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1
Negative Nominal Interest Rates:
History and Current Proposals
CAWM Discussion Paper No. 43 – January 2011
Cordelius Ilgmann† – Martin Menner‡
[preliminary and unrevised version]
Abstract:
Given the renewed interest in negative interest rates as a means for overcoming the zero
bound on nominal interest rates, this article reviews the history of negative nominal interest
rates and gives a brief survey over the current proposals that received popular attention in the
wake of the financial crisis of 2007/08. It is demonstrated that ‘taxing money’ proposals have a
long intellectual history and that instead of being the conjecture of a monetary crank, they are
a serious policy proposal. In a second step the article points out that, besides the more popular
debate on a Gesell tax as a means to remove the zero bound on nominal interest rates, there is
a class of neoclassical search-models that advocates a negative tax on money as efficiency
enhancing. This strand of the literature has so far been largely ignored by the policy debate on
negative interest rates.
Keywords: negative interest rates, history of economic thought, Silvio Gesell, zero bound,
search-theoretical models, monetary policy
† Department of Economics, University of Muenster, Germany. Email: ilgmann@insiwo.de
‡ Department of Economics, Universidad de Alicante, Spain. Email: mmenner@merlin.fae.ua.es
2
Introduction
The current recession is without doubt the most serious economic crisis since the end of
World War II, a real ‘once-in-a-century event’ (IMF, 2009, p. 3). Nearly three years after the
onset of the crisis, most central bank base rates are still close to zero, with high although
eventually diminishing interest spreads on financial markets. Investment and capacity
utilization however have remained far below normal levels in many industrial states. With
central banks’ base rates approaching zero, conventional monetary policy has run out of
option concerning the reduction of market interest rates which is necessary to revive the ailing
economy. Being left with no other option, central banks around the world have turned to a
combination of quantitative and qualitative easing,
1
policies whose success in reviving the
economy have been fairly small, especially in the United States.
Thus, Gregory Mankiw (2009), in an article in the New York Times, reflected on the
possibility of negative interest rates as a way to revive lending. The idea might seem absurd at
first glance, but, as Mankiw’ points out, the same applied to the idea of negative numbers,
which were rejected by early mathematicians as impossibility. Indeed, in an internal study, the
Federal Reserve Bank specified the ideal interest rate at minus five percent (Guha, 2009) and
the Swedish central bank actually cut its deposit rate to minus 0.25% at the height of the crisis
(Sveriges Riksbank, 2009). Thus, the financial crisis fired a monetary policy debate that took
place mainly in the blogosphere, in parliamentary or congressional evidence or in speeches
(see for further references Buiter, 2010, p. 216). As a consequence negative interest rates
received popular attention beyond the small group of academics who have worked on the
issue since the millennium.
In fact, the (academic) debate on negative interest rates stretches back over more than a
century to the late 19th century. Silvio Gesell is widely accredited to be the first proponent of
negative nominal interest rates. Gesell’s ideas have attracted a small, but convinced group of
followers, and he must be regarded as the founding father of a persistent social movement:
the Freiwirtschaftsbewegung (free-economy movement).
2
And even if his proposal of a
negative tax on money was never adopted on a large scale, there were some regional
initiatives during the Great Depression.
3
Moreover, in the course of the 20th century, Gesell’s
idea was taken up by various prominent economists such as Irving Fisher and John Maynard
Keynes. Indeed, Fisher was a stout proponent of taxing money (‘stamp script’) which he saw as
1
See Buiter (2009) for a suggested distinction between the two.
2
See Bartsch (1994) for the history of the free-economy movement.
3
a feasible method for reflating the economy of the 1930s, and Keynes endorsed parts of
Gesell’s theoretical reasoning, calling him a ‘strange, unduly neglected prophet’ (Keynes 1936,
p. 353).
Nonetheless, during the post war era, orthodox authors have paid little attention to the
possibility of negative interest rates, and scholars of the history of economic thought have
called Gesell a ‘typical monetary crank’ (Garvy, 1975, p. 392). Recently, however, Japan’s
experience of persistent deflationary pressure and economic stagnation, instigated a handful
of scholars to re-examine Gesell’s idea of taxing money as a means of overcoming the zero
bound on interest rates. While these authors have made repeated references to Gesell as the
first proponent of negative interest rates, they pay little attention to his economic theory.
Consequently, this literature examined the benefits of negative interest rates in Walrasian
dynamic stochastic general equilibrium (DSGE) models, in which money is not necessary for
the efficient allocation of resources.
Hence, in the policy debate, only models where money has no allocative effect and is thus
neutral were used to justify the call for negative interest rates. In fact, most of their advocates
had overlooked that there is another class of models that considers a tax on money as
efficiency enhancing. The common feature of these monetary search models, which build on
the seminal work of Kiyotaki and Wright (1991, 1993), is that they set up an environment
where money eases bilateral trade by eliminating the need for a double coincidence of wants.
Hence, money plays an essential role in the sense that some of the allocations achievable in a
monetary equilibrium cannot be achieved in a barter economy, and therefore the use of
money increases welfare. Nevertheless, monetary economies can still suffer from several kinds
of inefficiencies. In early applications of search-models researchers considered a tax on money
as a ‘proxy for inflation’, and in some examples as a means to overcome inefficiencies in the
monetary exchange process. These authors were seemingly unaware of Gesell and the zero
bound and did not have in mind negative interest rates as an additional policy tool as in the
current debate. Modelling advances made the ‘proxy for inflation’ role of money taxes
obsolete, since the effects of inflation could now be studied directly. Since a tax on money had
not been not recognized as a policy instrument itself, its efficiency enhancing role has not been
studied further in modern search models.
4
4
In a companion paper (Menner, 2010), one of us takes a new hold on the efficiency properties of a tax on money
in a last-generation search-model, as well as on its effectiveness to foster output and employment in a recession
scenario, and on its role to achieve negative nominal interest rates.
4
Thus, the aim of this paper is to give a concise review of the various strands of the
literature dealing with negative interest rates from past to present. We show that, besides its
anarchistic origins, there are two orthodox strands of research that show the potentially
beneficial effects of negative interest rates, but have so far been unconnected in the literature.
By highlighting the diverse origins of the proposal, we hope to convey the message that
negative interest rates are not the ‘idée fixe’ of a monetary crank, but a serious policy proposal
and that the issue should be further examined.
The remainder of this article proceeds as follows. Section two depicts the historical origins
of negative interest rates and their reception up until the end of the 20th century. Section three
reviews the existing literature on the negative interest rates as a means for removing the zero
bound. Section four elaborates on the so far overlooked efficiency enhancing property of
negative interest rates in monetary search-models and connects the two existing modern
strands of the literature. The last section examines the practical implications of taxing money
and concludes.
