## Executive Summary — wpiea2019084 ## Source details **Canonical URL:** [Executive Summary — wpiea2019084](https://www.imf.org/-/media/files/publications/wp/2019/wpiea2019084.pdf) ## Other formats - [Markdown version](/-/media/files/publications/wp/2019/wpiea2019084.pdf.md) - [Structured JSON version](/-/media/files/publications/wp/2019/wpiea2019084.pdf.json) --- ### Key findings about the zero lower bound (ZLB) and policy challenge - After a decade of zero or near-zero rates, advanced country central banks have raised rates or are considering raising rates—but the ZLB remains a serious obstacle to future monetary policy. - Typical policy-rate cuts during recessions in advanced countries have been 500-600 basis points; at present policy rates in most advanced countries remain too close to zero to make cuts of that size possible without using negative rates. - Simulations (Kiley and Roberts (2017)) suggest the ZLB could be binding 30-40 percent of the time in the future and these episodes are likely to persist for several years. - The ZLB is not a law of nature; it is a policy choice. With readily available tools, a central bank can enable deep negative rates whenever needed—maintaining the power of monetary policy to end recessions quickly. ### Organizing principles and typology of approaches - Organizing principles: - (1) role of banks and the private-sector financial system in transmitting a negative paper currency interest rate (PCIR); - (2) whether the approach requires quantity restrictions on cash or relies on the price system to alter paper-currency returns; - (3) whether negative PCIR is created via the capital gains term or the dividend term in the rate-of-return equation. - Two approaches judged best (minimum distance from current system and least political cost): - (a) the clean approach — an electronic-money system that takes paper currency off par (creates a crawling exchange rate between paper currency and electronic money); - (b) the rental fee approach — keeps paper currency at par at the cash window and imposes a rental fee (negative dividend) on cash held by banks. - Preference rationale: - Relying on banks reduces central bank implementation burden and political cost. - Relying on the price system (vs. quantity restrictions) reduces administrative burdens and disruption to transactions. ### The clean approach (electronic-money exchange rate) - Mechanism: - Create a time-varying exchange rate between paper currency and electronic money at the central bank cash window. - Example: to establish a -1 percent PCIR, at the end of the year the central bank would credit only 99 electronic dollars when a commercial bank redeposits a 100-dollar paper note; similarly, issuing paper reduces reserves proportionally — producing a crawling peg and a capital-gains depreciation of paper currency equal to the PCIR. - Bureaucratic equivalents include time-varying deposit fees on net deposits at the cash window establishing an exchange rate (1 - deposit fee). - Conditions and features: - Electronic money must be effectively the unit of account (prices for a significant fraction of expenditure expressed in electronic units). - No quantity constraints on cash are required; policy works through the price system. - Central bank can defend the declared exchange rate because it can create unlimited amounts of either form of money at the cash window. - Side effects and mitigants: - Potential costs: psychological/computational costs from paper currency off-par; legacy debt-contract issues; confusion of numeraire; sticky prices in paper currency. - Mitigants: encourage digitalization; consider central bank digital currency with a precedent nonzero interest rate. - Legal challenges: some jurisdictions face monetary-law barriers to formally creating an exchange rate between two central-bank-issued instruments; partial implementations (e.g., deposit fees on newly issued banknotes) are possible. ### The rental fee approach (negative dividend on cash while keeping cash at par) - Mechanism: - Central bank charges a rental fee on cumulative net cash withdrawals by commercial banks at the cash window (a negative PCIR by reducing dividend yield while keeping capital gains term at zero). - Example: to generate a -1% PCIR the central bank announces a 1 percent per annum rental fee on cumulative net withdrawals; the fee can be charged monthly on outstanding cumulative net withdrawals. - Central banks already track net cash withdrawals by bank, so implementation is localized at the cash window. - Existing precedents: - Swiss National Bank (SNB) practice since 2014: negative rate on excess sight deposit balances with exemption thresholds that reflect net increases in cash holdings—effectively imposes a charge on excess cash withdrawals. - Bank of Japan (BoJ) implementation (2016) adjusts tiers and takes into account cash exchanges; BoJ applies negative rates to bank-held cash but has not charged cumulative net withdrawals passed to customers (though it could). - Transmission and main concern: - Central-bank concern: enabling commercial banks to pass on the rental fee to customers without causing large-scale cash arbitrage (withdraw, store, redeposit) or severe retail frictions. - Central banks can block arbitrage at the cash window; remaining challenge is minimizing side effects from commercial-bank pass-through. ### Managing side effects of the rental fee approach - Principal side effects identified: - (i) Bank profitability problem: difficulty passing negative rates to retail depositors squeezes net interest margins for banks reliant on retail deposits. - (ii) Cash-rental-fee pass-through problem: banks may respond by charging substantial one-time withdrawal fees or restricting cash withdrawals, inconveniencing households. - (iii) Gresham’s Law problem: divergence between “tame” paper currency (with rental-fee obligation) and “wild” paper currency (in the wild without such obligation) can cause hoarding, reduced circulation, or emergence of a premium for wild cash. - Tools and policy responses: - Primary recommendation to address bank-profitability risk: - Use the interest-on-reserves formula (tiered remuneration) to subsidize banks in providing zero interest rates for small household deposit accounts. - Examples: exemption thresholds or tiered systems (SNB, BoJ, Danmarks Nationalbank precedents); or targeted lending facilities (ECB TLTRO-style negative lending rates tied to lending targets). - To manage pass-through problem: - Support bank contract modifications and business-practice changes; allow exemptions for modest per-customer monthly cash withdrawals to avoid inconveniencing households. - Allow banks to experiment with fees, ATM/teller fee structures, and per-customer limits; central bank support and suasion with regulators is important. - To manage Gresham’s Law effects (optional): - Use prohibition-type tools selectively (e.g., limits or bans on certain cash-based financial instruments) to reduce incentives for wild-cash premium or centralized storage. - Accept some increase in electronic transactions as a beneficial side effect. - Design assumptions when using tools: - Central bank has already set electronic rates negative (policy target and rates applying to marginal additions to reserves). - Central bank has established a negative PCIR at the cash window using the rental fee mechanism to block cash-window arbitrage. - Exemption policies can allow households a monthly fee-free cash withdrawal up to a per-customer limit to avoid household inconvenience while preventing large-scale withdrawals. - Example operational concept: - Suggested “pass-back” exemption formula concept: - monthly rental-fee-free cash withdrawal limit = min{ max per retail depositor, ∑ actual amount withdrawn by depositor retail depositors } - depositors would need an identification number and designate a primary bank to avoid double-dipping. - Central bank could announce it would lower the per-depositor exemption limit if cash withdrawals rose above historical norms or signs of centralized paper currency storage business activity appeared. ### Taxonomy: price approaches vs. quantity restrictions; withdrawal and deposit limit approaches - The 2x2x2 taxonomy dimensions: 1. Government acting directly vs. relying on financial system to transmit negative PCIR. 2. Quantity restrictions on cash vs. relying solely on the price system. 3. Achieving negative return on paper currency via dividend term or capital gains term. - Withdrawal limit approach (Goodfriend-style): - Put a ceiling on the stock of paper currency to short-circuit arbitrage (withdrawing → storing → redepositing at par). - Creates a freely floating exchange rate between paper currency and bank money when net withdrawals would have occurred if paper currency were at par. - Deposit limit approach: - Limit cumulative net deposits in a calendar year to no more than x% of paper currency a bank had on books at the beginning of the year; choose x nonbinding in normal times but binding when interest rates recently negative. - May reduce paper currency value below par (capital loss for existing paper currency holders). - Key trade-offs: - Withdrawal limits enhance asset value of existing paper currency (capital gain); deposit limits hurt it (capital loss). - Both create floating exchange rates and risk public consternation/volatility; the clean approach yields a smoother path. ### The prohibition approach: tools, arbitrage, and scale challenges - Approach: avoid taking paper currency off par or imposing PCIR at the cash window; instead focus on legal obstacles to paper currency storage and use as collateral to limit demand for paper currency. - Nature of feared arbitrage/disintermediation: - Arbitrage requires converting large amounts of government-controlled electronic money into paper currency, safely storing it, and redepositing at par—on a scale approaching the national debt. - Example magnitude: for the US this would mean storing an amount of paper currency close to $20 trillion. - Even