you wanted an interest rate of -5%. If I’ve got £1000 in my bank account now what’s going to happen to it?
Miles Kimball: Under that scenario that’s going to turn in £950 in a year if you leave it in your bank account. Now I want to make sure that if you take it out of your bank account and put it back in at a later date it turns into the same £950.
So you say if you put paper pounds into your account a year from now you face a 5% deposit charge. The Bank of England only has to do that on reserves that it holds, but the banks would transmit that to everybody else.
Frances Coppola: They might not.
Miles Kimball: That’s why you have to allow people to refuse payment in paper currency at par, which is the key legal issue. Firms, individuals, creditors and government agencies have to be allowed to refuse payment at par.
Jonathan Portes: So let me get this straight, I know if I leave my £1000 in my account the bank is offering me an interest rate of -5% so I decide to take £1000 out. Now say I return it a year later, how does the bank know how much to charge?
Miles Kimball: They don’t need to. The Bank of England is announcing on any day what the exchange rate is so all the banks need to do is look at whatever the exchange rate is on that day.
As long as you have one central bank and two currencies the idea is totally credible. Nobody doubts that a pound is worth one hundred pence and that’s because the same central bank can issue both currencies. The same principle applies to electronic money and paper money.
Tomas Hirst: So if you take a £10 note to a shop to buy ten pounds worth of goods, how is a shopkeeper supposed to refuse to accept the payment?
Miles Kimball: It’s going to take you months and months before the deposit charge is even 3%. Right now shops are paying something like 1.5% in credit card company fees so at the moment shops hope people pay in cash but under this proposal they might prefer people to pay on credit card. If shops can absorb the 1.5% they can probably absorb 3% before having to push up prices.
People might even be able to get cash at a discount from the banks for a period of time. However, I do worry a little bit about spreads opening up if banks decide not to pass on negative rates to people.
From a legal point of view if you abolish legal tender, it’s just a central bank deposit charge – although you would need to insure that vault cash counted in reserve requirements was discounted in the same way.
Frances Coppola: I’m convinced that the mechanism can work, but it’s the effects that worry me. The key question is whether we are talking about negative deposit rates, negative lending rates or both. There have already been some experiments with negative deposit rates but not lending rates.
When you’ve got a negative deposit rate you might get some very untoward things start happening such as yield curve inversion. It could also mean the end of shadow banking as it would force money market funds to “break the buck”.
What actually happened when they attempted it in Denmark is that banks hid it from their customers by raising rates to borrowers. They absorbed the charge and didn’t pass the negative rates to customers. That’s absolutely not the impact you want.
Miles Kimball: They wouldn’t have done that if rates had been dropped to say -3% as they couldn’t have afforded to.
Frances Coppola: Yes, they could. And that’s what worries me. There’s no particular reason why banks would want to pass negative rates onto customers knowing that it could cause them simply to leave.
Miles Kimball: If domestic banks are doing that and running down their capital you could just raise capital requirements to prevent it from happening.
Frances Coppola: But you’re assuming that banks want to lend. In the UK we have a very badly damaged banking system, which as far as I can see doesn’t want to lend.
Miles Kimball: There’s got to be some rate low enough that would compel them to lend. You have to make sure there’s no place to hide other than putting money to work in the real economy.
Jonathan Portes: What stops companies from just moving all their money abroad?
Miles Kimball: The great thing about electronic money is that if any major country does it, it would force other countries to follow. You get a massive carry trade and capital outflows so if the UK does it you would get a massive export boost.
Hopefully others would then follow and you would get a massive worldwide monetary expansion.
Tomas Hirst: Doesn’t that assume that there is no structural impairment to the export sector and it can respond quickly to currency falls?
Miles Kimball: People in the UK may want to send pounds abroad but remember those pounds are still earning an interest rate of -5%, say, so folks abroad aren’t going to want to hold onto them either.
So if you don’t get others to follow, you can invite them to do a currency intervention and buy government debt at -5% and in effect you get a huge subsidy.
How to Set the Exchange Rate Between Paper Currency and Electronic Money – Confessions of a Supply-Side Liberal
The strange world of negative interest rates – Coppola Comment
Lingering Doubts over Negative Rates – Pieria