By Scott Fullwiler
Willem Buiter, Greg Mankiw, and Scott Sumner have all recently proposed negative nominal interest rates on reserves or currency as a way to stimulate consumer spending and bank lending. It may be nothing more than a coincidence, but the Swedish Riksbank just set the rate it pays banks on reserve balances at -0.25%, effectively taxing banks for holding reserve balances. But I think they are all missing the point, and here’s why.The classic example of a negative nominal interest rate—long suggested by a number of economists for avoiding deflation—is a tax on currency, which can be summarized in an example Mankiw provides:“Imagine that the Fed were to announce that, a year from today, it would pick a digit from zero to 9 out of a hat. All currency with a serial number ending in that digit would no longer be legal tender. Suddenly, the expected return to holding currency would become negative 10 percent. That move would free the Fed to cut interest rates below zero. People would be delighted to lend money at negative 3 percent, since losing 3 percent is better than losing 10. Of course, some people might decide that at those rates, they would rather spend the money — for example, by buying a new car. But because expanding aggregate demand is precisely the goal of the interest rate cut, such an incentive isn’t a flaw — it’s a benefit.”
Well, I don’t know about you, but my response would be pretty clear if the Fed made such an announcement: I’d stop holding currency and just use my debit card (most major purchases already aren’t done with currency, anyway). And so would most everyone else. Banks would then sell their currency back to the Fed and the Fed would pay banks reserve balances in exchange (as it usually does). I highly doubt this would lead any bank to cut its lending rates, as Mankiw thinks.
The response and result are in essence unchanged if instead you require individuals to periodically pay to have their currency “stamped” for validation (which Buiter also describes)—I would use a debit card or go to the ATM machine on the day I was going to spend.
The idea of the currency tax is to incentivize people to spend their idle balances, instead of save them. But it doesn’t do this since we can simply switch to holding financial assets that don’t have such a tax. And no matter how far up the chain of liquid financial assets you want to go with the tax (deposits, money market funds savings accounts, etc., as Buiter notes are also options for the tax), I just keep moving my balances to the next most liquid and non-taxed financial asset (or buy everything with a credit card and then pay it off at the end of the month) while financial institutions will also have a substantial incentive to continually design and redesign special liquid accounts (or credit card-type arrangements) that can avoid or otherwise minimize the tax.
In a sense we already tried this in the early 1980s with high interest rates that were essentially a tax on non-interest earning balances, with the end result (for liquidity portfolios, not the economy as a whole) that individuals just started more actively managing their liquidity to minimize the opportunity cost of holding transaction balances while it became less and less clear precisely what was and was not “money.” The currency tax and taxes on transaction account balances similarly just widen the spread between what is earned on non-transaction balances versus transaction balances.
The currency tax also begs the more important point. The problem IS NOT that people have idle balances and aren’t spending them (and it almost never is the problem in a recession). The problem IS that people don’t have enough income (or don’t have the certainty that their current income will be sustained) and/or savings to make them comfortable to spend or to borrow to spend. Indeed, the household sector as a whole is trying to deleverage, not sit on idle balances. And in fact, a tax on currency or transaction balances REDUCES income, obviously, for those holding the types of financial assets being taxed . . . so instead of a monetary stimulus, what you really have with this tax increase is a fiscal TIGHTENING.
What about a tax on bank reserve accounts? (That is, the Fed paying negative interest on reserve balances held by banks.) Sumner argues that, aside from the Fed publicly committing to a nominal GDP growth path (the “expectations about monetary policy are all that matter” view of neoclassical economists. . . which I won’t address here), “the second most effective option would be a modest interest penalty on excess reserves, perhaps 2%.” But this is perhaps even more misguided than a currency tax. And this is what Sweden’s central bank just decided to do (though with a smaller penalty of 0.25%).
In short, the proposal assumes that banks either need the reserve balances (if you tax all reserve balances) for the actual act of creating the loan or (as appears to be the case in Sumner’s proposal to tax only excess balances) they need the reserve balances because of reserve requirements. So, in their view, the tax would give incentive to banks to either get the reserve balances off their balance sheets by “lending” them (so as to avoid a tax on any balances), or to lend in order to transform the balances from excess balances into required balances (so as to avoid an excess reserves tax).
