Escaping the zero lower bound: edge share.

Having already written on this subject, I post here today another take on the issue of the current conundrums about Monetary Policy. The quest between Inflation targeting – if the target should be raised above the 2% consensus – is again brought to the front line of discussion. This Blog longandvariable defends here a position of criticism (rightly so…) about the today’s feasibility of Electronic money and its potential of resolving the issue of zero lower bound in Monetary Economics. The last paragraph is worth a recall:

What Rogoff thinks would particularly ‘baffle’ central bankers’ constituents was that they had changed their minds about the benefits of price stability.  There’s something in this.  But it should not be the overriding concern.    And:  the profession has done a lot of changing of minds recently!  We would hardly decide against tightening prudential supervisory standards on the grounds that we would baffle everyone that we had changed our minds on it.  On the contrary, it would be perplexing if the authorities had not changed their minds in the light of the evidence about what constituted good policy.  So too with inflation.  For generations, the authorities wrestled with different metallic standards for monetary policy.  Finally, we ‘changed our minds’ about this being the right thing to do.  It was probably baffling at the beginning.  But slowly people got used to the meaninglessness of the ‘promise to pay the bearer on demand the sum of’ text.”

Escaping the zero lower bound: electronic money, or higher inflation?.

via Escaping the zero lower bound: electronic money, or higher inflation?.


Paper Currency and Electronic Currency

Today there is a refresher on the current struggles in Monetary Economics. And again Izabella Kaminska in Aphaville share with us views and links about the topic.

So it seems that Paper Currency and the traditional forms of Central Government Money have their days counted. It is like one of my friend’s recent literary project: Unbelieving Count ( ….from the Portuguese Contagem Descrente). Anyway, back to Economics…..

The relevant Academic Kenneth Rogoff is recently working on this subject with interesting papers and opinion. With passages like this:

” The idea of raising target inflation to reduce the likelihood of hitting the zero bound is indeed an alternative approach. Blanchard et al. point out that if central banks permanently raised their target inflation rates from 2% to 4%, it would leave them scope to make deeper cuts to real interest rates in severe downturns. Arguably, paying negative interest rates is a better approach if, as many believe, inflation becomes more unstable as the general level of inflation rises. Robert Hall (1983) argues forcefully that the central role of monetary policy should be to provide a stable unit of account, and in principle the ability to pay negative interest rates facilitates its ability to achieve this in today’s low inflation environment (Hall, 2002, 2012).”

Rogoff explain us that there are challenges to the full implementation of Electronic cash, as the nature of fiat money systems expose them to fraud and tax evasion on massive and difficult to monitor scales:

” ….. There is nothing, however, in standard theories of money that requires transactions to be anonymous from tax- or law-enforcement authorities. And yet there is a significant body of evidence that a large percentage of currency in most countries, generally well over 50%, is used precisely to hide transactions. I have summarized the international evidence in earlier research (Rogoff 1998, 2002). Other than the introduction of the euro, rather little has changed except that, if anything, anonymous currencies have continued to grow at a faster rate than nominal GDP.

A somewhat vindication of the virtues of the European single currency, which I endorse in many ways. Interesting in all of this is the puzzle of the demand for money in current monetary systems with money not back by real safe assets. Here Kaminska on the subject: ‘‘The problem this poses for the public purse is that even though the substitution of paper cash for electronic cash should not theoretically affect seigniorage revenue for the government — because phased-out paper currency demand would be replaced by demand for electronic central bank reserves — the non-anonymous nature of electronic money would likely lead to a large shrinkage in demand.”

But, caveat emptor:

In Rogoff’s opinion, Treasuries or other anonymous vehicles would have to absorb that loss instead.

The only caveat would be if the government managed to introduce a fully anonymous electronic money in its own right.

As he notes:

The government would continue to garner seigniorage revenues from the underground economy and the problem of the zero bound on nominal interest rates would be effectively eliminated. That said, it is far from clear that the government can credibly issue a fully anonymous electronic currency and even if it could, anonymous electronic fiat money has all the drawbacks of an anonymous paper currency in facilitating tax evasion and illegal activity.”

