We’ve spilt a fair few pixels on the potential limits of negative rates and proposals to get around the pesky zero lower bound. Citi’s Buiter has weighed in on this for some time and has done so again on Thursday.
To wit:
We present three practical ways to eliminate the ELB: i) abolish currency, ii) tax currency or iii) remove the fixed exchange rate between zero-interest cash currency and central bank reserves/deposits denominated in a virtual currency.
There’s more in the usual place for those who want it but, for now we thought we might just pull out his list of disadvantages to getting rid of cash — a subject he’s obviously visited plenty of times before before, say in 2009 for example when he said that “[Cash] is a redundant, indeed dominated medium of exchange and means of payment for legitimate transactions”.
But back to Thursday (with our emphasis):
First, and probably the most common, is that abolishing currency will constitute a noticeable change to many people’s lives and change often tends to be resisted. A recent estimate suggests that currency is still used in 85% of global consumer transactions.11 But it is worth noting that in the advanced economies at least (and many emerging markets), there is an ever-growing range of electronic payment and settlement vehicles, and currency has virtually become a redundant medium of exchange and means of payment for legitimate, legal transactions (see e.g. Bolt (2006)). Among legitimate payments, currency is mostly used for smaller retail payments, which is why the share of cash in transactions by value is usually much smaller than by volume. For instance, in the US, cash is used in 46$ of consumer transactions by volume, but only in 23% by value (Bargnall et al (2014)).The use of cash is also steadily declining.12
Second, currency use remains high among the poor and some older people. That is true even in advanced economies. At most, this would call for the preservation of low-denomination coins and currency, certainly nothing larger than a $5 note and it would not be necessary for the central bank to provide such currency, potentially in unlimited amounts, on demand. Making a limited amount of small-denomination currency available would be a combination of our first and third proposals (the third one being allowing for an exchange rate between currency and central bank reserves). A limited amount of small-denomination currency available would be unlikely to ever be an effective constraint on the central bank’s ability to set policy rates. Having said that, in our view, it would be preferable to provide the ‘great unbanked’ with automatic access to a bank account instead of retaining the limited use of currency. The benefits in terms of social and financial inclusion are likely to outweigh even non-trivial costs of account opening.13
Third, central banks and governments would lose seigniorage revenue. This is true, and the amounts of money involved can be non-trivial, unless there were to be an offsetting and significant increase in the demand for the other components of the monetary base. For instance, required reserves that pay less than the interest rate on non-monetary financial instruments would be a source of seigniorage and if excess reserves have some material non-pecuniary convenience yield, the central bank could even make profits on excess reserves held by the central bank. Seigniorage, the resources that can be appropriated through the issuance of central bank liabilities (including currency) that pay less than the market yield on otherwise similar non-central bank liabilities can be an important source of state revenue, either for the central bank or for its beneficial owner, typically the Ministry of Finance or Treasury, or for both. For example, over the course of 2014, the stock of euro bank notes and coins increased by €61bn (0.6% of GDP). For the Federal Reserve, the increase in the stock of coins and notes was $87bn (0.5% of GDP). Elsewhere, we have pointed out the significance of seigniorage for central bank loss-absorption capacity and fiscal issues.14
Fourth, abolishing currency would inevitably be associated with a loss of privacy and create risks of excessive intrusion by the government (and other would-be inspectors). The well-known monetary economist Charles Goodhart indeed refers to the proposal to abolish currency as “shockingly illiberal”. But this cost has to be seen against the cost that the anonymity of currency presents to society. Even though hard evidence is hard to come by, it is very likely that the underground economy and the criminal community are among the heaviest users of currency (where the value of anonymity that currency provides is likely to be the highest). Evidence consistent with this hypothesis includes the fact that high-denomination notes account for a rather large share of total currency outstanding (e.g. €500 notes account for almost 30% of total currency outstanding in the Eurozone by value15). In our view, the net benefit to society from giving up the anonymity of currency holdings is likely to be positive (including for tax compliance).
Fifth, switching exclusively to electronic payments may create new security and operational risks. At times, payment systems, or other critical elements of infrastructure needed for transactions, book-keeping or appraisal purposes, may be unavailable or malfunctioning. It is true that anything that can be programmed can probably be hacked – there is no such thing as an absolutely secure ‘cyber currency’. But technological progress in IT (and notably payment systems) remains swift and should further reduce the incidence of outages and malfunctions over time. In addition, it is hardly true that currency works particularly smoothly, with the risk of forgery and counterfeit money probably at least as prevalent for currency as it might be for electronic payments.
All very sensible, we’re just not 100 per cent with him on the conclusion:
In summary, we therefore conclude that the arguments against abolishing currency seem rather weak.
Do they though? And even if they do, we’d suggest weak arguments can still manifest as large barriers which even current trends will struggle to overcome any time soon.
Related links:
Cancel currency? — John Cochrane
Alphaville’s emoney file
Alphaville’s ZLB file
Alphaville neg rates file
Printing clever weird stuff … aka money – Toby Nangle
Overcoming the zero bound on nominal interest rates with negative interest on currency : Gesell’s solution – Buiter and Panigirtzoglou (2003, pdf)