far smaller illegal storage figures (example: $100 billion) would be far short of $20 trillion and unlikely to cause serious disintermediation. - Four prohibition tools (priority order): i. Ban electrification of paper currency (e.g., prohibit mutual funds/ETFs/money market funds backed by paper currency; impose ceilings on holdings by large firms). ii. Ban storage of paper currency as a business (prohibit paying for storage of someone else’s paper currency; prohibit paying more than par for paper currency). iii. Restrict cross-border movement of paper currency (AML/tax-declaration style controls). iv. Retire large denomination notes (raise physical storage costs, noting limitations). - Assessment: prohibition approach can work but has the worst side effects among approaches considered. ### Combining rental fee and prohibition approaches - Strategy: rental fee at the cash window plus selective prohibition measures (especially ban on paper-currency-as-business), plus liberal exemption amount for monthly household withdrawals and subsidies for zero rates on small deposit accounts. - Rationale: - Without a ban on paper-currency-as-business, households could withdraw exemption maximum and sell excess to storage businesses, raising wild cash above par. - Ban on paper-currency-as-business makes the exemption nonbinding for most households; households can obtain up to the exemption at par from their bank, reducing demand for black-market wild paper currency. - Rental fee + prohibition elements reinforce each other; banning paper-currency-as-business is the key prohibition measure in the combination. - Legislative authority may be required; political feasibility determines available options. - Policy design suggestion: unless legally barred, adding a rental fee to a ban on paper-currency-as-business is preferable to the ban alone. ### Supply-demand framework and graphical insights (ROERC and OCC curves) - Demand for paper currency: Rate of Effective Return on Cash (ROERC) curve - ROERC is downward-sloping, flattening at the store-of-value return unless storage costs alter the flat portion. - Classical ZLB: ROERC becomes perfectly elastic at zero beyond a point, producing a liquidity trap. - Supply of paper currency: Opportunity Cost of Cash (OCC) curve - OCC incorporates value of reserves and interest on reserves (IOR). - When monetary base is large, OCC is driven down to the IOR (flat portion at left); excess reserves below about $1 trillion may raise the opportunity cost of cash above IOR. - Equilibrium insights: - Clean approach: cut IOR and PCIR in tandem to avoid arbitrage and enable deep negative rates with smooth exchange-rate path for cash. - Rental fee approach: increase rental fee while cutting IOR; banks with cash-window access face flow cost of holding cash—similar graphical outcome to the clean approach but different ROERC interpretation. - Prohibition approach: demand-side restrictions make ROERC downward-sloping everywhere; cutting IOR becomes effective since increased cash storage raises marginal storage cost. - Policy implication: effectiveness depends on monetary base and elasticity of cash demand; different approaches shift ROERC and OCC differently. ### Literature review and evidence on bank profitability and transmission under negative rates - Theoretical points: - Brunnermeier and Koby (2016): define a ‘reversal rate’ where interest rate cuts become contractionary as net interest margin declines faster than balance-sheet gains; omission of central-bank subsidies matters for the reversal-rate result. - Eggertsson et al. (2017, 2019): New Keynesian models with storage costs and nominal frictions deliver an effective lower bound; clean/rental fee mechanisms and subsidies could solve the ZLB problem. - Rognlie (2016): negative rates can be optimal given storage costs; negative rates most useful when paper-currency demand is relatively inelastic. - Empirical findings (mixed but not decisive against mild negative rates): - Borio et al. (2017): low rates can reduce bank profitability; sensitivity increases as rates fall. - Bikker and Vervliet (2017): net interest margin reductions can be offset by adjusting other margins. - Bech and Malkhozov (2016): transmission from policy to money-market rates similar in negative and low-rate regimes; retail deposit rates insulated. - Lopez, Rose, and Spiegel (2018): cross-country panel finds savings on deposit expenses and gains in non-interest income largely offset interest income losses—"surprisingly benign implications of negative rates for commercial banks thus far." - Heterogeneous bank responses: Heider et al. (2016), Basten and Mariathasan (2018), Demiralp et al. (2017) show varying portfolio adjustments and fee responses depending on funding structure and excess reserves. - No experience yet with rates below -1%; uncertainty remains for deeply negative territory. - Operational implication: monitor and support bank profits (tiered IOR, targeted loans) to mitigate reversal concerns. ### Transmission mechanism once the ZLB is broken - Main claim: transmission mechanism is not qualitatively different once the ZLB is broken; standard channels remain operative. - Conditions: no money illusion and properly addressed paper-currency and bank-profitability issues (via PCIR reductions, rental fees, subsidies, and/or prohibition measures). - Result: cuts in nominal rates (positive or negative) affect real rates and stimulate the economy through standard substitution, wealth, exchange-rate, and multiplier channels. - Central banks have effectively unlimited monetary policy firepower if PCIR is a policy instrument and banks are supported; the only practical limit is the danger of overstimulating the economy. ### Recommended complementary policy to reduce political costs - Use the interest-on-reserves formula to subsidize commercial banks to provide zero interest rates for small deposit accounts—avoiding a sore point for voters and a stress point for banks. - Communication strategy (three steps): 1. Measure markets’ perception of the effective lower bound and use it as a policy instrument. 2. Make markets aware of central bank tools that can eliminate the effective lower bound and manage side effects (ideally before a recession). 3. Convince markets the central bank is willing to use the new tools as called for. - Practical communication actions: - Demonstrate tools to reduce political costs (e.g., explicitly link tiered IOR to shielding small household accounts). - Demonstrate implementation of a paper currency deposit fee or rental fee at a small dosage (e.g. 5 bps) to show rates are not sticky at zero; examples: Swiss National Bank and Danmarks Nationalbank implemented low-dosage versions, and BoJ’s policy was close to a paper currency rental fee. ### Political economy guidance and timing - Short, deep negative-rate episodes are politically preferable to prolonged mild negative rates; central banks have limited time (authors suggest "say two years") to restore recovery before being blamed for slow recovery and a low natural rate. - Mitigants to political cost: - Pre-communication and making markets aware of tools in normal times. - Subsidizing zero rates for small deposit accounts to shield vulnerable households. - Using low-dosage demonstrations to build credibility and technical experience. ### Comparative assessment and policy guidance - Preferred approaches: - First-best: clean approach (electronic-money crawling exchange rate taking paper currency off par) — fewest undesirable side-effects and operates through the price system. - Second-best: rental fee approach — feasible where legal/political barriers prevent taking paper currency off par; effective but entails side effects requiring active management. - Prohibition approach: can work but likely has the worst side effects. - Policy design: rely on banks for transmission and on the price system where possible; complement with tiered IOR subsidies and selective prohibition elements as needed. ### Conclusions (summary stance) - A lower bound on interest rates has been a serious obstacle to recession-fighting; political challenges have impeded expansion of toolkits to enable deep negative rates. - Readily available approaches exist to enable deep negative rates, empowering central banks to end recessions within a short time; these approaches can “do a lot with a little,” increasing political feasibility and staying within central bank authority. - Best approaches are those that (i) rely on banks for transmission and (ii) do not impose quantity restrictions on cash: the clean approach and the rental fee approach. - Implementation requires creating a negative PCIR at the cash window; effective communication and complementary policies (notably shielding small deposit accounts via interest-on-reserves subsidies) are critical to minimize political costs. - Call for further work by economists, banking experts, lawyers, policymakers, and journalists to enable the option of deep negative rates and maintain monetary policy effectiveness. *Source: IMF working paper wpiea2019084 — Executive Summary and selected sections (wpiea2019084).* ### Executive Summary ...................................................................................................... ### Executive Summary ### Overview and Structure - Table of contents listing main sections and page references as provided: - Executive Summary ................................................................................................................................... 3 - I. Introduction ...................................................................................................................................... 5 - II. History of Thought on How to Create a Non-Zero PCIR ................................................................. 9 - III. The Central Bank Cash Window and the Power to Create a Non-Zero PCIR ............................... 12 - IV. The Clean Approach: Using an Exchange Rate to Create a Non-Zero PCIR ................................. 