Negative interest rates, hot potatoes, and banks

Let's start out very simple.

The central bank issues banknotes, and those banknotes are the only type of money that people use, to buy and sell everything else. It really doesn't matter if people keep those banknotes in their pockets or if they keep them in a shoebox at the central bank with their name on it. If they keep them in their pockets, they buy things by putting their banknotes in the seller's pocket. If they keep them in a shoebox at the bank, they buy things by sending a form letter ("cheque") or email (Interac) telling the bank to take the notes out of the buyer's shoebox and put them in the seller's shoebox. Pockets and shoeboxes are all the same. And it really doesn't matter if the shoeboxes and notes all get burned in a fire, as long as the bank keeps a record of how much virtual money is in each person's virtual shoebox.

Remember that MV=PT. Stock of Money times Velocity of circulation = Price level times Transactions.

There are two ways the central bank can increase MV:

It can increase M (by printing more money and buying something with it). Each individual wants to get rid of that extra money, and can get rid of the extra money by spending it, though this is impossible in aggregate, though their attempts to get rid of it by spending it cause PT to rise. We call this the "hot potato" effect.

It can increase V. There are two ways it can increase V.

One way to increase V is to tell people it will increase M in future, so that people expect P to rise in future, so the increased expected rate of inflation reduces the real rate of interest people earn by holding money in their pockets or shoeboxes.

The second way to increase V is to reduce the rate of interest it pays people for holding money in their pockets or shoeboxes. It could reduce that rate of interest below 0% if it wishes. Silvo Gesell advocated paying a negative interest rate on holding money, precisely to increase V.

Again, each individual can get rid of unwanted money by spending it, though this is impossible in aggregate, though their attempts to get rid of it by spending it cause PT to rise. Again, we call this the "hot potato" effect.

If people hold money in their shoeboxes it is administratively very easy for the central bank to pay positive or negative interest on the money people hold. Computers can do this easily. But if people hold money in their pockets it's administratively harder to pay positive or negative interest.

Now let's complicate the story a little.

The central bank decides to retain a monopoly on the money-in-pockets business, but decides to privatise the money-in-shoeboxes business. (Yes, this is totally ahistorical; the commercial banks existed before the central bank, and used to issue their own money-in-pockets.) Several competing commercial banks take over the money-in-shoebox business, issuing their own (virtual) notes that are only allowed to be kept in shoeboxes at the issuing bank. But the central bank makes one exception to its decision to get out of the money-in-shoebox business; it will allow the commercial banks to keep the central bank money they own in a shoebox at the central bank, if they want. Regular people must keep their central bank money in their pockets.

Each commercial bank promises to fix the exchange rate between its own money and central bank money at one-to-one. It does this by promising to swap the two monies in either direction. The central bank makes no such promise (though it promises to help the commercial banks keep their promises in an emergency, by acting as lender of last resort, provided they get their act together quickly). This asymmetrical hub and spoke system of fixed exchange rates, where it is the commercial banks and not the central bank that is responsible for fixing the exchange rate, is what gives the central bank its power. This is what makes the central bank the alpha leader and the commercial banks the beta followers. The alpha central bank can make its money more valuable or less valuable; the beta commercial banks just have to follow along, to keep their exchange rates fixed.

Regular people can use either commercial bank money-in-shoeboxes or central bank money-in-pockets to buy things from each other. One is more convenient in some cases, and the other is more convenient in other cases. The two types of money are substitutes, but not perfect substitutes. The commercial banks are in direct competition with each other, but in limited competition with the central bank, for regular people's money business.

But the central bank is the bankers' bank. The commercial banks use central bank money between themselves. If a regular person buys something using BMO money-in shoebox from another regular person who wants TD money-in-shoebox, the two commercial banks transfer central bank money from the BMO shoebox to the TD shoebox at the central bank.

Commercial banks can pay any interest rate they want, positive or negative, on their money-in-shoeboxes, subject to direct competition from other commercial banks, and subject to limited competition from the central bank. (And they can charge any other fees they want, like fees for sending them form letters or emails.) The central bank can also pay any rate of interest it wants, positive or negative, on its money-in-shoeboxes. (And shoeboxes can contain negative amounts of money, or red notes with negative value, called "overdrafts", with a spread between the interest rate on positive balances and the interest rate on negative balances.) But it is administratively difficult for the central bank to pay interest, positive or negative, on money-in-pockets. So that money always pays 0% interest.