This is the money multiplier view that doesn’t apply to a non-gold standard monetary system like ours (or Sweden’s) since it assumes banks are constrained in their abilities to create loans and deposits by the quantity of reserve balances or excess balances. I’ve explained this at length in my previous posts to this blog, so I won’t go into detail here. In short, though, banks create loans and deposits simultaneously out of thin air. A bank short of balances to meet reserve requirements AUTOMATICALLY receives an overdraft in its reserve account at the Fed’s stated penalty rate, which it then clears with the lowest cost liability it can find. Neither reserve requirements nor the quantity of reserve balances banks hold have anything to do with their abilities to lend.
What will happen, then? Instead of providing an incentive for banks to lend, banks instead will have an incentive to rid their balance sheets of reserve balances. So they will try to trade them in the interbank markets. But in the aggregate, banks only trade the existing quantity of balances among themselves as only a change in the central bank’s balance sheet alters the quantity of balances circulating. So unless the central bank takes action to drain the reserve balances, the undesired excess quantity will just lead banks to bid the overnight rate down to the rate paid on reserve balances, if it’s not already there (as in the US; in Sweden this would be -0.25% unless the balances are drained to hit a higher target rate).
And what is the effect? For banks holding the extra balances not drained by the central bank, the effect is a reduction in their income, as they have to transfer income to the central bank to pay the tax. This then, in the case of the US, would raise the Fed’s profits (all things equal) and thereby raise the amount the Fed turns over to the Treasury (since the Fed turns its profits after paying a fixed percent dividend to member banks). So . . . instead of helping banks lend via monetary easing, we again have a fiscal tightening, as the government’s budget deficit has been reduced, however marginally. Further, by reducing bank profits, you reduce bank capital . . . again probably marginally, but nonetheless, not the most intelligent thing to do in the midst of a banking crisis.
But what about the fact that interest rates people can borrow at may have fallen? Doesn’t this help the economy? First, note that this is NOT the primary reason anyone has advocated negative nominal rates . . . the primary reasons have been to encourage spending idle balances and bank lending, which as I’ve explained here, they do neither. Second, this all depends, since in the private sector, for every borrower paying a lower rate, there is a lender/saver receiving a lower rate, while the private sector also sees reduced income from government securities it is holding. So any improvement in the incentive to borrow (which currently is not very interest sensitive as the private sector deleverages) must be weighed against the offsetting effect of reduced income for lenders and savers.
Returning to remedies for the economy, if the problem is a lack of spending, why not a simple payroll tax holiday, for example, as my fellow bloggers have proposed? This increases spending by increasing incomes and savings, rather than by the attempt at intimidation of a negative interest rate on people already short of income and savings that is the root cause of low spending in the first place. Unfortunately, those recommending penalties on currency, deposits, or reserves don’t fully understand monetary operations given that their basic framework is inapplicable to a modern monetary system such as ours.
"I highly doubt this would lead any bank to cut its lending rates, as Mankiw thinks"I suppose it should be: "I highly doubt this would lead any bank to increase its lending rates, as Mankiw thinks"
Hi Actually, no . . . Mankiw suggests lenders would cut interest rates . . . By "lending rates," I meant interest rates charged, not growth in loans. Sorry for any confusion. Best,Scott
I kind of doubt a payroll tax holiday would be very effective either. The existing tax cuts and increases to federal benefit payments from the stimulus bill are currently being largely offset by a higher personal saving rate. Disposable Personal Income is up a significant amount since December, but Personal Consumption Expenditures have risen much less. The bottom line is that people don't feel like extending themselves right now and nothing of a temporary nature is probably going to have much effect on spending.
