Wednesday, May 28, 2014

Is It Time To Eliminate Paper Currency?

The answer is yes according to Ken Rogoff:
Has the time come to consider phasing out anonymous paper currency, starting with large denomination notes? Getting rid of physical currency, and replacing it with electronic money, would kill two birds with one stone.

First, it would eliminate the zero bound on policy interest rates that has handcuffed central banks since the financial crisis. At present, if central banks try setting rates too far below zero, people will start bailing out into cash. Second, phasing out currency would address the concern that a significant fraction, particularly of large denomination notes, appears to be used to facilitate tax evasion and illegal activity.
Not so fast. One can solve the zero lower bound (ZLB) problem without eliminating paper currency. All that is needed is to either (1) allow the exchange rate between deposits and paper currency to fluctuate or (2) have a systematic approach to monetary policy that is very aggressive when the treat of the ZLB is looming. The former would create a discount on paper notes during slumps so that the Fed could impose a negative nominal interest rate on deposits and get away with it. The latter would use a nominal GDP level target which would both raise money velocity via expectation management and commit the Fed to do whatever is necessary to hit the level target. Both approaches should take care of the ZLB problem. Miles Kimball has written extensively about the first approach and Scott Sumner done the same for second one. Read here for the details of these plans.


  1. They have never attempted to hit absolute zero, so this complaint is bogus.

    The relationship between MB/NGDP and short rates is very robust, and is very nonlinear. If they tried to hit and keep "absolute zero" short term rates, they just might find that the monetary base goes infinite, which would solve their false "ZLB problem".

    Also, within the monetary base, currency has a robust relationship with NGDP reflation. (Reserves, not so much.) Reserves affect interest rates, but not nominal output. Economies at very low interest rates need more, not less, currency in their monetary base to raise nominal output.

    IMHO, eliminating currency is mostly about gaining all-encompassing financial control and surveillance, not helping the economy.

    Not that the FT will ever tell you this.

  2. Anonymous, yes, your solution is essentially the same thing as the NGDP option above. That is the one I have long advocated.

  3. Negative interest is crazy: it makes it profitable to engage in negative output. E.g. I borrow at minus 10%, buy something that declines in value at 5% a year and then sell a year later at a profit.

    Only professional economists could think up a way of bringing about negative output, i.e. wealth destruction.

  4. Zero bound applies to interest rates - which don't have much to do with pumping up AD in a deleveraging environment. Before the introduction of the payment of interest on IBDDs (between 1942 & Sept 2008), the CBs always bought short term securities whenever they had excess reserve balances. This had the effect of boosting both the money stock & reserves. With a remuneration rate in excess of all money market rates its has the effect of only boosting excess reserve balances. Thus the remuneration rate has emasculated the Fed's "open market power".

    Consider that the resumption of CB lending/investing is not necessarily an important factor in our continued economic recovery. Dropping the remuneration rate would reinvigorate non-inflationary NB lending/investing (where savings are matched with investment). I.e., it would restore the wholesale funding market for the NBs that Bankrupt U Bernanke destroyed (bolstering NIM in the borrow short - to lend long savings-investment paradigm).

    For an explanation of non-bank (non-inflationary), vs. commercial bank (inflationary), lending/investing (traditional vs. shadow) see:

    "Should Commercial Banks Accept Savings Deposits?” by Leland J. Pritchard, Edward E. Edwards, and Lester V. Chandler at the 1961 Conference on Savings and Residential Financing in Chicago, Illinois

  5. "money still matters"

    Neither Dr. Paul Spindt’s “debit-weighted-money-index”, nor Dr. William Barnett’s “Divisia – aggregates”, nor the FRB-STL's "Monetary Services Indexes" (MSI) created by Dr. Richard Anderson & Dr. Barry Jones correctly define the money stock. Money is the measure of liquidity.

    The non-banks are the customers of the commercial banks. Thus all demand drafts originating from the NBs clear through the CBs. Therefore bank debits are a much more accurate measure of the money stock & money flows. That being the case, legal (required reserves) represent AD better than M4. And RRs are based on transaction type deposit accounts 30 days prior. Rates-of-change in RRs are a proxy for bank debits as bank reserves largely driven by bank payments (debits). Then - for the last 100 years the lags for monetary flows have been mathematical constants.

  6. Money flows are cumulative figures. Roc’s in short-term money flows (proxy for real-output), are always a mirror image of the seasonal economic inflection pattern (I.e., empirical evidence that roc’s in MVt = roc’s in real-output).

    First column = proxy for real-gDp. Second column = proxy for inflation:

    01/1/2014 ,,,,, 0.16 ,,,,, 0.34
    02/1/2014 ,,,,, 0.13 ,,,,, 0.38
    03/1/2014 ,,,,, 0.14 ,,,,, 0.32
    04/1/2014 ,,,,, 0.15 ,,,,, 0.33
    05/1/2014 ,,,,, 0.15 ,,,,, 0.39
    06/1/2014 ,,,,, 0.14 ,,,,, 0.35
    07/1/2014 ,,,,, 0.14 ,,,,, 0.30
    08/1/2014 ,,,,, 0.09 ,,,,, 0.26 projected short-fall in AD
    09/1/2014 ,,,,, 0.09 ,,,,, 0.27
    10/1/2014 ,,,,, 0.02 ,,,,, 0.23
    11/1/2014 ,,,,, 0.02 ,,,,, 0.22
    12/1/2014 ,,,,, 0.03 ,,,,, 0.16

  7. Roc's in MVt = roc's in nominal-gDp (proxy for all transactions in Irving Fisher's "equation of exchange"). I.e., the decline in money flows (real-gDp), during the 1st qtr of 2014 exhibits the identical pattern as the decline in money flows (real-gDp), during the 1st qtr of 2011.

