with Martin Andersson, from Sweden’s Ministry of Finance

and with me

The key to unlimited firepower in monetary policy is to deal with the problem of people storing cash. As I describe in my interview, my own approach to avoiding the problem of people storing paper currency to get an interest rate close to zero rather than the intended negative interest rate during a serious downturn is to charge private banks a deposit fee when they turn in cash at the cash window of the central bank for credit in their reserve accounts with the central bank.

Such a charge at the cash window of the central bank closes the loophole that would otherwise allow financial firms to earn a zero interest rate (minus storage costs) by using cash. In this system, regular people who are saving for long periods of time could still in all likelihood earn positive interest rates on bank accounts and a zero rate on cash over longer periods of time, but the ability to earn a zero interest rate from cash would be temporarily suspended during the worst of an economic downturn. As a result, other interest rates could be pushed down as low as necessary to heal the economy. 

After these two conferences, I visited the Bank of Finland as well as the central banks of Sweden, Norway and Canada to explain at length my views on how to enable central banks to cut interest rates as much as they think they should, without being stopped short by the problem of paper currency storage. As compared to my visits to central banks before the conference I find the change in attitudes toward the possibility of deep negative interest rates as a result of these conferences has been dramatic.

The Sveriges Riksbank in Sweden already has negative interest rates, and could easily go further.

The Bank of Canada is less likely to need negative interest rates in the immediate future, but already has an “Effective Lower Bound” working group focused on exploring the possibilities for negative interest rate policy in the next recession. After the London conferences, and my extended discussions with them, these central banks are all thinking more seriously about the possibility that the danger of massive paper currency storage in a negative interest rate environment can be averted by appropriate action at the cash window of a central bank.

Introducing new tools for monetary policy is inherently controversial, but recent years have seen important additions to what is seen in most central banks as the acceptable toolkit: the use of quantitative easing (QE) and more recently the use of mild negative interest rates. Modifications to the way paper currency is handled at the cash window of the central bank to make deep negative rates possible could plausibly be the next major addition to the monetary policy toolkit. If so, the world could be better prepared to deal with the next recession than many people expect.

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