Am I the only one who finds this an odd set of statements from the resident monetary expert at EconLog? I’ll add my bold so you see where I’m coming from.
Everyone seems to assume that the zero lower bound is the key problem. But how do we know this? Has the lower bound ever been tested? Not as far as I know.
In standard new Keynesian models…the key assumption is that it’s not possible to pay negative interest on bank reserves. Except that it is possible, indeed it’s been done.
When economists are confronted with this fact, they point out that commercial bank deposits at the Fed and vault cash are near perfect substitutes, and thus negative interest on reserves would merely cause the money to move out of the central bank and into vault cash. However this doesn’t really resolve the issue, as it’s certainly technically feasible to pay negative interest on vault cash.
Indeed it’s technically possible to pay strongly negative interest on bank reserves, including vault cash. How negative? There is no lower bound.
When economists are confronted with this fact they suggest that sharply negative interest rates on reserves would depress bank deposit rates so low (so far negative) that the public would pull money out of the banking system, and hold it as currency.
That is certainly true, but the important question is how much? Today, banks in the US hold nearly $3 trillion in reserves; what if all of that went into circulation? How about $10 trillion, or $15 trillion? Maybe nothing would happen, it would all go under mattresses, or into safety deposit boxes. On the other hand maybe it would create a Latin American-style hyperinflation. We simply don’t know. (I bet on hyperinflation, if the currency stock exceeds $10 trillion.)
I understand all this, but here’s what I don’t understand—why the lack of curiosity? You are in a prison cell. The door to your cell might be locked, or it might be unlocked. You don’t know. But wouldn’t you be curious? Wouldn’t you try to open the door to see if you could freely walk out into the sunshine? Or would you just sit there, day after day, year after year, wondering? Is it locked?
The world’s central banks have chosen to just sit there, wondering. They haven’t tried lowering IOR so far negative that all of the bloated base money floods out into cash held by the public. They aren’t curious. Nor are academic economists. Why not?
P.S. For those who are newcomers to Free Advice, let me give the periodic explanation: I typically read stuff on the internet that I disagree with. So I focus on Paul Krugman and Scott Sumner, because they are the best popularizers of the views that you fix recessions by (a) government spending money and (b) government creating money. I think both views are horribly wrong, and so the best use of my internet time is to go after these two guys. As far as I can tell, nobody else reads them (with a critical eye) as closely as I do.
Perhaps one day Ray Lopez and I will start a weekly podcast titled, “Sorry Sumner.”