14 - V. The Rental Fee Approach: Using a Rental Fee to Create a Non-Zero PCIR .................................. 20 - VI. Managing the Side Effects of the Rental Fee Approach ................................................................. 23 - VII. Negative PCIR Based on the Price System vs. Quantity Restrictions ............................................ 36 - VIII. The Withdrawal Limit Approach and the Deposit Limit Approach ............................................... 37 - IX. The Prohibition Approach .............................................................................................................. 39 - X. Combining the Rental Fee Approach and the Prohibition Approach ............................................. 45 - XI. The Supply and Demand of Paper Currency: Contrasting Different Approaches to Enabling Deep Negative Rates ...................................................................................................................... 48 - XII. Brief Literature Review on the Impact of Negative Rates on Bank Profitability and on the Transmission Mechanism ............................................................................................................... 56 - XIII. Is the Transmission Mechanism Different Once the Zero Lower Bound has been Broken? ......... 61 - XIV. Alternative Policies and Complementary Policies to Negative Interest Rate Policy ...................... 72 - XV. Using Communication Tools to Overcome Political Challenges in Implementing Deep Negative Rates ................................................................................................................................ 76 - XVI. Conclusion ...................................................................................................................................... 83 - References ................................................................................................................................................ 85 ### Major Themes (mapped from section headings) - Historical context and theory - II. History of Thought on How to Create a Non-Zero PCIR (p. 9) - I. Introduction (p. 5) - Institutional tools and mechanisms to create non-zero PCIR - III. The Central Bank Cash Window and the Power to Create a Non-Zero PCIR (p. 12) - IV. The Clean Approach: Using an Exchange Rate to Create a Non-Zero PCIR (p. 14) - V. The Rental Fee Approach: Using a Rental Fee to Create a Non-Zero PCIR (p. 20) - Managing implementation and side effects - VI. Managing the Side Effects of the Rental Fee Approach (p. 23) - XI. The Supply and Demand of Paper Currency: Contrasting Different Approaches to Enabling Deep Negative Rates (p. 48) - Policy design alternatives and restrictions - VII. Negative PCIR Based on the Price System vs. Quantity Restrictions (p. 36) - VIII. The Withdrawal Limit Approach and the Deposit Limit Approach (p. 37) - IX. The Prohibition Approach (p. 39) - X. Combining the Rental Fee Approach and the Prohibition Approach (p. 45) - Effects, transmission, and supporting analysis - XII. Brief Literature Review on the Impact of Negative Rates on Bank Profitability and on the Transmission Mechanism (p. 56) - XIII. Is the Transmission Mechanism Different Once the Zero Lower Bound has been Broken? (p. 61) - Complementary policies and communication - XIV. Alternative Policies and Complementary Policies to Negative Interest Rate Policy (p. 72) - XV. Using Communication Tools to Overcome Political Challenges in Implementing Deep Negative Rates (p. 76) - Conclusion and references - XVI. Conclusion (p. 83) - References (p. 85) *Source: wpiea2019084 - Executive Summary (PDF) — table of contents as provided.* ### Executive Summary ### Executive Summary — wpiea2019084 ### Key findings about the zero lower bound (ZLB) and policy challenge - After a decade of zero or near-zero rates, advanced country central banks have raised rates or are considering raising rates—but the ZLB remains a serious obstacle to future monetary policy. - Typical policy-rate cuts during recessions in advanced countries have been 500-600 basis points; at present policy rates in most advanced countries remain too close to zero to make cuts of that size possible without using negative rates. - Simulations (Kiley and Roberts (2017)) suggest the ZLB could be binding 30-40 percent of the time in the future and these episodes are likely to persist for several years. - The ZLB is not a law of nature; it is a policy choice. With readily available tools, a central bank can enable deep negative rates whenever needed—maintaining the power of monetary policy to end recessions quickly. ### Organizing principles and typology of approaches - Organizing principles used in the paper: - (1) the role of banks and the private-sector financial system in transmitting a negative paper currency interest rate (PCIR); - (2) whether the approach requires quantity restrictions on cash or relies on the price system to alter paper-currency returns; - (3) whether the negative PCIR is created via the capital gains term (appreciation/depreciation of cash) or the dividend term in the rate-of-return equation. - The paper surveys historical proposals and presents new approaches. Two approaches judged best (minimum distance from current system and least political cost) are: - (a) the clean approach — an electronic-money system that takes paper currency off par (creates a crawling exchange rate between paper currency and electronic money); - (b) the rental fee approach — keeps paper currency at par at the cash window and imposes a rental fee (negative dividend) on cash held by banks. ### Why rely on banks and the price system - Relying on banks for transmission: - Reduces central bank implementation burden and political cost; political problems become customer-relationship problems for commercial banks. - Most bank-transmission approaches require implementation only at the central bank’s cash window; after minimalist implementation, the private sector can transmit the rest. - Relying on the price system (vs. quantity restrictions on cash): - Reduces administrative burdens and avoids drastic changes in how people transact, thereby reducing political opposition. - Conclusion: approaches that both rely on banks and the price system are at a minimum distance from the current monetary system and likely carry the least political cost. ### The transmission mechanism under deep negative rates - Standard interest-rate transmission mechanisms to aggregate demand are likely to remain unchanged in deep negative-rate territory once the rate of return on paper currency becomes a policy variable and bank health is attended to. - When PCIR is a policy instrument and banks are supported, central banks have effectively unlimited monetary policy firepower; only the danger of overstimulating the economy limits stimulus. ### Recommended complementary policy to reduce political costs - Use the interest-on-reserves formula to subsidize commercial banks to provide zero interest rates for small deposit accounts—avoiding a sore point for voters and a stress point for banks. - Communication strategy (three steps): 1. Measure markets’ perception of the effective lower bound and use it as a policy instrument; 2. Make markets aware of central bank tools that can eliminate the effective lower bound and manage side effects (ideally before a recession); 3. Convince markets the central bank is willing to use the new tools as called for. --- ### The clean approach (electronic-money exchange rate) ### Mechanism - Create a time-varying exchange rate between paper currency and electronic money at the central bank cash window. - Example: to establish a -1 percent PCIR, at the end of the year the central bank would credit only 99 electronic dollars when a commercial bank redeposits a 100-dollar paper note; similarly, issuing paper reduces reserves proportionally. This produces a crawling peg and a capital-gains depreciation of paper currency equal to the PCIR. - Economically equivalent bureaucratic implementations include time-varying deposit fees on net deposits at the cash window that establish an exchange rate (1 - deposit fee). ### Conditions and features - Electronic money must be effectively the unit of account (prices for a significant fraction of expenditure expressed in electronic units). - No quantity constraints on cash are required; policy works through the price system. - The central bank can defend the declared exchange rate because it can create unlimited amounts of either form of money at the cash window. ### Side effects and mitigants - Potential costs: - Psychological and computational costs of paper currency being away from par; - Issues with old debt contracts not denominated in electronic units (can be addressed by legislation or clauses); - Confusion from thinking in paper-currency numeraire; - Costs if some prices are sticky in paper currency. - Mitigants: - Encourage digitalization of payments to strengthen electronic money as unit of account; - Consider central bank digital currency that can have a nonzero interest rate (positive in normal times to set precedent and accelerate digitalization). - Legal challenges: some jurisdictions may face monetary-law barriers to formally creating an exchange rate between two central-bank-issued instruments; partial implementations (e.g., applying deposit fees only to newly issued banknotes) are possible. --- ### The rental fee approach (negative dividend on cash while keeping cash at par) ### Mechanism - Central bank charges a rental fee on cumulative net cash withdrawals by commercial banks at the cash window (a negative PCIR by reducing dividend yield while keeping capital gains term at zero). - Example: to generate a -1% PCIR the central bank announces a 1 percent per annum rental fee on cumulative net withdrawals; the fee can be charged monthly on outstanding cumulative net withdrawals. - Central banks already track net cash withdrawals by bank, so implementation is localized at the cash window. ### Existing precedents - Swiss