The idea that banks hold roughly 8% more of their assets in cash because of the 25bp reserve interest rate is dubious at best. Yet that idea — the high price elasticity of reserve balances — underpins the negative interest rate proposal.Presumably banks hold excess reserves because they want risk-free, strings-free, liquidity. It is the management's response to deflationary tail risk, and therefore provides evidence that the Fed has not made that tail risk disappear despite its alphabet-soup of liquidity facilities.So the question is, how would a penalty rate affect bank demand for reserve liquidity? One answer is, not much as long as deflation tail-risk fears persist. Another is, not much because banks would simply pass the tax on to customers in the form of higher loan rates. In today's credit-short, oligopolistic banking environment, it is likely that most of the the "tax" would be passed through. In essence, it is not the reserve interest rate that controls bank behavior but the marginal utility of holding reserves versus earning spreads on holding risk assets. It seems to me that negative-rate proponents make all kinds of implicit, unexamined assumptions about that trade-off. They need to think more critically about their own assumptions, make them explicit, and defend them.
Scott Sumner has been trying to post a response to this, but hasn't been successful for some reason. Here's what he said about it in comments at The Money Illusion———-quote———–The proposal would not drive interbank loan rates significantly negative, as banks could always exchange ERs for T-bills. And T-bill yields could not go significantly negative because non-bank holders of T-bills can always hold cash. So he doesn’t seem to have read my specific proposal on April 22nd. I’m guessing he just read a summary somewhere. The idea was to move ERs into cash in circulation. It is not intended to significantly lower rates, but rather relies on the monetarist “excess cash balance” mechanism.Another mistake is to assume it would hurt bank profits. It could, but need not if the Fed doesn’t want it to. They could simply pay positive interest on RRs to offset the negative interest on ERs. All this is explained in this post:http://blogsandwikis.bentley.edu/themoneyillusion/?p=1032———-endquote———–
Personally, besides the fact that I rarely carry cash in the first place, if they did start to "tax" my savings account (which is immune to zeroing the value of specific bills with this or that serial number) I would likely switch to holding silver and some more gold coins (or coins in general beyond PMs) and trade my US dollars for Canadian or some other foreign currency.
I think the point was briefly touched upon but more emphasis needs to be stated on the fact that through the past forty years of lending, evntually you reach a point where the only people you have left to lend to as a result of supplying the other groups with loans is high risk individuals or entities. You can afford to be discriminate on who you lend money to in the beginning of such a cycle but at the end you cannot. The banks reached that stage about thirteen years ago when lending standards began to fall. They had no choice, when you fuel each and every recovery with easier credit this is what happens eventually. You reach a point of no return and the system breaks. If you think the CEO's making the policy for these loans didn't know that this was the last hurrah then you must think them stupid. They are not. The old system has simply reached it's end.
Good takedown of the latterday version of Central Planning.Many of those who often criticized, neigh ridiculed, "socialist" style industrial policy have always been oh so enthusiastic about manipulating that which is at the heart of an economy: money. That includes a supposed acolyte of Ayn Rand, known derisively to some as the Maestro.This nonsense and accompanying financial crisis has happened so many times in recorded history that one wonders if we, as a society, will ever learn. Yup, hoocoodanode for all eternity. Hello Twilight Zone.