Silvio Gesell and free money
It is commonly recognized that the idea of a tax on money was first proposed by Silivo
Gesell, a successful businessman, autodidactic economist, and prominent social reformer. He
proposed a libertarian economic theory and political economy that aimed at creating a truly
competitive market that would ensure the just distribution of income. Thus, he strongly
refuted the Marxist economic theory and their proposed solution of collective property as ‘the
death of personal freedom’ (Gesell, 1958, p. 15), embracing the ‘Manchester System’ as the
natural economic order he aimed to create, in which everyone would be remunerated with the
full proceeds of his own labour (Gesell, 1958, pp. 11-12). Gesell’s followers claim that he laid
the foundations of a libertarian anarchist economic theory, which went beyond Marx’s call for
collective property (Bartsch, 1989, pp. 29-31), and constitutes an independent ‘third way’ (Flik,
2004, p. 124) for reconciling socialism with economic and personal freedom, ‘an alternative
beyond hitherto realized economic systems’ (Onken, 2000, p. 614). In addition, Gesell
developed a rather colourful social utopia which combined Darwinian elements with the
philosophies of Nietzsche and Stirner.
5
This mingling of economic theory, political ideas and
social utopia made his reputation as an ‘anarchist prince’ (Preparata, 2002, p. 218).
5
For a concise introduction to Gesell’s utopia of an ‘akratic’ society see Bartsch (1989, pp. 24-31).
5
Gesell begun his autodidactic reflections on the monetary system instigated by the on-
going economic and social crisis in 19th century Argentina, where he had opened his own
business after his emigration in 1887.
6
In his debut treatise, Die Reformation im Münzwesen als
Brücke zum Sozialen Staat, Gesell (1891, pp. 51-55) presents his main concept of negative
interest rates on ready money, which he later named Freigeld (free money). Concerning the
practical implementation of negative interest rates, Gesell advocated that in order to remain
legal tender, a stamp worth a thousandth of the note’s face value had to be attached to it once
a week, amounting to an annual depreciation rate of approximately 5 % (Gesell, 1958, pp. 266-
276). It is this proposal of taxing money that is commonly referred to by authors working on
the subject as Gesell’s main contribution to economic theory.
However, Gesell not only invented the instrument, in his main work, The Natural Economic
Order (Gesell, 1958), he also offers an economic theory that justifies and explains his call for
taxing money. In fact, some scholars of the history of economic thought have argued that
Gesell importance for economic thinking is not to be found in his invention of the policy
instrument, but rather in his radical theory of interest which appears as a direct predecessor to
Keynes’s deliberations on interest as a monetary phenomenon. In his doctoral dissertation in
1940 and two subsequent articles in 1942, Dudley Dillard was the first economist to
demonstrate the close kinship between the monetary theories of the famous French anarchist
Proudhon, Gesell, and Keynes,
7
and this conclusion was independently upheld by various other
authors working on the subject.
8
The striking theoretical similarities are further evidence in
support of the Post Keynesian claim that the General Theory’s main theoretical innovation – a
monetary theory of interest – has been completely ignored by mainstream economists
(Ilgmann, 2009).
9
6
See Werner (1990) and Onken (1999) for overviews on Silvio Gesell’ life and work. Ilgmann (2009) offers a short
discussion on Gesell’s place in the History of Thought.
7
Dullard established striking theoretical similarities between Keynes, Gesell and the Proudhon (Dillard, 1942b, pp.
75-76), with Gesell ‘primarily interesting as the link between the other two’ (Dillard, *1940+ 1997, p. 6). In a further
article on Keynes’ political economy, Dillard (1946, p. 149) argued that ‘Keynes’ judgement of the relative merits of
Marx and Gesell, *...+, would seem to reveal much more about Keynes than it does about either Marx or Gesell’ and
in his book on Keynes, Dillard (1948, pp. 322-323) maintained that studying Gesell indeed furthers the
understanding of Keynes’s theoretical innovations.
8
See also Michael Herland (1977) and Jérôme Blanc (1998; 2002). The most radical view is put forward by Guido
Preparata (2002) who accuses Keynes of plagiarism of Gesell’s idea of a monetary rate of interest. Darity (1995)
comments on the similarities in their political economy.
9
This interpretation of the General Theory is suggested in Ilgmann (2009) and is akin with the Post Keynesian
interpretation. It is supported by various statements made in defense of the General Theory, e. g. Keynes (1937a, p.
216): ‘The rate of interest obviously measures *...+ the premium which has to be offered to induce people to hold
their wealth in some other form than hoarded money.’ He also defended his view in an article in The Economic
Journal where he stated ‘*…+ the rate of interest is that rate at which the demand and supply of liquid resources are
balanced. Saving does not come into the picture at all (Keynes, 1937b, p. 668). Keynes (& Robertson, 1938, pp. 318-
319): ‘Now that we have got away from the idea of the rate of interest being depended on saving and have reached
6
A complete analysis of Gesell’s theory is beyond the scope of this article; nevertheless
because Gesell’s economic theory has rarely been discussed in the literature, in the following
we will attempt a brief sketch of his reasoning.
10
Gesell’s starting point is that holding money
does not involve carrying charges. Goods on the other hand are subject to natural decay and
thus holding them incurs considerable costs. Therefore, money holders may withhold their
money from circulation while those possessing goods, producers and merchants, cannot.
Gesell now assumes that this difference in the quality between money and goods leads to
strategic behaviour on the part of the money holders. They might withhold from buying, thus
leaving the suppliers of goods with the losses caused by natural decay. Therefore the latter are
willing to pay a ‘bribe’ (in Gesell’s terminology) to the money holders in order to avoid the
depreciation on their goods and products. This is the source of ‘basic’ interested, unearned
income due to the different physical properties of money and goods.
11
This is the kernel of his
theory: interest as a pure monetary phenomenon due to its negligible carrying charges.
Moreover, this micro analysis holds serious implications for Gesell’s macro model, which is
founded on the Quantity Theory. According to Gesell, production, which is constant in the
short run, determines aggregate supply, while the amount of money divided by the price level
times velocity of circulation constitutes aggregate demand. Thus, supply is given by exogenous,
in the short run constant factors, while the velocity of circulation depends on the strategic
behaviour of the money holders. They will only bring their money into circulation if they
receive a profit margin – basic interest. Therefore, while aggregate supply is determined by the
stock of goods, aggregate demand is subject to fluctuations and may therefore differ from
supply. Gesell thus rejects Say’s law that each supply creates its own demand (see also Dillard,
*1940+ 1997, p. 161). Consequently, in Gesell’s model, aggregate supply and demand are only
in equilibrium, if the supply side is able to generate a profit margin above the production costs
that allows them to pay basic interest.
the idea of its being in some sense a monetary phenomenon, the remaining difference of opinion cannot be
fundamental and agreement should be within reach.’ Several Post Keynesian authors have underlined their
interpretation of Keynes by referring to Keynes’ praise for Gesell. See, for example, Argitis (2008, pp. 251-253),
Davidson (2000, p. 49), and Cowen and Krozner (1994, pp. 387-388).
10
The following paragraph draws on the interpretation of Gesell and Keynes’ embracing comments as suggested by
Ilgmann (2009).
11
Gesell assumed that ‘basic’ interest had been between four and five percent throughout the ages, denying that
the competition between money lenders would drive the rate of interest down. The only limits to the monetary
determined rate of interest were the amount of money that needed to circulate for the essential needs of everyday
life, such as food, as well the competition of barter once money interest rates become prohibitively high. It must be
noted, however, that Gesell acknowledged that interest rates contain risk and inflation premiums (Gesell, 1958, pp.