National Bank (SNB) practice since 2014: negative rate on excess sight deposit balances with exemption thresholds that reflect net increases in cash holdings—effectively imposes a charge on excess cash withdrawals. - Bank of Japan (BoJ) implementation (2016) adjusts tiers and takes into account cash exchanges; BoJ applies negative rates to bank-held cash but has not charged cumulative net withdrawals passed to customers (though it could). ### Transmission and main concern - Main central-bank concern: enabling commercial banks to pass on the rental fee to customers without causing large-scale cash arbitrage (withdraw, store, redeposit) or severe retail frictions. - Central banks can block arbitrage at the cash window; the remaining challenge is minimizing side effects from commercial-bank attempts to pass-through the rental fee. --- ### Managing side effects of the rental fee approach ### Principal side effects identified - (i) Bank profitability problem: difficulty passing negative rates to retail depositors squeezes net interest margins for banks reliant on retail deposits. - (ii) Cash-rental-fee pass-through problem: banks may respond by charging substantial one-time withdrawal fees or restricting cash withdrawals, inconveniencing households. - (iii) Gresham’s Law problem: divergence between “tame” paper currency (with rental-fee obligation) and “wild” paper currency (in the wild without such obligation) can cause hoarding, reduced circulation, and potential centralization of cash storage or emergence of a premium for wild cash. ### Tools and policy responses - Primary recommendation to address bank-profitability risk: - Use the interest-on-reserves formula (tiered remuneration) to subsidize banks in providing zero rates to small household deposit accounts. - Examples: exemption thresholds or tiered systems (SNB, BoJ, Danmarks Nationalbank precedents); or targeted lending facilities (ECB TLTRO-style negative lending rates tied to lending targets). - To manage pass-through problem: - Support bank contract modifications and business-practice changes; allow exemptions for modest per-customer monthly cash withdrawals to avoid inconveniencing households. - Allow commercial banks to experiment with fees, ATM/teller fee structures, and per-customer limits; central bank support and suasion with regulators is important. - To manage Gresham’s Law effects (optional tools): - Use prohibition-type tools selectively (e.g., limits or bans on certain cash-based financial instruments) to reduce incentives for wild-cash premium or centralized storage. - Accept some increase in electronic transactions as a silver lining; reduced cash circulation can accelerate digitalization and law-enforcement benefits. ### Design assumptions and background - Background assumptions used when discussing tools: - Central bank has already set electronic rates negative (policy target and rates applying to marginal additions to reserves); - Central bank has established a negative PCIR at the cash window using the rental fee mechanism to block cash-window arbitrage; - There is a negative between-tax-year interest rate in the tax system (or tax authorities will discourage tax-prepayment hoarding). - Exemption policies can allow households a monthly fee-free cash withdrawal up to a per-customer limit to avoid household inconvenience while preventing large-scale withdrawals. --- ### Comparative assessment and policy guidance ### Preferred approach - First-best: the clean approach (electronic-money crawling exchange rate that takes paper currency off par) — fewest undesirable side-effects and operates through the price system. - Second-best: the rental fee approach — feasible where legal/political barriers prevent taking paper currency off par; effective but entails side effects that require active management. ### Political economy considerations - Short, deep negative-rate episodes are politically preferable to prolonged mild negative rates; central banks have limited time to act before being blamed for slow recovery or a low natural rate. - Complementary policies (interest-on-reserves subsidy to protect small depositors) and effective pre-communication about tools and readiness can reduce political costs. - Legal issues vary by jurisdiction; multiple approaches are presented because one approach may be feasible in one legal environment but not in another. --- *Source: Executive Summary (wpiea2019084) — IMF working paper wpiea2019084, “Executive Summary”* ### 1. It takes care of the bank profitability problem, or the bulk of the bank profitability problem. ### 1. It takes care of the bank profitability problem, or the bulk of the bank profitability problem. ### Key finding: bank profitability - It takes care of the bank profitability problem, or the bulk of the bank profitability problem. ### Mechanism: over-the-limit marker and customer communication - The limit defining what amounts of money are over the limit provides a marker for banks in explaining to customers that large accounts will have the over-the-limit amount subject to negative interest rates. This should make pass-through to large accounts a bit easier for the banks. ### Policy implication: zero interest on small-scale deposits and currency storage - Being able to get zero interest rates on small-scale deposit accounts should reduce the incentive for households to do small-scale paper currency storage. - 34 *wpiea2019084 - 1. It takes care of the bank profitability problem, or the bulk of the bank profitability problem.* ### 4. Avoiding negative interest rates on small deposit accounts avoids a potential political problem ### 4. Avoiding negative interest rates on small deposit accounts avoids a potential political problem ### Political and bank-customer considerations; subsidy via interest-on-reserves - Avoiding negative rates on small retail deposit accounts is important to avert a political/customer-relations problem for the central bank and for commercial banks. - Commercial banks can be relied on to avoid negative deposit rates for small accounts "as long as those banks can do so without hurting the bottom line." - A subsidy through the interest-on-reserves formula ensures that banks can provide zero rates for small deposit accounts without hurting their bottom line. - If (i) the central bank is successful at avoiding massive paper currency storage (and attendant disintermediation) and (ii) the central bank subsidizes zero rates to small deposit accounts, banks should only have a profitability problem if they fail to pass on negative rates to those with large deposit accounts. - Experience in Switzerland, Denmark, and Sweden suggests large or sophisticated depositors adjust quickly to negative rates after initial complaints. - Objective of a two-tier system: have negative rates prevail generally in the markets but shield those least able to understand negative rates (and possibly accomplish some redistribution, though not toward the poorest who may not have bank accounts). *Source: wpiea2019084 - 4. Avoiding negative interest rates on small deposit accounts avoids a potential political problem* --- ### Supporting bank contract modifications that discourage cash withdrawals - Once a negative PCIR is enforced at the cash window, banks have a strong incentive to discourage cash withdrawals to avoid handing out cash at a loss; the central bank should support banks modifying contracts/business practices to limit cash withdrawals. - Central bank and other bank regulators should support banks in their efforts to limit total quantity of cash withdrawals; supervisory rules aimed at soundness may raise legal issues if used for monetary policy objectives. - Ways commercial banks might discourage large household cash withdrawals: - Put fees on each withdrawal transaction at a bank’s own ATMs and impose a maximum amount for each cash withdrawal. - Impose similar fees at human teller windows. - Discontinue cash withdrawals at the teller window, directing customers to ATMs. - Keep a low inventory of cash in the branch (other than ATMs) so tellers often cannot supply large cash amounts. - These fees/restrictions are more acceptable if a certain monthly exemption amount of paper currency withdrawals is free from fees/restrictions. - Central bank can subsidize banks in giving household depositors some amount of paper currency each month that is exempt from rental fees at the central bank’s cash window; suggested “pass-back” exemption formula concept: - monthly rental-fee-free cash withdrawal limit = min{ max per retail depositor, ∑ actual amount withdrawn by depositor retail depositors } - depositors would need an identification number and designate a primary bank to avoid double-dipping. - The central bank could announce it would lower the per-depositor exemption limit if cash withdrawals rose above historical norms or signs of centralized paper currency storage business activity appeared. - If a liquid exchange rate emerges on wild paper currency, an exemption amount is equivalent to a transfer from bank to customer; representing it as an exemption plus proportional rebate if less than maximum might be attractive. - Business depositors: net cash withdrawals over a month are uncommon; banks can charge fees in uncommon legitimate cases (e.g., initial stock of change for a new cash business) without large public reaction. - Monitoring risk: if households perceive a paper dollar in the wild is more valuable than a dollar in the bank, they may withdraw up to the exemption each month; central bank should manage exemption credibility and adjust if necessary. *Source: wpiea2019084 - 4. Avoiding negative interest rates on small deposit accounts avoids a potential political problem* --- ### Taxonomy: price approaches vs. quantity restrictions; withdrawal and deposit limit approaches - The 2x2x2 taxonomy for enabling deep negative rates has three dimensions: 1. Government acting directly vs. relying on financial system to transmit negative PCIR. 2. Quantity restrictions on cash vs. relying solely on the price system. 