Fascinating subject, certainly. And a subject that should spark interest with anyone with ability to think through and who likes to hypothesise and suggest ways forward, which Izabella encourages in the rest of  entry:

”Rogoff also suggests that any attempt to introduce a fully anonymous state currency would probably transform the central bank into a universal bank — something we’ve suggested is already happening due to the Fed already expanding its balance sheet to money market funds.

Rogoff says that might not be so bad if there were rules and protocols in place to ensure the government could not abuse its unique information advantage in that regard.

Nevertheless, none of this spares the country from the risk that another country’s paper currency might end up becoming used more commonly in the economy instead.

Overall, Rogoff concludes further study of the costs and benefits of phasing out paper currency is necessary, especially since we may already live in the “twilight of the paper currency era anyway”.

In any case, a few points we’re left confused about:

1) First, Rogoff claims that if there were concerns about anonymous digital central bank cash, people would likely park money in Treasuries instead and that this would reduce seigniorage income.

Surely, this thinking doesn’t make sense? Wouldn’t the money redirected from zero-yielding cash, which is provided by the government on demand (especially so that it is always zero yielding), be redirected into yielding securities in such a way that it would have negative yielding effects? If that’s the case the negative rates provided to the government would be a form of seigniorage revenue, and could be exploited by greater borrowing at zero rates.

2) Second, doesn’t Rogoff neglect the seigniorage revenue that’s already being lost — irrespective of anonymity — due to the shortage of safe assets problem? The market also has a preference for creating private money substitutes — whether they’re bearer notes collateralised by art, collateralised commodities in no-man’s land stores or bitcoin — rather than taking on more free debt. After all, the former currently allocates the money much more questionably than structured public policy might do.

3) Why has no-one yet made the connection between anonymity — which is injected into the system by means of anonymous bearer currency which “neither buyer nor seller requires knowledge of its history” — and our inability to model or control systemic risk?

All thoughts appreciated.”

Good thinking and significant suggestions will certainly be appreciated.



How not to do Macroeconomics – with an Edge

Following the spirit d’état in the Edge in the past couple of weeks about Economic theory and applications (… and maybe implications…) I post today a link to the Blog Unlearning Economics. It is about the current deeply interesting and important debates surrounding issues in Macroeconomics like: the proper modeling framework for macro, the Rational Expectations literature and its critics, Monetary Economics and zero-bound constraints on interest rates, and so on. Deep issues highlighting an era which is demanding for Economic Sciences.  Excellent for the many links it provides to other Blogs and articles of academic preeminence and quality. There is also a sequel that is certainly worth the read as well.

How Not to Do Macroeconomics.

The brave new World of Money Creation (II)

The following is a recent addition to Izabella Kaminska in her FT’s Alphaville series: Free Money! Series. More interesting bits again and another vindication of Private Money creation in a World of monopoly control of the money supply. Specially:

”A more prudent path might just be encouraging both the central bank and the market to get better at identifying over or under issuance where and when it happens, something which could be made easier if private money’s price signal was detached from the state peg.

We generally lean to the view that in the long term it probably doesn’t matter what you do. If one form of money is repressed, it’s more than likely another form will spring up in its place. If one form is over-issued, meanwhile, more than likely a superior form will enter the market to take its place.