431-436), but he maintained that these would only be slightly above zero after the introduction of negative interest
rates. Risk premium, understood as the marginal costs of lending, will be low, because most savers will invest their
money in life insurance, which, in turn, will invest in real assets that act as securities (Gesell, 1958, pp. 407-408).
7
This reasoning of Gesell is somewhat confusing to a modern economist. Basically, he
assumes that basic interest is added to the production costs of a product, which corresponds
to the cost of capital in modern accounting. However, he argues that real capital only offers a
positive yield because it is scarce and it is kept scare because of the existence of basic interest.
Because the productivity of real capital must equal at the margin the monetary rate of
interest, the capital stock, which would normally expand until the marginal efficiency of real
capital would become zero, falls always short of demand because any growth that would push
down capital’s marginal efficiency below the monetarily determined basic rate is impossible.
This inclusion of capital costs in the production costs of goods is what he assumes to be the
‘transfer of basic interest to the wares’ (Gesell, 1958, pp. 387-389).
Based on these insights, Gesell explained the occurrence of economic crises.
12
Effective
demand as determined by money supply is only available in the absence of deflation and
deflationary expectations respectively.
13
As the capital stock, including the amount of
commodities, rises, prices begin to fall, lowering marginal capital productivity and, because
deflation raises the real interest earned on money, while lowering it on real capital assets,
disinvestment takes place, reducing general output. Moreover, in such a situation people will
find it increasingly difficult to service their liabilities. This notion is nothing less than a
description of a deflationary spiral in the spirit of Irving Fisher, in which, once deflation sets in,
effective demand decreases, which in turn further depresses prices. If the monetary
authorities now increase the amount of money in order to increase demand and to offset
deflation, the additional money will simply be hoarded.
14
The system will only be restored to
equilibrium when capital endowment and hence output have fallen to such an extent that the
marginal productivity of capital equals once again basic interest.
Given this analysis, Gesell’s cure for economic crises is therefore to subject money to
natural decay via taxation, thereby restoring the validity of the Quantity Theory and Say’s Law.
With depreciative fiat currency, money involves carrying charges, and those possessing it are
no longer able to hoard, which in turn would render the velocity of circulation and effective
demand constant. This enables the authorities to ensure price stability by steering the amount
12
As (Dillard, *1940+ 1997, p. 171) pointed out, Gesell ‘offers no separate theory of crisis’. Rather, he explains
disequilibria through the nature of interest.
13
‘When confidence exists, there is money in the market; when confidence is wanting, money withdraws – such is
the teaching of experience’ (Gesell, 1958, p. 260).
14
‘Supply therefore becomes larger and more urgent, because demand hesitates, and demand hesitates simply
because supply is too large in proportion to demand’ (Gesell, 1958, p. 232). ‘This therefore, is the law of demand,
that it disappears when it becomes insufficient’ (Gesell, 1958, p. 235 *bold type in the original+).
8
of money in circulation by means of an independent monetary policy
15
. In addition, interest
and the power of the rentier would disappear while the capital stock would expand until its
marginal efficiency is zero, raising output and employment. This is – in a nutshell – the essence
of Gesell economic theory, which constitutes the foundation of an independent anarchist
economic theory (Bartsch, 1989, pp. 20-30).
Given the seemingly simple solution offered by Gesell, it is no wonder that his proposal of
taxing money has received recognition mainly in times of crisis, probably most prominently
during the interwar period,
16
when Gesell briefly became the Minister of Finance in the
Bavarian Soviet Republic. During the same period, his policy proposal and theoretical
reasoning was also taken up by Irving Fischer (1933) and J. M. Keynes (1936). Fisher on the one
hand promoted negative interest rates in his book on stamp scrip, but remained overly
sceptical of Gesell’s theory: ‘There is much in Gesell's philosophy to which, as an economist, I
cannot subscribe, especially his theory of interest; but Stamp Scrip, I believe, can, in the
present emergency, be made at least as useful an invention as Manuel Garcia's [a singer]
laryngoscope’ (Fisher, 1933, pp. 17 *our emphasis+).
During the Great Depression, Fisher was labelled ‘the patron saint of the stamp scrip
movement’ in the United States by one commentator (Reeve, 1943, 165) and his assistant,
Hans R. L. Cohrssen, a committed free-economist, counted approximately 450 U.S.
municipalities that wanted to issue stamp script. Moreover, in 1932 there was a short-lived
legislative initiative (Bankhead-Pettengill Bill) which asked for the creation of one billion
Dollars of stamp script in order to finance labour intensive public works. For the same reason,
the state of Oregon planned to issue 80 million Dollars in stamp script in 1933, but the plan
was stopped by the Treasury, who was willing to accept stamp script on a local level, but did
not endorse general monetary reform (Cohrssen, 1991, p. 5; see also Gatch, 2006, p. 19).
Moreover, most local currencies were designed as ‘self-liquidating’, meaning that a note was
meant to circulate until it accumulated sufficient stamps to redeem the note at face value
against dollars. Therefore, the bills were stamped per transaction and not per period of time,
as Gesell and Fisher had suggested which amounted to an additional sales tax. Worse, in order
to increase its acceptance, sponsors of the plan pledged to deposit an equivalent amount of
15
Gesell's matter of concern was the achievement of price stability in an environment where money keeps
circulating steadily and interest rates are low. His periodic tax on money was meant to disincentivate the hoarding
of money without recurring to high interest rates or positive inflation rates. Therefore, it is not comprehensible that
Gesell was labelled an ‘inflationist’ by Ludwig von Mises (1952), F.A. Hayek (1976) and other Austrian economists.
16
Gesell was comparatively well-known pre-World War II, as is shown by Dillard’s (1942a, p. 348) list of works
referring to Gesell and by his appearance in the Encyclopedia of the Social Sciences (Garvy, 1975, p. 392).
9
Dollars in escrow in order to ensure redemption, a measure practically nullifying the inflating
effect of the additional currency. Thus, the majority of local currencies during the Great
Depression neither served Fisher’s or Gesell’s goals, as only a handful of municipalities
introduced time based script (Gatch, 2006, pp. 27-29; see also Warner, 2010)
Keynes (1936, p. 353) on the other hand praised Gesell’s ‘flashes of deep insight’ because
he defined interest as ‘being in some sense a monetary phenomenon’ Keynes (& Robertson,
1938, pp. 318-319) caused by money’s superior liquidity premium, but dismissed negative
interest as ‘not feasible in the form in which he [Gesell] proposed it‘ (Keynes, 1936, pp. 356-
357). Followers of Gesell have typically taken this as an implicit acceptance of the latter
theoretical stance and tend to ignore that Keynes (1936, p. 356) also stated that ‘there is a
great defect in Gesell’s theory’ because ‘the notion of liquidity-preference had escaped him’.
Indeed, Keynes called Gesell’s theory only ‘half a theory of interest’ (Keynes, 1936, p. 356)
because in his opinion Gesell failed to understand the role of uncertainty in determining
liquidity preference and hence the rate of interest. Nevertheless, these embracing remarks
shed new light on the extent of Keynes’ attack on the classics, which he accused of having
failed to develop an adequate theory of interest.