3. Achieving negative return on paper currency via dividend term or capital gains term. - Quantity-restriction approaches impose limits on withdrawal, storage, or redeposit of cash; price approaches operate through price signals with no physical restrictions. - Withdrawal limit approach (Goodfriend-style): - Put a ceiling on the stock of paper currency (short-circuits arbitrage of withdrawing → storing → redepositing at par). - Creates a freely floating exchange rate between paper currency and bank money when net withdrawals would have occurred if paper currency were at par. - When rates go negative, paper currency would be driven above par and expected to depreciate toward par at the negative nominal interest rate. - Deposit limit approach: - Limit cumulative net deposits in a calendar year to no more than x% of paper currency a bank had on books at the beginning of the year; choose x nonbinding in normal times but binding when interest rates recently negative. - May reduce paper currency value below par (capital loss for existing paper currency holders). - Credibility concern: will the central bank actually limit deposits later when crisis passes? Combining withdrawal and deposit limits may be preferable. - Key trade-offs: - Withdrawal limits enhance asset value of existing paper currency (capital gain); deposit limits hurt it (capital loss). - Both approaches create floating exchange rates for paper currency and risk public consternation/volatility; the clean approach yields a smoother path. *Source: wpiea2019084 - 4. Avoiding negative interest rates on small deposit accounts avoids a potential political problem* --- ### The prohibition approach: tools, nature of arbitrage, and scale challenges - The prohibition approach avoids taking paper currency off par or imposing PCIR at the cash window and instead focuses on legal obstacles to paper currency storage and use as collateral; it limits demand for paper currency. - Nature of feared arbitrage/disintermediation: - Arbitrage requires converting large amounts of government-controlled electronic money into paper currency, safely storing it (from criminals and government), and redepositing at par—on a scale approaching the national debt to impose a lower bound. - Example magnitude: for the US this would mean storing an amount of paper currency close to $20 trillion. - Even before that scale, disintermediation concerns will arise and matter for central banks and banking system stability. - Four prohibition tools (listed in order of priority): i. Ban electrification of paper currency: - (a) Prohibit mutual funds, ETFs, money market funds, or other vehicles that provide electronic funds backed by paper currency. - (b) Impose a ceiling on holdings of paper currency by publicly listed firms and large private firms (example illustration: limit of 3% used as illustrative numeric example). - Purpose: reduce investor dollars attracted to paper currency via electronically tradable assets. ii. Ban storage of paper currency as a business: - Two laws: (1) no legal payment for storing someone else’s paper currency; (2) no one can legally pay more than par for paper currency. - Makes it difficult to centralize paper currency storage and capture scale economies. - Perfect enforcement not required; an illustrative figure: $100 billion of additional illegal paper currency storage would be far short of $20 trillion and unlikely to cause serious disintermediation. iii. Restrict cross-border movement of paper currency: - Aim to avoid offshore money market funds backed by cash and offshore storage businesses; this resembles existing AML/tax-declaration practices. iv. Retire large denomination notes: - Increasing physical storage costs of cash; limitations include storage costs that depend on value not bulk and ability to store large value even in small space with low-denomination notes. - The prohibition approach can work but has the worst side effects of the approaches considered; it targets both banks/large firms and shadow actors/new cash-storage business models. - Monitoring metrics for the prohibition approach: - Stock of paper currency demanded. - Black-market price of untraceable paper currency. - Disintermediation indicators—if any flash red, central bank should consider additional measures. *Source: wpiea2019084 - 4. Avoiding negative interest rates on small deposit accounts avoids a potential political problem* --- ### Combining rental fee and prohibition approaches; role of exemption amounts and subsidies - Rental fee approach: impose a rental fee (or negative PCIR) at the cash window so banks face the cost of cash withdrawals; this preempts paper currency arbitrage and makes deep negative rates broadly feasible. - Combination strategy to keep paper currency close to par while eliminating lower bound: - Use rental fee at cash window plus prohibition approach elements (especially a ban on paper currency storage as a business). - Provide a liberal exemption amount for rental-fee-free monthly cash withdrawals to households and subsidize zero rates for small deposit accounts (via interest-on-reserves formula) to reduce disintermediation incentives. - Key points: - Without a ban on paper-currency-as-business, households would withdraw exemption maximum and sell excess to storage businesses, raising wild cash above par. - A ban on paper currency storage as a business makes the exemption nonbinding for most households; typical households can get up to the exemption at par from their bank, reducing demand for black-market wild paper currency. - Rental fee + prohibition elements (electrification ban, cross-border controls, retiring large denominations) reinforce each other; banning paper-currency-as-business is the key prohibition measure in the combination. - Legislative authority may be required for prohibition measures and rental fee; political feasibility determines available options. - Policy design suggestion: Unless legally barred, adding a rental fee to a ban on paper-currency-as-business is preferable to the ban alone. *Source: wpiea2019084 - 4. Avoiding negative interest rates on small deposit accounts avoids a potential political problem* --- ### Supply-demand framework and graphical insights (ROERC and OCC curves) - Demand for paper currency: Rate of Effective Return on Cash (ROERC) curve - ROERC is downward-sloping, flattening at the store-of-value return (superficial zero) unless storage costs make the flat portion at a nominal rate below zero equal to negative storage cost. - Classical ZLB: ROERC becomes perfectly elastic at zero beyond a point, producing a liquidity trap. - Supply of paper currency: Opportunity Cost of Cash (OCC) curve - OCC incorporates value of reserves (required and excess) and interest on reserves (IOR). - When monetary base is large, OCC is driven down to the IOR (flat portion at left); excess reserve needs create a steep right portion. - Reference: excess reserves below about $1 trillion may raise the opportunity cost of cash above IOR (Ricardo Reis insight). - Equilibrium insights: - With effective lower bound (ELB) slightly below zero: IOR < ELB < 0. Expanding monetary base or cutting IOR without changing PCIR may not lower market interest rates (policy ineffectiveness). - Clean approach: cut IOR and PCIR in tandem to avoid arbitrage and enable deep negative rates with smooth exchange-rate path for cash. - Rental fee approach: increase rental fee while cutting IOR; banks with cash-window access face flow cost of holding cash—similar graphical outcome to the clean approach but different interpretation of ROERC (bank-domain demand vs. whole private sector). - Prohibition approach (without rental fee): demand-side restrictions make ROERC downward-sloping everywhere; cutting IOR becomes effective in lowering economy-wide rate since increased cash storage raises marginal storage cost, bringing ROERC down toward new lower IOR. - Policy implication: the prohibition approach can render monetary policy effective (via IOR cuts or OMOs) depending on monetary base and elasticity of cash demand. *Source: wpiea2019084 - 4. Avoiding negative interest rates on small deposit accounts avoids a potential political problem* --- ### Literature review and evidence on bank profitability and transmission under negative rates - Theoretical contributions: - Brunnermeier and Koby (2016): define a ‘reversal rate’ where interest rate cuts become contractionary because net interest margin declines faster than balance-sheet gains; reversal can occur at positive rates if balance-sheet effects dominate. They omit central-bank subsidies to banks; such subsidies can push reversal rate lower. - Eggertsson et al. (2017, 2019): New Keynesian models with storage costs of money and nominal frictions deliver an effective lower bound; they omit clean/rental fee mechanisms and central-bank subsidies but note those changes could solve ZLB problems. - Matthew Rognlie (2016): negative rates can be optimal given storage costs; negative rates most useful when paper-currency demand is relatively inelastic. - Empirical findings: - Broad evidence is mixed but not decisive against negative rates at mild magnitudes: - Borio et al. (2017): low rates can reduce bank profitability; sensitivity increases as rates fall. - Bikker and Vervliet (2017): net interest margin reductions can be offset by adjusting other margins. - Bech and Malkhozov (2016): transmission from policy to money-market rates similar in negative and low-rate regimes; retail deposit rates insulated from negative rates. - Turk (2016): Danish and Swedish banks broadly stable; deposit rate stickiness at zero; large corporates more likely to have negative deposit rates. - Jose Lopez, Andrew Rose, and Mark Spiegel (2018): cross-country bank panel finds savings on deposit expenses and gains in non-interest income largely offset interest income losses—"surprisingly benign implications of negative rates for commercial banks thus far." - Heterogeneous bank responses: Heider et al. (2016), Basten and Mariathasan (2018), Demiralp et al. (2017) show varying portfolio adjustments and fee responses depending on bank funding structure and excess reserves. - No experience yet with rates below -1%; uncertainty remains for deeply negative territory. - Authors' perspective: - The concept of a reversal rate signals the operational importance of monitoring and supporting bank profits and balance sheets when lowering rates. - Central banks routinely use effective transfers to banks (tiered IOR, targeted loans) to support profitability; these can mitigate reversal concerns. - Clean and rental-fee approaches and subsidies can lower the paper currency return or compensate banks, enabling deeper negative rates. - The prohibition approach can work but likely has the worst side effects; a deposit-limit + withdrawal-limit combination may balance effectiveness, credibility, and side effects better than either alone. *Source: wpiea2019084 - 4. Avoiding negative interest rates on small deposit accounts avoids a potential political problem* --- ### Transmission mechanism once the ZLB is broken - Main claim: transmission mechanism is not qualitatively different once the zero lower bound is broken; standard channels remain operative. - With no money illusion and properly addressed paper-currency and bank-profitability issues, cuts in nominal rates (positive or negative) affect real rates and thus stimulate the economy via standard channels. - Assenmacher and Krogstrup (2018) quoted: "we see no reasons to anticipate that monetary policy transmission to savings and investment behavior would be hampered with deeply negative interest rates"—main uncertainty is nominal money illusion, which can be managed via communication/education. - Policy implication: if paper-currency return problem and bank profitability problem are addressed (via PCIR reductions, rental fees, subsidies, and/or prohibition measures), negative rates are conventional monetary policy tools with potentially unlimited dosage for stimulus. *Source: wpiea2019084 - 4. Avoiding negative interest rates on small deposit accounts avoids a potential political problem* *Italic: Source — IMF working paper section: wpiea2019084 - 4. Avoiding negative interest rates on small deposit accounts avoids a potential political problem* ### 1. a substitution effect on both the borrower and lender; ### 1. a substitution effect on both the borrower and lender; ### Identified effects - 1. a substitution effect on both the borrower and lender; - 2. effective wealth impacts that—aside from the overall expansion of the economy—are of equal and opposite size for the borrower and lender in any borrowing-lending relationship but are likely to interact with a higher marginal propensity to consume for a borrower than for a lender; - 3. exchange rate effects; *Source: https://www.imf.org/-/media/files/publications/wp/2019/wpiea2019084.pdf* ### 4. the knock-on effect from the overall expansion of the economy—a multiplier for interest-rate ### 4. the knock-on effect from the overall expansion of the economy—a multiplier for interest-rate effects ### A. The Principle of Countervailing Wealth Effects - Wealth effects come in offsetting pairs: the wealth effect for the borrower and for the lender in each borrower-lender relationship. - Apart from the overall expansion or contraction of the economy (the source of a multiplier), the effective sizes of the pair of wealth shocks for each borrower-lender relationship are equal and opposite. - The net wealth effect therefore comes down to who has the bigger marginal propensity to spend—the borrower or the lender. ### B. The Effect of Redistributions - If everyone were identical (aside from any multiplier from aggregate expansion), wealth effects from interest rate changes would net to zero because the present value of payments from human and physical capital net of investment matches the present value and pattern of consumption. - In heterogeneous populations, borrowers almost always have a higher marginal propensity to spend than lenders. - "Marginal propensity to spend" defined as the sum of the marginal propensity to consume, the marginal propensity to invest and the marginal propensity to do government purchases given a fall in rates. - Correlation: borrowers tend to have high average propensity to spend; lenders tend to have low average propensity to spend; high correlation between average and marginal propensities. ### C. The Fiscal Arm of the Government as a Party to Borrower-Lender Relationships - Interest rate cuts reduce a key measure of government deficits; in a recession, most governments would likely spend the savings on interest payments due to lower rates. - The authors suspect the marginal propensity to spend out of savings from lower interest rate payments is close to 100% for most governments. - Reactive changes in government spending due to wealth or substitution effects from lower rates should be considered part of monetary policy transmission rather than fiscal policy. - Policies that strengthen the substitution effect on government spending—pursuing capital spending in an interest-sensitive way—enhance monetary policy transmission. - Exception: in hyperinflationary situations, the fiscal arm can be less responsive (lower MPC) to interest rate increases; this "fiscal dominance" is more likely in hyperinflationary than deflationary situations. - Examples: - Governments and Treasury Bill Holders: lower Treasury Bill rates transfer wealth from bill holders to the government, likely increasing aggregate demand. - Governments and Holders of Long-Term Government Bonds: less redistribution; focus shifts to substitution effects and bond-holders shifting consumption forward. - Government Lending: effects depend on whether lending is short-term/floating or long-term/fixed-rate; unclear which side has higher marginal propensity to spend in some cases. ### D. The Central Bank and Private Banks as Parties to Borrower-Lender Relationships - When central bank lending rate and interest on reserves align with target/Treasury bill rates, redistribution from rate cuts is largely between savers and those borrowing from banks, with the central bank mainly a conduit. - Central banks usually have positive net wealth and low direct marginal propensity to spend; funds remitted to the fiscal arm are likely associated with high marginal propensity to spend. - Central bank discretion over remittances and bank support increases stabilization power; recent trends (e.g., in the US) show less discretion for the Fed in remits and bank support. - Paper currency is an asset of the central bank; lowering paper currency interest rate transfers wealth from certain currency holders (including criminals) to the central bank, increasing seignorage often passed to the fiscal arm. - Banks: banks as a whole would benefit from rate cuts except for difficulty passing on low rates to depositors. - Recommendation: central banks should provide effective subsidies through the interest-on-reserves formula to encourage banks to exempt small accounts from negative interest rates (with rules preventing subsidy capture by splitting large deposits across banks). - Rationale: (1) avoids negative rates for numerous small depositors likely to have high marginal propensity to spend; (2) helps banks by undoing harm from negative rates on reserves. - Heuristic: treat banks as if they had a marginal propensity to spend above 100% to capture their amplification role in the economy. ### E. Adding in Borrower-Lender Relationships that Do Not Involve the Government - Few lender-side cases where lender MPC > borrower MPC; one example: retirees holding bonds of companies with no viable investment projects and low dividend propensity. - Aggregation exercises (e.g., Adrien Auclert (2016)) suggest that, appropriately weighted, borrowers overall have a higher marginal propensity to spend than lenders. - Examples of transmission across the economy: - Mortgages: lower rates make houses easier to buy/build; mortgage payers (higher propensity to consume) gain spending capacity; owners of mortgages lose effective wealth. - Car Loans: lower rates ease car purchases—primarily substitution effects—benefiting car buyers and dealers; holders of securities backed by car loans see wealth declines partially offset by substitution effects. - Venture Capital: low rates make startup funding easier/cheaper; substitution toward burn/investment favors idea-holders who typically spend more on realizing projects. - Commercial Paper: lower rates reduce borrowing costs for businesses, easing near-term survival and possibly encouraging expansion; investors in commercial paper lose effective wealth but gain some substitution-induced consumption. - Firms with Liquid Asset Hoards: lower rates reduce returns on hoards, lowering hurdle rates and increasing internal funding for new projects (substitution effect); such firms may have lower MPCs than typical firms or government. - Overall: many channels beyond international capital flows transmit interest rate cuts into aggregate demand. ### F. Effects of Interest Rate Cuts on International Capital Flows and Exchange Rates - If all countries cut rates by the same amount (e.g., "1 percentage point"), international capital flow effects and exchange rate/trade balance effects should be modest. - However, when one country cuts rates while others hold fixed, capital flows can be strong: - Rate cuts cause portfolio shifts away from domestic assets toward foreign assets, producing capital outflows and domestic currency depreciation that raises net exports—an additional substitution effect. - This channel is especially powerful for small open economies. - Important principles: - Historical dominance of a transmission channel does not imply it is essential; other channels can be in reserve and become important if one channel is blocked. - Interest rate cuts should be judged by effect per basis point; a 10 basis point (.1 percentage point) cut should not be expected to have a huge effect merely because