Mankiw-It May Be Time for the Fed to Go Negative ?

silverharp

This article by Mankiw seems to have put Mish's nose out of joint and I can see why , Mish responded with an article called -Time For Mankiw To Resign
http://globaleconomicanalysis.blogspot.com/2009/04/time-for-mankiv-to-resign.html


I cant see the logic of trying to generate artificial inflation myself , simple logic tells me the consumer for once is trying to be semi rational in his spending habits and doesnt need to be poked and prodded by policy makers in to more reckless behaviour. Is it just an obsession with trying to get one or 2 economic guages to go up regardless to the underlying reality of the situation?


http://www.nytimes.com/2009/04/19/business/economy/19view.html?_r=1

It May Be Time for the Fed to Go Negative
Published: April 18, 2009
WITH unemployment rising and the financial system in shambles, it’s hard not to feel negative about the economy right now. The answer to our problems, however, could well be more negativity. But I’m not talking about attitude. I‘m talking about numbers.


Let’s start with the basics: What is the best way for an economy to escape a recession?

Until recently, most economists relied on monetary policy. Recessions result from an insufficient demand for goods and services — and so, the thinking goes, our central bank can remedy this deficiency by cutting interest rates. Lower interest rates encourage households and businesses to borrow and spend. More spending means more demand for goods and services, which leads to greater employment for workers to meet that demand.

The problem today, it seems, is that the Federal Reserve has done just about as much interest rate cutting as it can. Its target for the federal funds rate is about zero, so it has turned to other tools, such as buying longer-term debt securities, to get the economy going again. But the efficacy of those tools is uncertain, and there are risks associated with them.

In many ways today, the Fed is in uncharted waters.

So why shouldn’t the Fed just keep cutting interest rates? Why not lower the target interest rate to, say, negative 3 percent?

At that interest rate, you could borrow and spend $100 and repay $97 next year. This opportunity would surely generate more borrowing and aggregate demand.

The problem with negative interest rates, however, is quickly apparent: nobody would lend on those terms. Rather than giving your money to a borrower who promises a negative return, it would be better to stick the cash in your mattress. Because holding money promises a return of exactly zero, lenders cannot offer less.

Unless, that is, we figure out a way to make holding money less attractive.

At one of my recent Harvard seminars, a graduate student proposed a clever scheme to do exactly that. (I will let the student remain anonymous. In case he ever wants to pursue a career as a central banker, having his name associated with this idea probably won’t help.)

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.

The idea of making money earn a negative return is not entirely new. In the late 19th century, the German economist Silvio Gesell argued for a tax on holding money. He was concerned that during times of financial stress, people hoard money rather than lend it. John Maynard Keynes approvingly cited the idea of a carrying tax on money. With banks now holding substantial excess reserves, Gesell’s concern about cash hoarding suddenly seems very modern.

If all of this seems too outlandish, there is a more prosaic way of obtaining negative interest rates: through inflation. Suppose that, looking ahead, the Fed commits itself to producing significant inflation. In this case, while nominal interest rates could remain at zero, real interest rates — interest rates measured in purchasing power — could become negative. If people were confident that they could repay their zero-interest loans in devalued dollars, they would have significant incentive to borrow and spend.

Having the central bank embrace inflation would shock economists and Fed watchers who view price stability as the foremost goal of monetary policy. But there are worse things than inflation. And guess what? We have them today. A little more inflation might be preferable to rising unemployment or a series of fiscal measures that pile on debt bequeathed to future generations.

Ben S. Bernanke, the Fed chairman, is the perfect person to make this commitment to higher inflation. Mr. Bernanke has long been an advocate of inflation targeting. In the past, advocates of inflation targeting have stressed the need to keep inflation from getting out of hand. But in the current environment, the goal could be to produce enough inflation to ensure that the real interest rate is sufficiently negative.

The idea of negative interest rates may strike some people as absurd, the concoction of some impractical theorist. Perhaps it is. But remember this: Early mathematicians thought that the idea of negative numbers was absurd. Today, these numbers are commonplace. Even children can be taught that some problems (such as 2x + 6 = 0) have no solution unless you are ready to invoke negative numbers.

Maybe some economic problems require the same trick.

N. Gregory Mankiw is a professor of economics at Harvard. He was an adviser to President George W. Bush.

Économiste Monétaire

I read that last night and I'm fairly certain that Mankiw is being facetious with the serial number-cash withdrawal idea. Mish seems to miss the the large amount of MFI excess reserves that are effected by the cost of holding cash in that scenario, which is in addition to physical currency. There's the obvious problem with that argument too, who wants to borrow ~$700bn in excess reserves? This idea shouldn't be a surprise, considering that a minus 6 percent Fed Funds rate argument was floated around (by Krugman, I think) based on a Taylor rule approximation a while back. Altering money's own rate of return isn't a new concept.