17
Keynes thus did not embrace negative
interest as such, but the underlying idea of interest as a monetary phenomenon (Ilgmann,
2009). Indeed, Pigou (1936, p. 124) saw the implication of Keynes appraisal of Gesell clearly:
‘For example, on p. 355, he seems to agree with Gesell that "the rate of interest is a purely
monetary phenomenon." If this were in fact his view, Mr. Keynes' divorce from classical
thought would be complete.’
Summing up the afore said, Gesell theory rest entirely on the different carrying charges of
money and goods and from today’s perspective appears rather naive. It seems rather unlikely
that taxing money would cure the ills of modern day capitalism as his supporters claim.
Nevertheless, in retrospect Gesell has remarkable achievements as an autodidactic scholar. He
advocated modern fiat money, even before World War One, at a time when the ‘golden
fetters’ were firmly in place and his idea of price stability as the sole target of monetary policy
is not far away from what most central banks nowadays strive for (Huth 2005). Moreover, he
advanced the notion of interest as a purely monetary phenomenon even before Keynes, a
remarkable deed that is often obscured by the fact that the extent of Keynes’ attack on his
‘fellow economists’ has largely been underestimated. Finally, as Irving Fisher said, he invented
17
‘Now I range myself with the heretics. I believe their flair and their instinct move them towards the right
conclusion. *….+ There is, I am convinced, a fatal flaw in that part of orthodox reasoning *…+ due to the failure of the
classical doctrine to develop a satisfactory and realistic theory of interest’ (Keynes, 1935, p. 36).
10
an instrument, albeit by accident, that could prove to be a valuable additional monetary policy
tool.
Removing the zero bound
Whatever the merits of Gesell as economist are, during the period of relative stability
following the Second World War, his idea of negative nominal interest rates was quickly
forgotten. Interest in Gesell’s proposal was only renewed through the Japanese experience
when the country faced a liquidity trap like situation during the 1990s, which rendered
monetary policy useless in fighting deflation and recession.
18
For this to happen, the existence
of a lower (zero)
19
bound is a necessary condition (Ewans, Guse & Honkapohja, 2007, p. 1438)
and since then, the implications of the zero bound and possible remedies were discussed yet
again (see Buiter, 2005b, Yates, 2004, and Ullersma, 2002, for reviews on the relevant
literature). However, before the outbreak of the financial crisis, the case of Japan remained
somewhat a curiosum since the majority of developed countries enjoyed a period of stable
growth in the last twenty years,
20
and previous to the current crisis, the risk of hitting the zero
floor to rates was considered to be very small, with the case of Japan being looked at as a rare
exception (Yates, 2004, p. 428; Ullersma, 2002, p. 293).
21
Thus, it is safe to say the zero lower bound was considered a ‘ghost’ from the past (Buiter,
2005b) in mainstream economics, in particular in the light of high inflation rates in the 1970s
and 1980s (Ullersma, 2002, pp. 273-277). Some authors nevertheless took up Gesell’s proposal
of a tax on money as a means of overcoming the zero bound on interest rates, as for example,
in Goodfriend (2000), Buiter and Panigirtzoglou (1999; 2003), Fukao (2005) and Buiter
(2005a,b; 2007; 2010). It was only the current crisis with central bank rates close to zero and
18
Krugman (1998), in his seminal work, argued that Japan faced a liquidity trap like situation at that time. We use
the term in the sense of Krugman (1998, p. 137), who defines it as ‘that awkward condition in which monetary
policy loses its grip because the nominal interest rate is essentially zero, in which the quantity of money becomes
irrelevant because money and bonds are essentially perfect substitutes’. A deflationary spiral is described as a
situation, ‘where inflation and expected inflation fall, nominal interest rates at some point come up against the zero
bound, real interest rates rise, aggregate demand and expected inflation fall even further, real rates rise by yet
more, and so on’ (Yates, 2004, p. 427).
19
Benhabib et al. (2000b, pp. 26-27) have rightfully pointed out that for a liquidity trap to persist, the existence of
some lower bound is a sufficient condition, given that the central bank conducts a Taylor-type monetary policy.
20
‘One of the most striking features of the economic landscape over the past twenty years or so has been a
substantial decline in macroeconomic volatility. [....] Similar declines in the volatility of output and inflation
occurred at about the same time in other major industrial countries, with the recent exception of Japan, a country
that has faced a distinctive set of economic problems in the past decade’ (Bernanke, 2004).
21
Some authors even questioned whether liquidity traps had developed at all during the Great Depression (Bordo
& Filardo, 2005, p. 817), although the latter is widely held as the textbook case (Ullersma, 2002, p. 276).
11
stagnating growth rates in many (western) economies which raised the awareness of a wider
audience for the possibility of negative interest rates.
22
The problem
The zero bound argument refers to the implicit zero interest on coin and currency as a risk
free instrument which forms the larger part of the monetary base, the remainder being
commercial bank reserves with the central bank. Since base money constitutes the most liquid
form of assets, a rational economic agent will not hold any other type of asset unless it earns a
higher return than base money (Buiter and Panigirtzoglou, 2003, p. 727). As long as the two
components of the monetary base are perfect substitutes concerning the provision of liquidity,
any deviation of their interest rates would cause the demand for the other to become infinite.
Thus, any attempt to levy negative interest rates must necessarily involve the whole monetary
base.
The zero bound exists because coins and currencies are bearer instruments as opposed to
registered instruments such as bank accounts (Buiter, 2010, p. 214). In fact, levying a tax on
commercial bank reserves and any form of registered account in order to make implicit
interest on these assets negative would be as trivial as collecting positive interest (Buiter &
Panigirtzoglou, 2003, p. 730). However, this cannot be done with coins and bank notes,
because these are anonymous bearer bonds and their transfer is not registered but by
delivery. Inducing the anonymous holders of coins and bills to pay the interest due is rather
difficult since they lack the incentive to do so. Given the existence of coin and currency with a
zero nominal interest rate, any attempt to levy negative interest on registered accounts above
the carry and storage costs of currency would cause substitution of the former by the latter.
Therefore, given the current form of paper money, the zero bound sets a limit to the
domain over which the nominal interest rate can be set. This in turn sets a floor to market
rates at the zero nominal interest rates of coin and currency. However, in reality this floor to
market rates is a lot higher since the latter contain risk premium and administrative costs.
23
Once base rates are close to zero, conventional monetary policy is ineffective for reducing
market interest rates any further. If one seeks to fully remove the zero bound, levying negative
interest rates on the whole monetary base becomes inevitable, and because bank notes are
22
At the time of writing (October 2010) the Federal Funds target rate is still between 0 and 0.25 per cent, the Bank
of Japans target rate is at 0.1 per cent, the Bank of England’s Rate is 0.5 per cent and the ECB main refinancing
operation is 1 per cent.
23
van Suntum et al. (2010) propose long-term central bank lending as way for reducing the floor to market rates
against zero.
12
bearer bonds with anonymous owners, paying the interest due would have to take place on
the bills themselves.
The Proposals
Scholars have come up with various schemes for removing the zero bound via negative
interest rates. Buiter (2010) proposes three different methods for removing the zero bound.