Commercial banks, just like the central bank, can increase their M by printing money and buying something with it. And what commercial banks normally buy, and what the central bank normally buys, is non-money IOUs. But the central bank normally buys IOU's signed by the federal government; and commercial banks normally buy IOU's signed by regular people. They call this "making a loan".

Which is basically what the Canadian monetary system looks like.

If there were no money-in-pockets, so regular people only used commercial bank money-in-shoeboxes, and commercial banks only used central bank money-in-shoeboxes, it would all be quite simple. If the central bank wanted to increase MV, it could increase M by buying something now, or increase V by promising to increase M in future, or increase V by reducing the interest rate it pays on money. This creates a hot potato effect between the commercial banks, as each commercial bank tries to get rid of central bank money. But that creates a second hot potato effect between regular people, because the way commercial banks try to get rid of their central bank money is by buying IOUs and by reducing the interest rates they pay on their money.

Hot potato central bank money creates hot potato commercial bank money. Which is exactly what the central bank wants, if it wants to increase PT.

And it makes absolutely no difference to this story whether nominal interest rates on holding money are positive or negative.

But the central bank money-in-pockets messes up this nice neat pyramid of stacked hot potatoes. Because the nominal interest rate on money-in-pockets is stuck at 0%. So if interest rates on money-in-shoeboxes fall, while the interest rate on money-in-pockets stays the same, commercial banks will face greater competition from central bank money for regular people's money business. Which they won't like.

If the two types of money became perfect substitutes at a 0% rate of interest, so that regular people would switch completely to using money-in-pockets if money-in-shoeboxes paid a negative rate, this would be the end of commercial banks. But they very probably aren't. We haven't seen much sign of people doing this as nominal rates of interest have fallen a lot over the last few decades. And money-in-pockets just seems so inconvenient for many purposes.

But there may be a psychological barrier from banks' customers to being paid negative rates of interest. A bit like a mirror-image of the old prejudice against usury on "barren" money.

And reducing the interest rate paid on money is only one way for central banks to create a hot potato and increase MV.

[This is my version covering the same ground as Scott Sumner and Frances Coppola. (I love how Frances talks about banks playing "pass the parcel", but I must insist on "hot potato" as the traditional metaphor, and in pass the parcel you want to be the one holding the parcel when the music stops, while in hot potato you want to avoid holding it).]

Comments

[JKH]

"Each commercial bank promises to fix the exchange rate between its own money and central bank money at one-to-one. It does this by promising to swap the two monies * IN EITHER DIRECTION *. The central bank makes no such promise."

I believe you've somewhat tweaked your original idea/description of "asymmetric redemption".

Am I wrong?

[Nick Rowe]

JKH: I would say I've clarified it. The "asymmetric" bit was always supposed to be an asymmetry between the commercial bank and the central bank. It's about *who* promises to buy or sell, not between buying and selling.

If Canada reverted back to fixed exchange rates, the Bank of Canada pegs the Looney to the USD, by promising to buy or sell at a fixed exchange rate. The Fed does not peg the USD to the Looney, and makes no promises. That puts the Fed in charge of US+Canada. If it were the other way round, the BoC would be in charge of Canada+US.

[Henry]

"Silvo Gesell advocated paying a negative interest rate on holding money, precisely to increase V."

Nick,

Just as the hot potato effect won't work in aggregate, won't that also apply in aggregate in trying to increase V?

[Henry]

OK I've done it again. Forget the question.

[Nick Rowe]

Henry: ;-) Actually, that's an interesting point. If the bank refuses to buy back its money, the players can't get rid of it. Each individual can choose his M, but they can't all choose M. But it's different with V. They can all increase V. And I think that's one advantage of thinking in terms of MY=PT instead of Md=Ms.

[Lord]

It can pay less interest or it can charge less interest, working on credit and term premiums which is probably more effective.

[Mike Sproul]

"Each individual wants to get rid of that extra money, and can get rid of the extra money by spending it, though this is impossible in aggregate, though their attempts to get rid of it by spending it cause PT to rise. We call this the "hot potato" effect."

But the new money wouldn't have been printed unless people wanted it enough to bring in stuff of equal value. And if people somehow get too much money anyway, then either it would reflux to the central bank, or other moneys issued by private banks would reflux to those banks. Either way, printing money won't affect PT.