Mankiw responds to the broad criticism here. I'm not particularly in favour of inducing inflation of that magnitude, considering that an explosion in inflation expectations would have detrimental effects to an economy already in recession and wages falling to improve competitiveness. Mankiw is citing a negative 1 percent (nominal) effective funds rate. Theory-for-theory's sake is how I view it. I wonder what the effect would be on holdings of U.S. debt.

silverharp

Économiste Monétaire wrote: »

. Mish seems to miss the the large amount of MFI excess reserves that are effected by the cost of holding cash in that scenario, which is in addition to physical currency. There's the obvious problem with that argument too, who wants to borrow ~$700bn in excess reserves? .

Does that include sweeps? I had the impression rightly or wrongly that banks held very little in the way of "cash"

Sweeps data
http://research.stlouisfed.org/swdata

Économiste Monétaire

silverharp wrote: »

Does that include sweeps? I had the impression rightly or wrongly that banks held very little in the way of "cash"

Sweeps data
http://research.stlouisfed.org/swdata

I probably should have outlined that train of thought. If you have an expected cost of holding money of 10%, you're going to offload your cash. People playing hot potato with currency begins to drive up prices, inflation lowers the cost of borrowings and increases the cost of demand deposits. The action (serial number based withdrawal) alone doesn't directly incur a cost for deposit holders and reserves at banks. Your point about those simply being numbers on a computer is correct. I was thinking more along the lines of: overall prices begin to rise, due to money velocity going vertical, and then the series of events after that—tying in with the excess reserves. My bad on the ambiguity.

An entirely different scenario would be everyone trying to off-load their currency into deposit accounts. That negates any cost to the consumer, but not so good for banks. A reverse bank run; everyone queuing up to put their money in rather than withdraw it . Also, what about subsequent deflationary effects from withdrawing 10% of the currency aspect of the monetary base? Offset that by printing every other number proportionately...

I think he intended this to be an amusing example of how to 'go negative', Mish might be taking it a tad bit too seriously. Next we'll see Krugman break out the interstellar trade paper... :pac:

Flamed Diving

Wouldn't this lead to a flight of capital from the US? I mean, if you are being taxed 3% for simply holding money, you would be better served by moving your savings out of the country, if possible, where you could get more favourable rates.

Secondly, I don't think the behaviour of individuals would be quite as predictable as Mankiw is postulating. It is rather a radical proposal, which could lead to radical behaviour. I don't mean simply with the velocity of money, either. I mean, who would end up lumped with the dead money, in the end? The supply-side?

silverharp

Économiste Monétaire wrote: »

An entirely different scenario would be everyone trying to off-load their currency into deposit accounts. That negates any cost to the consumer, but not so good for banks. A reverse bank run; everyone queuing up to put their money in rather than withdraw it . Also, what about subsequent deflationary effects from withdrawing 10% of the currency aspect of the monetary base? Offset that by printing every other number proportionately...

I think he intended this to be an amusing example of how to 'go negative', Mish might be taking it a tad bit too seriously. Next we'll see Krugman break out the interstellar trade paper... :pac:

"A reverse bank run" - you should copyright that. Maybe a sense of humour failure on Mish's part but the rest of the article gives the impression that Mankiw is desperate for any solution that will create inflation as if that would solve anything.

scipio

silverharp wrote: »

"A reverse bank run" - you should copyright that. Maybe a sense of humour failure on Mish's part but the rest of the article gives the impression that Mankiw is desperate for any solution that will create inflation as if that would solve anything.

I think inflation is already guaranteed once the recovery starts. I saw a stat, i don't know where , that 47% of the US M3 is Bank Reserves:eek: the FED will have some job reeling all that in once it gets going and you can guarantee they'll reacat too late due to political pressure not to harm the recovery.

Anyway Mish's site is great one I regularily monitor.

leninbenjamin

facetious or not; Manqiw has lost the head for publishing that...

leninbenjamin

leninbenjamin wrote: »

facetious or not; Manqiw has lost the head for publishing that...

He didn't 'publish' it, its just an opinion piece in a paper. Its not like it made it into the AER.

I've seen much worse on a regular basis in the Irish press.

Flamed Diving

How would the de-tenderising of the currency work, though? Would it be done on a quarterly basis? I could imagine the mayhem at the end of every quarter!

It may result in a new style of spreading risk, based on serial codes.

leninbenjamin

Deleted User wrote: »

He didn't 'publish' it, its just an opinion piece in a paper. Its not like it made it into the AER.

I've seen much worse on a regular basis in the Irish press.

it was published in a newspaper... he submitted something to be published in a newspaper.

And what the hell does our own Press have to do with anything? Here's supposed to be one of the worlds leading economists, with a hand in educating nearly every student who gets an economics degree in the western world, and he's let off writing sh*te like that?

silverharp

some light relief

https://www.youtube.com/watch?v=VVp8UGjECt4