One very interesting proposal is separating the means of payment function of currency and its
unit of account role, was already suggested by Einaudi (1953) and Gaitskell (1969). Buiter
(2005a) refers to Eisler (1932), who distinguished between the function as “unit of account” on
the one hand and as a “medium of exchange” as well as “store of value” on the other hand.
Eisler himself was rather not concerned about the implications of the zero bound, but his
motivation was to shield the economy from the negative effects of inflation. Nevertheless, in
the recent literature Eisler’s proposal is taken up as a method for removing the zero bound by
separating the means of payment function of currency and its unit of account role (Boyle,
2002, Davies, 2004, and Buiter, 2005a; 2010).
According to Buiter’s (2005a; 2010) scheme, the existing currency is withdrawn and
replaced by a new government-issued currency. This new currency only serves as legal tender
and cannot be used to denominate prices of commodities and hence all prices, wages and
contracts are denominated in a different unit of account. Since there are no coins or notes of
the currency that serves as the unit of account, the monetary authorities may set a negative
rate of interest on all registered accounts in the manner described above. In order to avoid a
flight into the legal tender, it is constantly depreciated against the currency which serves as a
unit of account. Covered interest parity demands that the rate of depreciation of the legal
tender must equal the negative interest rate on the unit of account (Buiter, 2010, p. 230).
Thus, the whole monetary base is subject to negative interest rates, although the nominal
interest rates on coins and bank notes respectively remain zero. Indeed, Eisler-like schemes
have been adopted in Latin America to fight inflation, most notably in Chile, but so far have not
been used as a method for removing the zero bound.
Nonetheless, the most commonly thought method for removing the zero bound is taxing
money. To begin with, the easiest way to implement such a scheme was to abolish coin and
bank notes altogether. Buiter (2010, pp. 222-226) considers coins and bank notes to be
redundant media of exchange, the larger part of it being held abroad for legitimate (store of
value in countries with high inflation rates) and illegitimate (underground economy) reasons.
In developed countries, its function of providing liquidity could easily be satisfied by bank
13
accounts. Roughly half of Dollar and Euro notes are held abroad and of the remainder only a
small fraction is held for transaction purposes.
24
As stated above, without coins and currency,
levying the tax on all non-bearer bonds is technically simple. . . If coins and currency are
completely replaced by electronic transfers via registered accounts, in theory there is no limit
to the domain over which the rate of interest can be set. In addition, there would be the
additional advantage of hitting the underground economy as the absence of anonymous
bearer bonds would make all economic transactions traceable.
Although abolishing coins and currency offers a seemingly simple solution to the zero
bound and Buiter’s argument about the redundancy of coins and notes is not easily refuted,
there are various problems associated with this scheme. Buiter (2010, pp. 223-224) states the
usefulness of currency as a means for payment and store of value for low-income households
is a standard argument for keeping coins and currency. However, given that the majority of
currency by value is held in large denominations which are hardly used for transaction
purposes, he believes that the real reason behind the continued existence is the substantial
seigniorage through the issuance of non-interest bearing and non-redeemable legal tender.
We believe that there are more good reasons for keeping coins and currency. First, having a
redundant system of payment besides complex electronic devices might be an additional
backup in case that the sophisticated electronic system fails. Indeed, blackouts and computer
bugs have in the past disturbed electronic payment systems and with cyber warfare becoming
increasingly sophisticated, having a redundant medium of exchange might even become a
question of national security. Second, with all transactions being done by registered accounts,
all economic activity of the population becomes traceable. While this has potential benefits
concerning the fight on crime, it will also raise the question of potential abuse and hence of
adequate data protection. Finally, there is also a psychological factor, because people might
not accept non-physical money, in particular in times of a crisis.
Thus, if one wishes to keep coins and currency as media of exchange, negative interest
rates could never exceed the (storage) carrying charges of ready money; otherwise the
demand for the latter would become indefinite. In the case of a sharp deflation, it might be
insufficient to lower real interest only by the margin given by the carrying costs (Buiter, 2005b,
p. 14). Therefore, if one seeks to fully remove the zero bound, taxing non-electronic money is
inevitable. Because bank notes are bearer bonds with anonymous owners, taxing would have
to take place on the bills themselves (Goodfriend, 2000, p. 1015, deems taxing coins to be
24
Buiter (2010, p. 223) concludes therefore that ‘the only domestic beneficiaries from the existence of anonymity-
providing currency are the underground economy’.
14
unnecessary, since storing great quantities of small change would incur high costs). As we
discussed above, Gesell advocated stamping ready money as a practical means of removing
the zero bound. With modern technology, using stamps could be replaced by electronic
devices (Goodfriend, 2000, pp. 1016-1017). With both components of the monetary base
subject to this tax, simple arbitrage would ensure that all other components of the money
supply will also yield negative nominal interest.
Model based evaluation
The modern treatment of negative nominal interest rates has not made halt at the verbal
analysis of the zero bound problem and proposals how to overcome it, but constructed
technical models to assess the effectiveness of negative interest rates to escape from liquidity
traps. Buiter and Panigirtzoglou (1999) build a continuous time representative agent model
where money is held despite of the existence of riskless bonds with positive yields because
money holdings generate direct utility. They consider two versions: In the flexible price version
of this Money-in-the-Utility-Function (MIU) model the Pareto-efficient monetary policy is the
so-called Friedman rule where agents are satiated with money and the interest rate on bonds
equals the interest on currency, i=iM. In the absence of policy measures to overcome the zero-
bound on nominal interest rates this interest rate of currency, iM, is zero, the Pareto-efficient
equilibrium coincides with the liquidity trap equilibrium. The only problem with the liquidity
trap is that the lower bound on interest rates might prevent the economy to achieve the
inflation target. By setting the interest rate on currency sufficiently negative, however, any
inflation target can be achieved.
The more interesting case is the Keynesian version, where output is demand-determined
and inflation adjusts to the gap between actual and potential output through an
accelerationist Phillips curve. The dynamics of the economic system are determined by a
system of 2 first-order differential equation in inflation and consumption, the latter one
switching when the interest rate reaches its lower bound. The 2-dimensional phase diagram
shows a saddle-point stable steady-state in the non-binding “normal” case (i> iM ) and a centre
surrounded by closed integral curves in the binding “liquidity trap” case (i=iM). The authors
then show that there exists demand or supply shocks that can lead the economy from the
“normal” saddle-point steady state to the liquidity trap equilibrium. A negative interest rate on
currency shifts the liquidity trap steady state and the boundary between the two regimes to
the left such that an economy caught in the liquidity trap can escape to the normal regime
with sufficiently negative interest rates on currency. Moreover, since negative interest rates on
15
currency widen the distance between the two steady states the likelihood to end up in a
liquidity trap is reduced as well.