it is in negative territory. - For central banks willing to go off the paper standard, there is no intrinsic lower bound other than the risk of overheating. - Wealth effects in open economies vary by asset type and currency denomination: - Domestic asset net positions: net lender in domestic assets reduces power of rate cuts due to negative wealth effect; net borrower in domestic assets increases power due to positive wealth effect. - Foreign-currency-denominated assets: currency depreciation from rate cuts generates capital gains for domestic lenders of foreign assets and capital losses for domestic borrowers of foreign assets. - If lenders have lower MPC than borrowers, depreciation-induced redistribution can reduce aggregate demand effectiveness. - Many countries are net borrowers in foreign-currency-denominated assets, which dampens or can reverse the stimulative effect of rate cuts. - Short-term vs. long-term: wealth effects from local currency assets are larger when assets are short-term or have prepayment options; for foreign assets, short-term vs. long-term matters less for small open economies that cannot affect foreign rates. - Policy implication: borrowing in foreign-currency-denominated assets (sovereign or private) is discouraged because it hampers monetary policy effectiveness. - Edge case: if full set of effects reversed the sign of rate cuts on aggregate demand, central banks could still adjust rates in the opposite direction to influence demand—only a knife-edge zero effect would render them powerless. ### F.iii Sovereign Wealth Funds - Sovereign wealth funds (SWFs) often have lower marginal propensity to spend than the fiscal arm. - If an SWF borrows at the Treasury bill rate to fund investments and has a lower MPC than Treasury bill holders, this creates a negative wealth effect. - However, the MPC differences may be small relative to the higher MPC of those who borrow domestically from the SWF; many SWFs have positive net wealth positions, so their lending effect can dominate. ### XIV. Alternative Policies and Complementary Policies to Negative Interest Rate Policy - Some observers argue the zero lower bound can be managed with fiscal policy, QE, forward guidance, or nominal GDP level targeting; authors note experience (e.g., Japan, the Great Recession) suggests existing tools have not delivered sufficiently quick recoveries and welfare costs can be large. - A. Fiscal Policy vs. Negative Interest Rate Policy - Traditional monetary policy advantages over fiscal policy: - Does not add to national debt. - Can be handled by independent technocratic central banks, less entangled with politics. - Political economy: fiscal policy is hard to technocratize because taxing and spending affect long-run incentives and redistribution. - Using large fiscal measures to replace lower rates would require extreme fiscal policy; in many countries, central banks could implement deeper negative rates without additional legislation, allowing politicians to distance themselves from the policy. - B. Quantitative Easing vs. Negative Interest Rate Policy - QE involves issuing reserves to buy public or private assets; in public assets it is a maturity transformation. - Experience: QE outcomes were better than alternatives but not good in an absolute sense; QE brings uncertain effectiveness, market distortions, unknown side effects, and harmful distributional consequences. - Key concerns with QE: - Scaling up QE may face asymptotes in spread effects. - Large deviations of spreads from historical averages may have undesirable side effects. - Theoretical uncertainty: in simple models QE does nothing (Modigliani-Miller/Ricardian Equivalence); QE effectiveness depends on model specifics and nonstandard elements that are not well understood. - Initial QE may have a "shock-and-awe" effect that is hard to replicate for marginal purchases. - By contrast, simple models emphasize real interest rates as the key variable; negative nominal rates have more straightforward interpretation in many models. - C. Cost of Delays When Using the Alternatives - Large dosages of fiscal policy or QE needed to substitute for deep negative rates have side effects; fear of side effects likely keeps dosages moderate and delays recovery. - Delays in applying sufficient QE or fiscal stimulus can cost "trillions of dollars worth of social welfare" relative to promptly pursuing deep negative interest rates (quoted in source). - Recommendation: promptly pursuing at least some intensification of negative interest rate policy, alongside fiscal expansion and QE as appropriate, is likely to yield better outcomes. *Italic source: wpiea2019084 - 4. the knock-on effect from the overall expansion of the economy—a multiplier for interest-rate effects* ### Section XV, “Using Communication Tools to Overcome Political Challenges in Implementing Deep ### Section XV, “Using Communication Tools to Overcome Political Challenges in Implementing Deep Negative Rates” ### Role of paper currency policy and timing - Even a very small dosage change in paper currency policy might have a substantial “shock and awe” effect. - Delaying use of deeper monetary tools can be costly; “‘buying time’” via large-scale balance sheet operations like quantitative easing (QE) can inject liquidity but “don’t address the underlying issues, and they come with their own set of costs, forms of collateral damage, and unintended consequences.” - Negative interest rate policy that includes reducing the rate of return on paper currency below zero is presented as the straightforward solution to a liquidity trap: “the liquidity trap is simply gone once one changes paper currency policy, and interest rate policy by the central bank can then proceed without constraint.” - Deep negative rates free monetary policy to stabilize the economy; long-run real interest rates and long-run productivity growth remain outside direct control of monetary policy, but enabling deep negative rates removes a distraction from policies to raise long-run productivity growth. ### Microprudential and macroprudential policies as complements to negative rates - Since the 2008 Financial Crisis, central banks worry about the effect of lower rates on financial stability. - The stimulus benefits of lower rates permit increases in capital requirements and tougher macroprudential measures without generating aggregate demand shortfalls; hence macroprudential measures are viewed as complements to negative interest rate policy. - Two interaction points: - Temporarily negative interest rates can help by raising long-term rates; enabling deep negative rates signals to markets that the zero lower bound has been effectively broken and that central banks will use negative rates to close output gaps, making higher future rates more likely. - Lower rates can mask deterioration in credit quality because monthly loan payments fall relative to operating income, increasing the risk of lending to insolvent or “zombie” firms; this can be addressed by tightening prudential tools, for example: - (i) require a strict loan to income ratio to restrict leverage by firms with low operating income, - (ii) impose amortization requirements so firms pay back a portion of principal in each period (noting that typical loan contracts may have a lower payback rate when interest rates are low), - (iii) use an improved supervisory approach for monitoring and classifying non-performing loans to ensure early detection of problem loans. - Concept definitions preserved from the source: - ‘Payback rate’: total payments made by the borrower (interest + principal) in a year as a fraction of the remaining value of the loan; differs from amortization rate because it includes interest payments; indicates the minimum operating income needed to cover required principal and interest payments. ### Depth of recession, required policy intensity, and political risks - Empirical point: for the U.S., Bernanke (2015) shows predictions of a modified Taylor rule with a weight of 1 on the output gap are generally close to actual Fed policy over the past two decades—until the Fed hit its treated zero lower bound in late 2008. Broadly, larger output gaps have been met with larger interest rate cuts. - Theoretical point: many models imply a negative output gap lowers attractiveness of investment; if investment adjusts slowly, the more negative the output gap, the lower the interest rate needed to stimulate investment—“the deeper the recession an economy is in, the lower a central bank needs to push interest rates in order to stimulate the economy.” - Political consequences: - Failure to provide sufficient stimulus in deep recessions (for example due to perceived zero lower bound) makes recovery slow, which can erode public trust and generate political attacks on central banks. - Persistent mildly low rates (instead of short-lived deep negative rates) risk creating the perception central banks control medium- and long-run interest rates (the natural rate), provoking concerns from pension funds and savers. - Central banks face political costs whether they act or do not act; these must be weighed against each other. The paper argues central banks generally have only a short period (“say two years”) to restore recovery before being blamed for slow recovery and a low natural rate. ### Mitigating political costs: three basic strategies - Political costs cannot be avoided but can be mitigated by: - Having deep negative rates be as much as possible an out-of-equilibrium phenomenon that is defended hypothetically (reducing need to implement). - Explaining tools of deep negative rates clearly, both before use and during use. - Subsidizing zero rates for small deposit accounts to protect vulnerable households. - Rationale: paying a modest political cost now to defend deep negative rates hypothetically can reduce the probability that actual deep negative rates must be defended later. ### Three-step communication plan (recommended) - 1. Measure markets’ perception of the effective lower bound and