Fulwiller:The way a penalty rate on excess reserves reduces the excess reserves is though an increase in quantity of checkable deposits and so the amount of reserves required. The individual bank seeks to rid itself of excess reserves (and reduce its penalty) by purchasing T-bills. The seller of the T-bills now has a balance in his checkable account. The individual bank has less reserves, but, as you note, the bank of the seller of the T-bills has more reserves. So, the total reserves are unchanged. But because the seller of the T-bill has a larger balance in his or her checkable deposit, and no one has any less funds in any checkable deposit, there are more reserves required.This process continues until there are no more excess reserves. Checkable deposits expand until all the reserves are now required. It is possible that this process would make T-bill yields negative (as you say.) But it isn't necessary. It depends on the market for T-bills and the amount of excess reserves. Either checkable deposits rise, bank holdings of T-bills rise, T-bill yields fall, and the process ends when there are no excess reserves (all the existing reserves now required because of the increase in checkable deposits) and lower and positive T-bill yields. Or else, T-bill yields fall to the level of the penalty and banks still have some excess reserves (and more required reserves and more checkable deposits,) but they don't buy any more T-bills because of the negative yields. And, yes, of course, the Federal Funds rate should drop too. In this equilibrium with banks holding excess reserves at negative yields, T-bill yields and Federal Funds would be negative too. But that isn't the only equilibrium.Sumner is right that zero interest currency puts a downward limit on the negative yields. His particular story about T-bill yields not falling too low because of currency as an alternative is a bit odd. I would think that the relevant alternative to T-bills is bank deposits rather than currency. But, of course, the penanatly on excesss reserves and falling yields for T-bills should reduce the interest rates banks are willing to pay on deposits.And so, I think the limit on the process is a currency drain from the banking system. It does get rid of excess reserves.Anyway, the tax on currency issue solves that problem.Your notion that the "solution" to the tax on curreny is that you will just deposit it all and use your debit card misses the point.The interest rates on deposits will turn negative too. That is the idea. Negative interest rates on deposits is easy. But currency is a problem. Negative deposits on currency just create a currency drain from the banking system. But a tax on currency stops that. And so, holding safe, short assets have negative nominal yields.Anyway, from the rest of your discussion, it appears that you don't understand how negative yields motivate increased expenditures, which is a more complicated issue.So, remember.. excess reserves are reduced by an expansion of checkable deposits and the amount of reserves that the banks are required to hold.And while Sumner does want to just put a penalty on excess reserves so that the quantity of checkable deposits expand without impacting the interest rates on T-bills or deposits, the Mankiw notion is to get all of these nominal interest rates negative– interbank lending, deposits, currency, T-bills. It is the short, low risk assets that are supposed to get negative yields. The purpose is to clear their markets without depressing total spending. Bill Woolsey
The way a penalty rate on excess reserves reduces the excess reserves is though an increase in quantity of checkable deposits and so the amount of reserves required. WHAT MAKES YOU THINK I DIDN’T KNOW THAT?The individual bank seeks to rid itself of excess reserves (and reduce its penalty) by purchasing T-bills. The seller of the T-bills now has a balance in his checkable account. The individual bank has less reserves, but, as you note, the bank of the seller of the T-bills has more reserves. So, the total reserves are unchanged. But because the seller of the T-bill has a larger balance in his or her checkable deposit, and no one has any less funds in any checkable deposit, there