These findings are upheld by Buiter and Panigirtzoglou (2003) and Buiter (2010) in New-
Keynesian discrete time MIU models with price setting a la Calvo-Woodford (Calvo, 1983;
Woodford, 2003) and forward looking Phillips-Curves. Buiter and Panigirtzoglou (2003) study
the effects of a Gesell tax in the model of Benhabib et al. (2001). In that framework the lower
bound on nominal interest rates becomes binding under sufficiently large negative shocks and
the economy enters a liquidity trap and can end in a deflationary spiral. Buiter and
Panigirtzoglou (2003) then show that the liquidity trap region can be completely eliminated by
setting the Gesell tax such that the interest rate on currency iM keeps a constant distance d to
the short-term interest rate i on non-monetary assets, that means iM = i –d, where d≥0, and i is
determined by the Taylor rule. They also note that setting d to zero would correspond to the
Friedman rule, that aims at eliminating the opportunity cost of holding money, and that this
policy would still eliminate the liquidity trap. The same holds true in the model of Buiter
(2010), where the author stresses that a Gesell tax would allow the authorities to target true
price stability (zero inflation) without fear of hitting the lower bound on interest rates.
The common feature of these model based studies of the Gesell tax and negative interest
rates is the focus on overcoming the zero bound and the corresponding liquidity trap and –
apart from the ad-hoc model of Buiter and Panigirtzoglou (1999) - the use of Walrasian DSGE
models. However, in all of these models, money has no essential role and is held only because
it enters the utility function directly. Hence, these studies do not address important issues like
the effects of Gesell taxes on efficiency of exchange or on the velocity of money. Moreover, as
has been stated by Wallace (1998) the Friedman rule is efficient in all models where money is
not essential, but there exist many models where money is essential and the Friedman rule
ceases to be optimal. .This leads us to con-sider the efficiency effects of Gesell taxes in a model
class with essential money in more detail.
Efficiency of monetary exchange
Independently of Gesell’s ideas and the debate on the zero bound, a tax on money
appeared in the literature on search-theoretic models of money. First, it was meant to be a
proxy for inflation in first-generation search models that could not study the effects of money
growth and inflation directly. Second, it was found that there was an efficiency enhancing role
of these money taxes in models where the endogenous choice of search-intensity leads to an
16
inefficient size of the ‘market’ due to externalities in the search for trading partners. When
modelling advancements made the proxy role of money taxes obsolete, since inflation could
now be studied directly, the efficiency enhancing role was attributed only to inflation, and the
policy tool money taxes was not recognized as such. Since the reader is probably not very
familiar with the search-theoretic literature
25
, we expose in the following the main deviations
from the Walrasian paradigm and review the discussions and results with respect to taxes on
money in the different generations of search models.
Monetary search models starting with Kiyotaki and Wright (1989, 1993) replace the
centralized Walrasian goods market by decentralized bilateral exchange of differentiated
goods among agents with heterogeneous tastes over these goods. In this environment money
can ease bilateral trade by overcoming the problem of an `absence of double coincidence of
wants'. Without money, the producer of say good A that likes good B would have to find a
producer of good B that likes good A – a difficult task when there is a large number of different
goods in the economy. A money holder, on the contrary, has just to search for a producer of
the desired good that accepts money. The latter will only do so if he expects others to accept
money in the future (in exchange for their products). Thus, if money is accepted across
economy as the medium exchange, the resulting monetary equilibrium is characterized by a
higher amount of transactions. Hence, money plays an essential role in the sense that some of
the allocations achievable in a monetary equilibrium cannot be achieved in an equilibrium
without money.
26
In terms of efficiency monetary equilibria improve on barter equilibria.
The literature distinguishes now three generations of search models of money, each of
them dealing in a different way with the high degree of heterogeneity of agents that arises
through the pairwise exchange of goods which is generating non-degenerate distributions of
goods inventories and money holdings.
27
The early search literature assumed indivisible money
and indivisible goods such that an agent could hold only 1 unit of money or 1 unit of goods and
trade took place at a constant price 1. This simplified the analysis since the distribution of
money was degenerate, each agent carrying either 0 or 1 units of money. A second generation
of models based on Shi (1995) and Trejos and Wright (1995) kept the simplifying assumption of
25
See for example Rupert et al. (2000, chapter 4) and Shi (2006) for an extensive overview over the literature
based on the search-theoretic approach.
26
Kocherlakota (1998) establishes that necessary conditions for the essentiality of money are the lack of complete
memory and of full commitment to future actions. The latter follows from the usual assumption of random-
matching and rules out the use of credit, while the former inhibits the use of punishments to trigger gift-giving
equilibria. See also Corbae, et.al. (2002) for models with directed search where money remains essential as long as
agents are restricted to one bilateral trade per period.
27
The use of simulation methods to keep track of these distributions is very cumbersome. See Molico (2006) and
Molico and Zhang (2006).
17
indivisible money holdings, but endogenized prices by allowing for divisible quantities of
goods. Prices are determined in each match through Nash-Bargaining over the quantity of
goods to be exchanged for one unit of money. Third generation search models abolish the
restrictive assumption of indivisible money and allow therefore to study directly positive
money growth and inflation. There are basically two competing approaches: the first one to
appear was the representative agent formulation in Shi (1997, 1998, 1999), who assumes that
the decision making unit - the household - is itself a continuum of agents and, hence,
idiosyncratic risk is fully insured. In a symmetric equilibrium each household ends up with the
same money and inventory holdings, capital stock and the same number of hired workers as
the average firm. The alternative approach elaborates on models of alternating decentralized
and centralized markets following Lagos and Wright (2005) and Arouba et al. (2006).
An interesting feature of these search models is that the exchange process can be
inefficiently low because of too little search effort of buyers. In the following we review the
literature on the effects of a tax on money on search-intensity or the number of buyers in the
market and hence on aggregate transactions, consumption and output in first and second
generation search models. Finally, we summarize the results of a recent study of the macro-
economic effects of money taxes in a full-fledged business cycle model with capital formation.
First generation search models with endogenous search intensity
Li (1995) was the first to point out the externalities that can arise with endogenous search
effort of buyers: Since search is costly, buyers compare their search costs with the private
gains from search, rather than considering the social gains and costs of a higher search
intensity. In sufficiently productive economies, there is a search externality that leads to a
lower aggregate number of transactions relative to the social optimum. The author then
proposes a tax on money to deal with this inefficiency. The welfare improving role for policies
which tax money balances 'emanates directly from the ability of such policies to increase
search efforts and the aggregate rate of transactions. That is, the search externality provides a
role for government in subsidizing search activity through taxing ‘nonsearch’', (Li (1995, p.
938)). This resembles Gesell's idea of taxing the hoarding of money to provide incentives for
the spending or lending of money balances.
28
Li (1995) derives the welfare improving role of
taxing money holdings in a first generation search model of money where goods and money
28
Most monetary search models deal only with the spending aspect and do not treat the possibility of lending idle
balances.
18
balances are indivisible.
29
The tax on money is modelled as a random expropriation of a unit of
money.
30
It is then also interpreted as a ‘proxy for inflation’, which is generally thought to have
the same consequences as the money tax in this model: increase in the cost of holding money,
crowding out of real commodities through seigniorage revenue and reduction of real money
balances. Finally, the author conjectures the optimality of inflation in more general models
that would allow for positive money growth rates. In a follow-up paper Li (1996) examines the
efficiency properties of money taxes in an extension of the model that allows for the storage
of unsold goods inventories and finds similar results.