Unfortunately, in our current framework, that counterbalancing effect has been broken. So, unless we get extremely radical private issuance outside of the banking system as it stands (which the altcoin movement might be signalling), chances are QE in its current asset-swapping form — as opposed to actual expansionary helicopter drops — is more than useless. ”

Izabella also adds the entry of Noah Smith at Noahpinion about the significance of interest rates (nominal and real) to this story:

” What I call the “Neo-Fisherite” assumption is that in the long term, r (the real interest rate) goes back to some equilibrium value, regardless of what the Fed does. So if the Fed holds R (the nominal interest rate) low for long enough, eventually inflation has to fall. This is exactly the opposite of the “monetarist” conclusion that if the Fed holds R very low for long enough, inflation will trend upward. ”

Which means, as Izabella notes that the current private issuance of state peg money (in the current economic situation and further compounded by Quantitative Easing) doesn’t amount to any real effect on economic activity. It just is too late, too few (I had earlier suspicions of QE being money thrown down the drain….). Or with further Noah Smith help:

” The thought experiment is this: Suppose there was no government debt, and the Fed raised nominal interest rates to 20% and held them there forever. What would happen to real rates? Well, they wouldn’t rise to 20% forever, because there’s just no way that our society can physically, technologically deliver a 20% riskless rate of return to bondholders. Eventually, one of two things would have to happen: either 1) the Fed’s control over the nominal interest rate would break down, or 2) inflation would rise (the Neo-Fisherite result). If the Fed can’t control the nominal interest rate, then our standard models of monetary policy all break down, and we have to think about the microeconomics of money demand, which is hard to do. But the only alternative would be the Neo-Fisherite result. ”

I would like end this post with a statement. I am completely neutral in this discussion. There isn’t for me any conflict of interests and these posts merely reflect my interest in this discussion and to further enhance views and promote debate.

The brave new World of Money creation….

Today’s Izabella Kaminska post on FT’s Alphaville is interesting, important and rightly pointing deep questions about modern monetary systems and the economic theories underpinning it. It starts by referring Martin Wolf’s article about the way modern money is created, with the excellent FT’s commentator and columnist defense of endogenous theory of money.

But Izabella displays nicely her criticism of that defense. I found quite interesting the notion that money is a kind of credit today of which the backing isn’t necessarily today’s collateral but future returns on investment, and that is what makes possible that deposits in the Banking system act as part of the money supply and is simultaneously a liability and a form of Equity to banks’ Balance Sheet.

Here the main part:

”If Wolf is right, then financial instability is very likely a product of the system’s tendency to take the private money issuance power of banks for granted. In reality, this power is thrust upon banks by system participants and can be easily compromised if these institutions prove unreliable at matching trusted liabilities with projected assets which don’t exist yet.

A great deal of the instability is so related to public misunderstanding about what bank money really is, namely imitation electronic cash which does a good job of mimicking state cash, the only safe source of purchasing power in a developed economy with a competent central bank. As FT Alphaville has stated before, that means unproven private liabilities get entangled with sovereign liabilities, making them impossible to differentiate or to value on individual terms, a fact which ultimately leaves the state on the hook for guaranteeing them even though it was not the state which was responsible for creating them.

The problem for financial stability comes about if, when the private issuance power of banks fails, there isn’t a more trusted authority that can step in to guarantee those liabilities directly — and equally so, if there is such an authority but they are unwilling to take on those private liabilities due to price stability fears. ”

All of this is after justified and put in the perspective that Central Banks are at the same time today with huge power in the System, for theirs is main job of guaranteeing stability, but also to assure that the main functions of Money are well established, like for example as a medium of exchange in a world of Fiat Money, but also with huge responsibility of getting the proper understanding the fundamentals of the Economy right, if they are to accomplish their mandates and goals. For the sake of us all and the credibility of the system.

We then expect further on this, for all the good reasons and not least for forming our own mature position as regards the ”who’s in the right” challenge posed by Kaminska, along the way witnessing her doubts and double Mind on Wolf’s pessimistic stance being definitely cleared…:

” In Wolf’s opinion towards the argument for eliminating of private money outright:

Our financial system is so unstable because the state first allowed it to create almost all the money in the economy and was then forced to insure it when performing that function. This is a giant hole at the heart of our market economies. It could be closed by separating the provision of money, rightly a function of the state, from the provision of finance, a function of the private sector.

This, as it happens, is where we respectfully agree but disagree at the same time with our esteemed colleague. But we’ll expand more on why that is in our next post.”