  8. There is always the problem of "deferred payments" when using the money metric (or money flows), to match the offsetting sale of goods & services (nominal-gDp). There is also an problem with measuring the turnover of money due to sudden & disproportionate swings (in both the enlargement or reduction), of the money stock.

    The best methods to eliminate any "noise" when comparing money flows (payments), with goods & services is to (1) use identical time periods, (2) to use the historical, distributed lag effect, & to (3) ignore the seasonally mal-adjusted data.

  9. Nice read! Very informative. Did you know that? Kingfisher sets its sights on expansion beyond Europe. Full story here:

  10. FT:

    Electronic currency isn’t free from crime
    From Ms Janet Tavakoli.
    Sir, It seems to me Kenneth Rogoff’s commentary, “Paper money is unfit for a world of high crime and low inflation” (May 28), is less about deterring crime and the problems of “low” inflation – food consumers in the US know double-digit inflation – than it is about eliminating the zero bound on interest rates and preventing people from bailing into cash.

    In other words, Mr Rogoff proposes to machinegun one of the lifeboats by eliminating paper currency as an alternative to unlimited digital currency.

    His specious argument about the anonymity of paper currency facilitating tax evasion and crime is propaganda.

    Massive programmes of drug- money laundering and tax evasion were facilitated with electronic currency. International banks eagerly participated in those crimes and the subsequent cover-ups. Banks that are ongoing beneficiaries of government subsidies paid taxpayer-subsidised fines, but senior officers did no jail time.

    If Mr Rogoff is interested in deterring crime, he might consider that. These are the people who are supposed to be, in part, stewards of sound sovereign currencies, and they never fail to disappoint.

    Janet Tavakoli, President, Tavakoli Structured Finance, Inc. Chicago, IL, US

  11. Currently we have a managed-currency system - a system in which the volume of currency in circulation is impersonally determined by the total effective demands of the public or the amount which meets most closely the needs of trade (for the underground economy, or black market, or whatnot).

    If you redeposit currency into the banking system, you will not change the total volume of the money stock, but you will increase the volume of excess reserves held by the commercial banks. I.e., you add to the "exit" problem.

  12. I am surprised that in all these years the US has never phased out a currency. They keep saying $3,000 per capita in circa, and that in Benjamin Franklins. Sure, Aunt Millie keeps $900 in her pocket.

    So, one day the Treasury says we have a really new $100, with a portrait Steve Jobs on it, and the Franklins have to be traded in for the Jobs. BTW, at the bank we will ask "How did you get so much money?"

    OT question for Beckworth: John Cochrane has written a paper to the effect the Fed should keep a large balance sheet---I guess that suggests keeping the one it has now. I know you like that idea, but do you have a take on his paper?

    1. Benjamin, I need to read it more closely before commenting.

  13. A large part of the "underground" economy is driven by tax avoidance. If you eliminate currency, then a lot of small loans from the lower economic strata will be called in. That would not help with job creation.

  14. Cumulative monetary flows (our means-of-payment money times its transactions rate-of-turnover), are not increasing, they have been decreasing. The 24 month moving average (of the 24 month roc), shows this.

    Bonds prices can become both cheap & expensive -depending upon how long they move in the same direction (up or down).

    This mirrors the CPI which peaked in Sept 2011 @ 0.039 and has been falling ever since (now @ 0.013). Using a 6 month moving average for the CPI, it shows a clear & steady downward trend.

    parse: dt, NSA cpi, yoy cpi, 6 month moving average NSA cpi

    06/1/2012 ,,,,,,, 0.026
    07/1/2012 ,,,,,,, 0.024
    08/1/2012 ,,,,,,, 0.021
    09/1/2012 ,,,,,,, 0.019
    10/1/2012 ,,,,,,, 0.018
    11/1/2012 ,,,,,,, 0.018
    12/1/2012 ,,,,,,, 0.018
    01/1/2013 ,,,,,,, 0.018
    02/1/2013 ,,,,,,, 0.018
    03/1/2013 ,,,,,,, 0.019
    04/1/2013 ,,,,,,, 0.018
    05/1/2013 ,,,,,,, 0.016
    06/1/2013 ,,,,,,, 0.015
    07/1/2013 ,,,,,,, 0.015
    08/1/2013 ,,,,,,, 0.016
    09/1/2013 ,,,,,,, 0.015
    10/1/2013 ,,,,,,, 0.015
    11/1/2013 ,,,,,,, 0.015
    12/1/2013 ,,,,,,, 0.014
    01/1/2014 ,,,,,,, 0.014
    02/1/2014 ,,,,,,, 0.013
    03/1/2014 ,,,,,,, 0.013
    04/1/2014 ,,,,,,, 0.013

    The cpi is fallilng. QE3 has failed.