Second Generation Search Models with Bargaining over Prices
The modelling advance through the introduction of bargaining over quantities allowed
researchers to study prices, but since it was still impossible to study positive money growth in
these models issues like inflation and money taxes did not play a role. A recent exception is the
treatment of a second generation search model in the paper of Liu, Wang and Wright (2008)
that reviews in a similar way as the present chapter the first and second generation search
models, but with respect to the effect of inflation on search-intensity.
31
Since the model with
bargaining has either no monetary equilibrium or generically a pair of equilibria – one with low
prices and another with high prices – the result that money taxes can increase search-
intensity, velocity and sales depends on the type of the equilibrium and on parameter values.
One can still find efficiency increasing effects of money taxes in some but not in all equilibria.
Notably, in their treatment there is no mentioning of the tax on money as a policy proposal on
its own or to engineer negative interest rates. Instead, they discuss money taxes only as a
proxy for inflation.
Third Generation Search Models with divisible money
When extending their analysis to a third generation search model in the tradition of Lagos
and Wright (2005), Liu et al. (2008) focus only on the effects of inflation, since their
environment now allows to study positive money growth rates directly. Therefore, it is no
exaggeration to claim that the two different literatures on money taxes – (1) as a proxy for
inflation and a means to overcome inefficiencies in the monetary exchange process and (2) the
Gesell tax proposal to remove the zero bound to nominal interest rates – have been totally
unconnected up to the present. A study on the effects of money taxes in a theoretical model in
29
See also Liu et al. (2008) as an excellent formal treatment of money taxes in the first generation model of Li
(1995).
30
Note the resemblance to the proposal of Mankiw (2009) to induce a carrying cost on notes through the
withdrawal of all notes of a special series or denomination.
31
Moreover, Liu et. al (2008) provide also a formal treatment of money taxes in a second generation search model.
19
the spirit of Lagos and Wright (2005) has still to be undertaken.
32
Menner (2010) studies the
long-run and short-run effects of a Gesell tax in a full-fledged monetary business cycle model
with capital accumulation that builds on Shi (1998) and was developed in Menner (2006).
Menner’s (2010) long-run analysis characterizes the dependence of the steady states of
various macroeconomic variables on the combination of money growth rates and Gesell taxes.
The main finding is, first, that at moderate levels of inflation, a Gesell tax can increase the
steady state levels output and capital and has positive effects on search-intensity,
consumption, investment and employment. Second, a monetary equilibrium with negative
interest rates can only be achieved by a positive Gesell Tax. Third, the Friedman rule, i.e. that
money growth rates should equal the discount factor, is feasible in the considered model only
if accompanied by a Gesell tax, which has to be quite heavy to achieve efficiency.
With respect to the short-run analysis, the focus is on the recovery path out of a recession
under different policy scenarios. The recession is modelled as a sequence of negative shocks to
time preference and investment efficiency that lower aggregate demand considerably, and
hence leads to drops in output and employment comparable to the last “great recession”
period in the US. The baseline scenario without policy intervention is then compared to 3
different policy scenarios: (a) a Gesell Tax of 6% (annualized) on money holdings, (b) a
monetary expansion made possible through negative interest rates implied by the application
of the Gesell Tax of scenario (a), and (c) a government spending profile that mimics the current
US stimulus program established in the American Recovery and Reinvestment Act of 2009
(ARRA)
33
. The introduction of a Gesell tax shortens the period of recovery and brings back
output and employment to its steady state level nearly as early as the extraordinarily
expensive fiscal stimulus program. It fosters private consumption and investment, while the
government spending package has negative (crowding-out) effects on private consumption
and investment. Adding a monetary expansion to the Gesell tax scenario as in scenario (b) has
dampening effects on impact on all variables, such that the recession is not that profound and
not that long-lasting, but in the medium and long run the economy follows quite closely the
economy of the pure Gesell tax scenario.
Summarizing, in the search-theoretic business cycle model of Menner (2010) that
overcomes the limitations of first and second generation search models a tax on money as
32
Note, however the various contributions to study the effects on inflation in these environments, e.g. Lagos-
Rocheteau(2005), Rocheteau-Wright (2005), Ennis (2008), Nosal (2008), Liu et. al (2008,2009).
33
This is done following Cogan et. al. (2010) who study government spending multipliers in a New-Keynesian
Macro-Model.
20
proposed initially by Gesell can have efficiency enhancing effects in the long run. Moreover,
besides allowing for negative interest rates and expansionary monetary policy in a demand
driven recession, it can have a role on its own as a policy instrument to speed up velocity and
foster aggregate demand by making people spend their money more rapidly.
Practical considerations of Taxing Money
Altering the existing monetary regime is always controversial. However, from a
historical perspective, the world’s monetary system has been changing constantly. Although
people tend to believe that the existing order is the only imaginable one, history teaches us
that the institutional design of money is subject to rapid changes, even if the underlying
purpose of facilitating exchange remains the idiosyncratic raison d'etre of money. For example,
the last one hundred years saw the widespread advent of fiat money during the First World
War, followed by a period of hyperinflation in many nations and a disastrous return to the gold
standard that contributed to the worldwide spread of the Great Depression. After the Second
World War, the Bretton Woods Dollar standard was the basis for the miraculous post war
recovery, but run into trouble at the beginning of the 1970s. In fact, our modern monetary
system of free floating fiat money is less than forty years old and is the outcome not of careful
institutional design but rather of trial and error. Moreover, China and other nations are still
pegging their currencies to the Dollar, thereby contributing to the gigantic trade imbalances of
today. Thus, today’s monetary regime is neither a natural system nor a carefully designed one.
It is rather the path dependent outcome of political and economic events, which should be
altered if the incentive to do so is compelling.
Cost and Benefits
If negative interest rates thus have a theoretical foundation beyond its anarchistic origins
and are technically feasible, this in turn raises questions about the potential costs and benefits
of such a policy scheme, because besides some local currencies, negative interests are so far
an untested policy tool, and hence it is difficult to quantify its effects. Nevertheless, in the
following we will attempt to sketch the possible implications of negative interest rates
independent of the concrete method of its implementation.
To begin with the costs of such a scheme, Yates (2004, p. 445) argues that negative interest
rates are similar to raising the inflation target, the costs being ‘the shoe-leather costs of
inflations in each case: *…+.’ This is not an argument against negative interest rates, at least in
the case of a deflationary shock. Indeed, raising expected inflation and thereby reducing real
21
interest rates is a commonly cited policy tool once the zero bound is hit. For example,
Svensson (2001) devised a ‘foolproof way for escaping the zero bound’ by devaluating the
exchange rate, thereby stimulating demand and inflation respectively. One frequently
proposed alternative to avoid a binding zero-bound of nominal interest rates would be a
higher target rate of inflation that raises nominal interest rates through the ‘Fisher effect’ of
higher expected inflation. Jung et al. (2005) have argued that central banks should raise
expected inflation by committing to a long term zero interest rate policy. However, while
Svenssons’s proposal will, in case of worldwide shock, only lead to beggar-thy-neighbour
policies, the other proposal depends on the credibility of the central bank and must lead to
inflation eventually.
Moreover, although inflation and Gesell taxes have the same ‘shoe-leather costs’ and
effects on search-activity, they make a big difference in terms of the working of the price
mechanism: while Gesell taxes are consistent with a zero inflation target, i.e. they do not move
the price level so that movements of individual prices can always be identified as such,
inflation moves the price level and we have Lucas's (1973) signal extraction problem where it
is hard to distinguish movements of prices of individual goods and the aggregate price level.