are more reserves required.OK, ASSUMING THEY DON’T CONVERT DEPOSITS TO, SAY, SAVINGS ACCOUNTS, CDS, MONEY MARKET FUNDS, REPOS, COMMERCIAL PAPER, ETC. THEY WERE SAVING, AFTER ALL.This process continues until there are no more excess reserves. Checkable deposits expand until all the reserves are now required. YOUR BIG IDEA TO SOLVE THE CRISIS IS TO MOVE TBILLS FROM THE NON-BANK PRIVATE SECTOR TO THE BANKS? AGAIN, ASSUMING THEY DON’T WANT TO SAVE ANYMORE. YOUR ENTIRE ANALYSIS MAKES THIS ASSUMPTION . . . THAT’S THE ONLY WAY THE TAX WILL WORK . . . AND I REJECT THAT ASSUMPTION. THEY WERE HOLDING T-BILLS FOR A REASON . . . AND THEY CAN SELL AND SPEND ANYWAY WITHOUT AN ER TAX AT ANY TIME. ALL YOU REALLY DID WAS LOWER THEIR INTEREST INCOMES. AND WITH A RR RATIO OF 10%, YOU’LL NEED TO MOVE ABOUT $6 TRILLION OF T-BILLS FROM PRIVATE SECTOR TO BANKS TO TURN $600 BILLION IN ER TO RR. GOOD LUCK.Either checkable deposits rise, bank holdings of T-bills rise, T-bill yields fall, and the process ends when there are no excess reserves (all the existing reserves now required because of the increase in checkable deposits) and lower and positive T-bill yields. Or else, T-bill yields fall to the level of the penalty and banks still have some excess reserves (and more required reserves and more checkable deposits,) but they don't buy any more T-bills because of the negative yields. AS ABOVE . . . YOU JUST REDUCED THEIR INTEREST INCOME. HOW DOES THAT GET PEOPLE TO STOP SAVING AND START SPENDING? His particular story about T-bill yields not falling too low because of currency as an alternative is a bit odd. YES . . . AS SHOWN LAST FALL, DUE TO DEPOSIT INSURANCE LIMITS, MANY WILL HOLD TBILLS AT NEGATIVE YIELDS. I would think that the relevant alternative to T-bills is bank deposits rather than currency. NO. THE ALTERNATIVES TO TBILLS ARE OTHER SHORT-TERM, INTEREST EARNING INVESTMENTS. THE EXCEPTION IS LAST FALL WHEN COUNTERPARTY RISKS LED DEPOSITORS TO HOLD TBILLS.And so, I think the limit on the process is a currency drain from the banking system. It does get rid of excess reserves.BANKS SELL THEIR CURRENCY TO THE CB AND RECEIVE RESERVE BALANCES IN RETURN. SO THIS RAISES RESERVES (AND EXCESS RESERVES). Your notion that the "solution" to the tax on curreny is that you will just deposit it all and use your debit card misses the point.YOU SHOULD HAVE KEPT READING . . . I DIDN’T STOP THERE.The interest rates on deposits will turn negative too. That is the idea. AND SO I MOVE TO A SAVINGS ACCOUNT. IF YOU TAX THAT, I MOVE TO A MUTUAL FUND. IF YOU TAX THAT, I KEEP MOVING AND THE FINANCIAL SECTOR KEEPS INNOVATING TO ASSIST ME (AS THEY ALWAYS HAVE). IF I REALLY DO END UP NOT ABLE TO AVOID THE FALL IN RATES, THEN YOU’VE JUST CUT MY INTEREST INCOME. HOW DOES THAT HELP ME SPEND?
Anyway, from the rest of your discussion, it appears that you don't understand how negative yields motivate increased expenditures, which is a more complicated issue.THEY MIGHT. BUT THEY HAVE TO FIGHT AGAINST TWO THINGS. FIRST, THIS HASN’T MOTIVATED ME TO SPEND MORE OF MY EXISTING BALANCES—JUST CAUSED ME TO TRY AS HARD AS POSSIBLE TO RECLASSIFY THEM TO AVOID THE TAX. SECOND, TO THE DEGREE I CAN’T AVOID THE TAX AND ALSO TO THE DEGREE AVERAGE RATES HAVE FALLEN, YOU’VE REDUCED MY INTEREST INCOME, SO I’M ACTUALLY WILLING TO SPEND LESS AT LEAST IN TERMS OF AVAILABLE INCOME.So, remember.. excess reserves are reduced by an expansion of checkable deposits and the amount of reserves that the banks are required to hold.DUH!the Mankiw notion is to get all of these nominal interest rates negative– interbank lending, deposits, currency, T-bills. It is the short, low risk assets that are supposed to get negative yields. The purpose is to clear their markets without depressing total spending. I UNDERSTAND THIS AND ADDRESSED THIS IN THE POST. APPARENTLY YOU MISSED IT.
Dear BillForgot to say this since I was trying so hard to get under the character limit, unsuccessfully.Thank you for the comments. Much appreciated and very helpful.Best,Scott
I also think that a negative interest rate wouldn't have the beneficial effects it should. Financial mechanism should be handled with care, especially by the authorities, but also by the citizens.