treat it as a policy instrument. - 2. Make the market aware of central bank tools that can eliminate the effective lower bound and can manage associated side effects (if possible before a recession). - 3. Convince markets that the central bank is willing to use the new tools as called for by: - demonstrating that the central bank has tools to reduce political costs of negative interest rates (such as avoiding negative rates on small households), and - demonstrating implementation of the paper currency deposit fee or the paper currency rental fee at a small dosage (e.g. 5 bps) to show that rates are not sticky at zero. - Note: “the Swiss National Bank and the Bank of Japan have already demonstrated the paper current rental fee at a small dosage. However, they did not do much to communicate how important and how powerful this tool is.” ### Measuring markets’ perception of the effective lower bound - Market perception can be inferred from the term structure of interest rates using shadow-rate models: - Example cited: ECB and Deutsche Bank staff developed a modified arbitrage-free ‘shadow rate’ term structure model to infer market perception of the effective lower bound on euro-area interest rates (Lemke and Vladu, 2016). - Their finding: “A decrease in the lower bound parameter leads to assigning positive probabilities to rate realizations that had been infeasible under the old lower bound. This leads, ceteris paribus, to a decrease in expected rates, forward rates and spot rates. The strength of the effect is stronger, the closer forward and spot rates were ranging to the lower bound before its shift. Overall, these results have an important implication for monetary policy: if the central bank manages to decrease the market’s perceived location of the lower bound, it can thereby decrease forward and spot rates, even in a situation where the lower bound is not yet binding.” - The market’s perception of the effective lower bound is therefore treated as a policy instrument that a central bank can influence but not directly control. - Similar exercises and conclusions are referenced for Kortela (2016) and Grisse, Krogstrup and Schumacher (2016). *Source: Section XV of wpiea2019084 — “Using Communication Tools to Overcome Political Challenges in Implementing Deep Negative Rates.”* ### conclusions. Grisse, Krogstrup and Schumacher (2016), use an event study of yield reactions to selected ### Conclusions ### Lowering markets’ perception of the effective lower bound - Grisse, Krogstrup and Schumacher (2016) find that long rates tended to drop in response to changed market beliefs about the location of the lower bound; central bank communication about the possible use of negative interest rates, or limits to this use, can have important effects on the monetary policy stance through the effect on markets’ beliefs about the location of the lower bound. - Recommendation: central banks facing the zero lower bound should act and communicate to drive down perceptions of the effective lower bound, treating markets’ perception as a policy tool. - Benefits of lowering perceived effective lower bound: - It can lower long rates. - Shifting perceptions and lowering the floor on long-term rates enhances the impact of quantitative easing (Rostagno et al., 2016). - It increases credibility for the inflation target directly (lower perceived floor on short-term rates) and indirectly (lower perceived floor on long-term rates). - Caution: pushing down the perceived effective lower bound may eventually raise rather than lower long-term rates if perceptions become low enough, by alleviating downward pressure from fears of being stuck at the bound and fostering “hope for return to the Great Moderation” and “hope for the return of a normal yield curve.” In a recessionary situation, such a rise in long-term rates can reflect expectations of a stronger near-term economy and be desirable for financial stability. ### Make the market aware of central bank tools to eliminate the zero lower bound - Two key steps to lower market perceptions: (1) make markets aware of tools that eliminate any effective lower bound and mitigate associated side effects; (2) convince markets the central bank is willing to use those tools. - Emphasize bank-centric tools working through the price system: the clean approach and the rental-fee approach. - Communicate about these tools in normal times (not only during deep recessions) to prepare markets and increase confidence in the central bank’s ability to fight deep recessions. - Support from prominent policymakers: at the 2016 Brookings Hutchins Center Event, Narayana Kocherlakota urged the Fed to talk openly about available tools; Ben Bernanke stressed that confidence in the Fed’s ability to address deflation affects current interest rate settings. ### Convince markets the central bank is prepared to use new tools - Two practical demonstrations to increase credibility: - Show central bank tools to reduce political costs of negative interest rates (e.g., avoiding negative rates on small households). - Demonstrate implementation of a paper currency deposit fee at a small dosage (e.g. 5 basis points / 5 bps) to show rates are not sticky at zero. - Political signaling advantages: - Demonstrating willingness to pay a modest political price during normal times increases confidence the central bank will pay larger political costs if deep negative rates are needed. - Protecting small household accounts: - Signal commitment to avoiding negative rates on small household accounts; use interest on reserves formula to subsidize zero rates for small households. - Several central banks have used tiering to subsidize banks, but no central bank has explicitly linked subsidies to shielding small household accounts; making this link explicit could yield political benefits. - Paper currency deposit fee implementation at small dosage (e.g. 5 bps) advantages: - Sends a strong market signal and boosts credibility. - Likely reduces markets’ perception of the effective lower bound and affects long rates. - Allows technical refinement of procedures before larger dosages may be needed. - Unlikely to affect most daily transactions since banks/retailers unlikely to pass on such a small fee. - Concentrates public criticism during a period when costs are low, easing later defense. - Note: Swiss National Bank and Danmarks Nationalbank have implemented low-dosage versions of the paper currency rental fee; Japan’s policy was close to the paper currency rental fee. These events were not used as communication opportunities beyond minimal mention; the rental fee approach requires framing and emphasis. ### Benefits of increasing central bank and broader government confidence in tools - Confidence in tools to eliminate or push down the effective lower bound yields several benefits: - Affects the optimal inflation target: ability to rely on negative rates can reduce the need to raise an inflation target (example: Bank of Canada’s decision context, Witmer and Yang, 2016; Bernanke 2016). - Eliminating the zero lower bound via the clean approach opens the possibility of a zero inflation target for major central banks (Agarwal and Kimball, 2015); rental fee approach could also reduce optimal inflation targets compared to treating the lower bound as fixed. - Removes the tradeoff between macroprudential measures and aggregate demand by providing two unencumbered tools for financial stability and aggregate demand. ### Distinguishing deep negative rates for brief periods from mild negative rates for long periods - Recommended policies emphasize deep negative rates for brief periods rather than mildly negative rates for extended periods. - Common misconception: negative rates must prevail for a long time. - If the long-run natural rate remains positive in nominal terms, deep negative rates that quickly close the output gap can be raised back to positive rates soon after. - Authors’ view: there is no known theoretical reason why the output gaps likely in the next recession could not be largely closed within 18 months or so given large enough interest rate cuts; the discussed policies can remove limits on how large interest rate cuts can be. - Quick recoveries allow deep negative rates to be short-lived; by contrast, mildly negative rates insufficient to spur quick recovery would need to persist for a long time, raising costs. ### Summary conclusions and policy stance - A lower bound on interest rates has been a serious obstacle to recession-fighting; political challenges have impeded expansion of toolkits to enable deep negative rates. - Central message: readily available approaches exist to enable deep negative rates, empowering central banks to end recessions within a short time; these approaches can “do a lot with a little,” increasing political feasibility and staying within central bank authority. - The best approaches for enabling deep negative rates are those that (i) rely on banks for transmission and (ii) do not impose quantity restrictions on cash: the “clean approach” and the “rental fee approach.” - Implementation requires creating a negative paper currency interest rate at the cash window; effective communication of logic and commitment is critical to minimize political costs and to stress that deep negative rates can remedy the economy quickly. - Complementary policy: encourage and support banks in providing zero interest rates on small deposit accounts even when other assets face negative rates; this should be a core element of each approach. - Call for further work by economists, financial and banking experts, lawyers, policymakers, and journalists: enabling the option of deep negative rates is critical for maintaining monetary policy effectiveness and mitigating prolonged recession hardship. *Conclusions (content unit wpiea2019084 - conclusions).* ### References ### wpiea2019084 - References ### Negative interest rates, zero lower bound, and policy frameworks - Agarwal, R. and Kimball, M., 2015. 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