Zero inflation is also optimal in sticky price models, since it reduces the need for price
adjustments and eliminates the distortion that arises through price dispersion
34
. In these
respects price stability with Gesell taxes is preferable to moderate inflation. Moreover, it is
probably easier to anchor expectations to a zero-inflation regime than to moderate inflation.
Another frequently citied objection is that providing the infrastructure for implementing
negative interest rates will cause considerable costs and that such a policy theme has not been
tested yet. Thus, Yates (2004, p. 446) argued there might be other more cost-effective
methods for escaping the zero bound, such as quantitative or credit easing, and from a policy
point of view, it might be wiser to use more thoroughly tried and tested methods. Admittedly,
implementing negative interest rates will come at some costs but so does any policy scheme
that tries to remove the zero bound.
35
Concerning the argument the negative interest rates are
untested: The possible side effects of the current enormous quantitative and qualitative easing
are equally unpredictable. On the contrary, not long ago the purchase of ailing securities, e. g.
treasury bonds, by central banks was considered to be a capital sin. At the same time the
34
See Woodford (2003) as an example of a large literature on optimal monetary policy with this view.
35
See for example Yates (2004, pp. 446-449) discussion on the merits on ‘money rains’ to overcome the zero
bound.
22
effectiveness of this ‘innovative’ monetary policy remains doubtful, given stagnating growth
rates the in the United States and elsewhere.
Concerning the benefits, the search-theoretical literature proposes a negative tax on
money to be efficiency enhancing. A “hot potato” effect similar to the one caused by inflation
increases velocity through higher search-effort of buyers trying to avoid the loss in value of
their money balances. This results in a higher sum of overall transactions and increases
aggregate activity. Moreover, it is undisputable that one of the benefits of negative interest
rates would be that of avoiding the floor to rates in the case of a sharp deflationary shock.
Thus, the argument concerning the cost-benefit ratio depends partly on the probability and
the scale of a deflationary spiral. While this risk was previously considered to very small indeed
(Yates, 2004, p. 464), the recent developments have reminded practitioners and economist
alike that the likelihood of such an event is not that small after all. If unconventional monetary
policy is not able to offset the asymmetry in the domain over which the official policy rate can
be set in the event of large deflationary shock, the cost of the zero bound may be vast indeed
(Buiter, 2010, p. 236). A Gesell tax combined with a low inflation target however can avoid the
distortions of considerable inflation and can be used to escape from a liquidity trap while a
higher inflation target cannot achieve this goal. Therefore, negative interest rates offer an
additional short-term policy option in the event of a large deflationary shock, if even such a
scheme may come with some costs.
Limitations
Obviously , the range over which negative rates could be set is not unlimited, as Buiter
(2007, p. 129) points out: ‘It goes without saying that for something to serve as a medium of
exchange and means of payment, it will have to be willingly held between transactions and
therefore will have to be a store of value.’ In Buiter’s view the storage of value complements
money in its primary function as medium. On the first sight this contrasts Gesell’s argument
that the two functions of money are dichotomous. However, this disagreement might be just a
matter of degree or of definition. What Gesell has in mind is the ‘joker’ position of money as
an unerodable store of value that inflicts on its role as means of exchange. If the value of
money does not erode too much it will very likely be accepted, as the experience of low-and
medium inflation periods shows. In a search theoretical paper, Cuadras-Morató (1997, p. 120)
showed that even a perishable good could serve as money because ‘what determines which
good appears as a medium of exchange are the extrinsic beliefs of agents about acceptability
of goods, more than the intrinsic qualities of goods’.
23
In reality, there will be definitely a limit to the rate of depreciation that will be accepted by
the public before the official currency will lose its status as commonly accepted medium of
exchange. Setting a very high rate of depreciation may lead to a substitution of the official
currency by other means of payment, as it is usually the case during periods of high inflation.
Hence, too negative interest rates may risk the status of the official fiat currency as commonly
accepted legal means of payment. These considerations Gesell had already in mind when he
proposed a 5% annualized rate of depreciation that should just contrast the storage cost
advantage of money against other goods and should not go further than that rate. The same
line of arguments may also explain to some extent the failure of some experiments of the
stamp scrip movement in the US in the 30’s that tried a too high tax rate on money.
Finally, a comment on the long-run implications of a Gesell tax is in order. It is very unlikely
that the imposition of Gesell taxes can lower real interest rates substantially in the long run,
and that ‘capital rents’ finally disappear because of the elimination of basic interest - ‘Urzins’
as Gesell claims. According to the classical and neoclassical view, the long-run real interest rate
is determined by thrift and productivity, i.e. by the levels of saving and investment and cannot
be affected by monetary reform. For Austrians the interest rate is determined psychologically
by the rate of time preference. Keynes’ liquidity preference theory, however, shares with
Gesell’s theory that the interest rate is a monetary phenomenon: according to Gesell interest
rates are high because of the low storage cost of money, while according to Keynes (1936,
Ch.17) what matters is that money has among all assets the largest difference between
liquidity premium and storage cost. Hence an increase in storage costs through a Gesell tax
would, in principle, counteract the high liquidity premium of money, but would not affect the
liquidity premium of other durable assets, such as gold. Consequently, their somewhat smaller
liquidity premium would still set a minimum standard for the long-term interest rate. This
view was already expressed by Keynes (1936, p. 358) himself: ‘Thus if currency notes were to
be deprived of their liquidity-premium by the stamping system, a long series of substitutes
would step into their shoes – bank-money, debts at call, foreign money, jewellery and the
precious metals generally, and so forth’. Hence, in the long run a tax on money will not lower
real interest rates substantially and thereby succeed in abolishing the ills of capitalism
completely, as many of Gesell’s followers claim. Therefore negative short term nominal
interest rates are – from a Post Keynesian perspective – no remedy towards the effects of
liquidity preference.
24
Conclusion
The aim of this paper was to give a concise review of the various theoretical origins of
negative interest rates, which so far have been unconnected in the literature. Evidently,
negative interest rates have come a long way from anarchistic to modern economic theory.
Even if their origins are to be found in a rather simplistic economic theory, which nevertheless
Keynes vividly embraced as being prophetic, various prominent economists have picked up the
proposal and have shown its value as an additional monetary policy tool. Instead of being the
fantasy of a monetary crank, negative interest rates draw on a variety of different modern
theoretical backgrounds.
Our review of the various strands of research suggests that a moderate tax on money may be
efficiency enhancing (in the absence of inflation) and implementing the infrastructure for
setting negative nominal interest rates may give central banks an additional valuable policy
tool in case of a large deflationary shock. A beneficial side effect could be that the velocity of
circulation of coins and notes and probably demand deposits might be considerably more
stable if subjected to the Gesell tax and this could render monetary control more efficient.
Given that many developed economies have reached the lower zero bound, with central banks
unable to combat unemployment and depression, we believe that there is a need for further
extensive research, especially in models with more relevant specifications of production,
investment, banking, and asset markets, and where money plays an essential role in exchange.
25
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