The interest rates on deposits will turn negative too. That is the idea. Your notion that the "solution" to the tax on curreny is that you will just deposit it all and use your debit card misses the point.===================Best Interest Rates
Carterr01Apparently you didn't see these two paragraphs when you read this post. I already anticipated your point and dealt with it therein:"No matter how far up the chain of liquid financial assets you want to go with the tax (deposits, money market funds savings accounts, etc., as Buiter notes are also options for the tax), I just keep moving my balances to the next most liquid and non-taxed financial asset (or buy everything with a credit card and then pay it off at the end of the month) while financial institutions will also have a substantial incentive to continually design and redesign special liquid accounts (or credit card-type arrangements) that can avoid or otherwise minimize the tax.""In a sense we already tried this in the early 1980s with high interest rates that were essentially a tax on non-interest earning balances, with the end result (for liquidity portfolios, not the economy as a whole) that individuals just started more actively managing their liquidity to minimize the opportunity cost of holding transaction balances while it became less and less clear precisely what was and was not “money.” The currency tax and taxes on transaction account balances similarly just widen the spread between what is earned on non-transaction balances versus transaction balances."Scott Fullwiler
I think interest rate manipulation is one of the few tools that the government has left simply because of the fact that the appetite for anything more direct has gone in a big way. A payroll tax holiday would be a real boon but it would be derided as a stimulus – something the latest session of congress has been mandated to avoid.
Charging for inter-bank balances held at the District Reserve Banks (instead of paying interest on them), reverses the flow of loan-funds in the economy, shrinking the size of the commercial banking system while simultaneously increasing CB profits. It increases aggregate monetary purchasing power (by releasing the volume of savings eligible for real-investment).
“Don’t know if anyone’s still engaged in the discussion above on negative rates, but I wrote two blogs at NEP three years ago critiquing the idea, including taxing currency.” ->
Still very much engaged 🙂
Comments below:
“I highly doubt this would lead any bank to cut its lending rates, as Mankiw thinks.” -> So you don’t think banking is a somewhat competitive market? The banking sector as a whole will never pass on any of its reduction in costs? I don’t buy that..
“The idea of the currency tax is to incentivize people to spend their idle balances, instead of save them.” ->
Well mostly it’s to incentivize borrowers to borrow & invest despite bleak economic prospects.
“But it doesn’t do this since we can simply switch to holding financial assets that don’t have such a tax.” -> You won’t be able to do that anymore than you could find 5% return today when target is 0%. Why would anyone borrow from you at 0% when they can borrow from a bank at -5%? (risk & term adjusted)
“What about a tax on bank reserve accounts?” ->
You keep calling it a tax while it’s really not. The money taken from the deposit accounts doesn’t go to the government, it goes to either the borrower, the bank shareholder, or the bank swap counterparty (or the bank employee). If the loan market is competitive and the swap market prices things correctly, it goes to the borrower.
Yes the Fed will be taking money from bank reserve accounts but it will also be PAYING interest on the repos it does to inject the liquidity in the first place, making it “net financial asset”-neutral for the private sector. (I’ve had that debate with Warren before and he agreed)
The only thing you could argue is a tax (and Warren has) is that yields on govt assets will go negative.
And obviously there is no way for the Fed not to charge the negative rate on excess reserves otherwise banks will just borrow money at negative rates and let it sit idle in excess reserves while they collect the difference risk-free.
Your argument on reserve fees and what banks do with reserve does not make sense to me. Interest on Required reserves should be target + 0bps otherwise you have an implicit tax on the banking sector. Interest on Excess reserves has to be target – X (I like X = 100bps because that’s sufficiently large to force banks to either lend out their excess reserves or let the Fed drain it away from them). Discount window = target + X (doesn’t have to be the same X), and target can be whatever you want it to be. 5%, 0%, -5%! It really doesn’t matter to the banks especially given that they hedge their interest rate risk..
“But what about the fact that interest rates people can borrow at may have fallen? Doesn’t this help the economy? First, note that this is NOT the primary reason anyone has advocated negative nominal rate.” ->
Note that IT IS the primary reason I’m advocating for it 🙂
“Second, this all depends, since in the private sector, for every borrower paying a lower rate, there is a lender/saver receiving a lower rate, while the private sector also sees reduced income from government securities it is holding. So any improvement in the incentive to borrow (which currently is not very interest sensitive as the private sector deleverages) must be weighed against the offsetting effect of reduced income for lenders and savers.” ->
Yup. If the deficit was smaller we wouldn’t have to look at that tradeoff haha 😀
All MMT jokes aside, I think the private sector is interest sensitive enough and that at sufficiently low rates, people will borrow to invest and start ventures.
