Daily Archives: July 11, 2009

Why Negative Nominal Interest Rates Miss the Point

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.”
Continue reading