Yes, rates are at historical lows, but deficits are also at historical highs.. MMT argues they’re still not high enough, I argue rates are still not low enough. Historical bands are made to be broken..
“[..] those with credit card debt, for instance, can’t take advantage of that because markups there are countercyclical.” -> Well yes, since a deflationary cycle is looming because of the man-made concept of a liquidity trap, spreads widen. I think if rates were kept high, it would be ever worse for the credit card borrowers.. I believe if the Fed chairman just uttered the words ‘negative rates’, credit spreads would tighten immediately..
(For some reason I was unable to post that comment on Warren’s blog so I put it here directly)
This was in response to this comment by Scott: http://moslereconomics.com/2012/05/31/brazil-cuts-rates-to-record-low-as-economy-stalls/comment-page-1/#comment-191918
Hi DOB,
Sorry that I never saw that.
1. When the Fed does a repo to inject reserves, it is lending, not borrowing, so NFA falls.
2. Yes, lower rates could stimulate borrowing/spending, which I granted in the discussion above with Bill, but (a) it will also lower income to savers, (b) it still requires more spending out of existing income rather than more spending out of rising income as fiscal policy would provide, and (c) all bets are off as to all the crazy portfolio shifts we will see in a world of negative rates. But, yes, you are right–the only way it possibly works is through more borrowing, not the other transmission mechanisms Mankiw and others I critiqued here were pushing. I just think it won’t work as well as you do, particularly in a balance sheet recession. Two possible paths that I would acknowledge could have a lot of impact, though, would be (a) refinancing by indebted households at negative rates, which would effectively raise incomes after debt service, and (b) if the Tsy or Fed were to buy conforming mortgages at negative rates and similarly enable refinancings. Far better if the two are combined, though the latter is actually fiscal policy and is preferred since it doesn’t bring as much potential problems to bank profits or money markets.
3. My reference to “banks won’t lower rates” was more related to the currency tax, not lower bank costs. Yes, lower bank costs could reduce bank lending rates.
Correction. If the Fed is lending at negative rates, then, yes, repo rates will be negative. these rates may or may not be lower than the rates charged to bank reserve accounts, though. In the more extreme setup you’ve suggested with a tax on ER of 5%, probably not, which would be a net drain of NFA. Again, I think having different rates on RR and ER will simply (a) reduce rates overall—which, as I explained above, could help, but might not, but certainly is the only avenue through which the ER tax could possibly work, which we both agree on–and (b) lead to massive portfolio shifts within banks and a move to all sorts of fees to depositors to recoup the lost income and raise RR. We’ve already seen this a bit with banks increasing their charges for ATM usage, for instance.
Let me clarify my point on portfolio shifts, FWIW . . .
“Required reserves should be target + 0bps otherwise you have an implicit tax on the banking sector. Interest on Excess reserves has to be target – X (I like X = 100bps because that’s sufficiently large to force banks to either lend out their excess reserves or let the Fed drain it away from them). Discount window = target + X (doesn’t have to be the same X), and target can be whatever you want it to be. 5%, 0%, -5%!”
OK, let’s assume the IOER is -5% and IORR is 5%. What do I do if I am a bank manager?
1. Push all non-deposit liabilities to negative rates as quickly as possible
2. Provide as much incentive as legally permissable to hold deposits.
3. Cease all deposit swap activities
4. Reduce vault cash as much as possible (to raise required reserve balances), perhaps restricting withdrawals to certain days of the week to ensure as little end of day balances as possible.
What do I do if I have my money in a MMMF? Move as much as possible to deposits, limited only by FDIC ceilings.
Has there been any more spending? Not from any of the above.
Has there been a reduction in interest rates? To the degree banks are successful in increasing RR relative to ER, rates might increase, actually. It’s completely unknown a priori.
Far better to have Fed or Tsy purchase conforming mortgages or even commercial loans at low, even negative rates, as that avoids all the portfolio shifts and uncertain (and perhaps perverse) outcomes, than to mess with IOER vs. IORR. If you think the issue is that rates aren’t low enough, then that’s the better approach. And it turns out to be a fiscal operation, low and behold.
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