[Henry]

Nick,

OK. Forget the bank side of things mentioned in your last post. I canned the question because I realized that in your next sentence in your set piece you made the same point I raised in the question. I figured in aggregate even if everyone transacts their money and they end up with it back again transactions still occurred, leaving the appearance of increased V. Is that what you are saying?

[Britonomist]

Nice post. So what I'd ask in this scenario is this: what happens if there are no worthwhile IOU's left for the commercial banks to buy (only IOU's left are so risky their expected return is near zero or lower)? How would increasing M increase MV in this case? I suppose this doesn't affect the potency of negative rates (as banks may choose zero or lower return from higher risk IOU's than negative rates), but since market monetarists generally think increasing M alone is sufficient (even at ZLB) then this question becomes pertinent.

[Scott Sumner]

I always assumed that if the rate on interest on bank reserves fell, and the rate of interest on cash stayed at zero, then the net effect was higher velocity for base money. Might that be wrong? And if so, what can we learn from the fact that negative IOR announcements seem to cause currencies to depreciate? Is that the empirical test that I assume it is?

[Henry]

Being the monetary ingénu that I am I've always thought of V as a balancing item in an equatorial threesome - it just falls out and has no real meaning. Of what use is it in monetary policy making?

[Nick Rowe]

Scott: let me think. If the CB cuts interest on bank reserves, then banks will hot potato those reserves, creating more commercial bank money, and also cut interest rates on deposits, both of which create hot potatoes for regular people, which pushes up prices of other goods and assets, including the prices of foreign currencies. But the opportunity cost of holding currency relative to demand deposits has fallen, so there will be a currency drain, which will reduce the magnitude of those effects. (I'm holding total base money constant.)

Britonomist: Thanks! In that case, if there is absolutely nothing commercial banks are willing to buy, when the central bank increases base money total money increases one-for-one with base money. People are still left holding more money than they initially desired.

Henry: yes.

Mike: "But the new money wouldn't have been printed unless people wanted it enough to bring in stuff of equal value."

No. Money is not like other assets. Money is the medium of exchange. If I sell you my car for $1,000, that does not mean I plan to hold that extra $1,000. I plan to spend it on something else, like a bike. I prefer the bike to the car. I do not prefer the money to the car.

Lord: yes, interest rates on non-money IOUs will fall too.

[Tom Brown]

Nick, this is a clear and easy to understand post, but it seems like something somebody like Miles Kimball has been fretting about for awhile now (i.e. the "cash problem" with negative interest rates). (At one time I was interested in this problem, and he had some good articles on his blog addressing it). BTW, I'm glad to see you're still using the "buys IOUs" phraseology. :D

[Tom Brown]

O/T: Nick does my PPF question here make sense? (I know you love your PPFs)

[Handle]

I wonder if the ban on usury created an economy-wide bias in favor of investment in the form of equity over debt, and, if so, whether there were any significant macro or historical effects of such a bias.

[Britonomist]

"Thanks! In that case, if there is absolutely nothing commercial banks are willing to buy, when the central bank increases base money total money increases one-for-one with base money. People are still left holding more money than they initially desired."

Well, not everybody in this case, just commercial banks. They have more money than desired, but if there's no good IOU's then the hot potato effect wont work so increasing M would have no effect. Wouldn't fiscal stimulus be needed in this case if you wanted to increase MV?

[Nick Rowe]

Tom: your PPF question makes sense. I could rig up an example where it works, e.g. you can't plant half an apple tree.

Handle: probably. But it's very easy to get round bans on interest. Just issue zero-coupon bonds, that sell at a discount to face value.

Britonomist. No. Not unless the central bank runs out of things to buy. The central bank can still create money. It's just that commercial banks now have 100% reserves at the margin, so the marginal money multiplier is one. We only have one hot potato process, not a stacked pyramid with 2 layers of hot potatoes. It's just like my original simple example, at the margin.

[Nick Rowe]

Tom: no forget that 1/2 tee example. You need some sort of complementarity between apples and bananas. One is a by-product of the other, or they like growing side-by-side.

[Tom Brown]

Nick, thanks. So a PPF can have slope > 0?

[Nick Rowe]

Tom: put wool on one axis, and mutton on the other axis. Technology is sheep. But if you allow free disposal of wool and mutton (you can throw away any excess you don't want), you get a rectangular PPF.

[Frances Coppola (@Frances_Coppola)]

Hi Nick,

Well, I could have said musical chairs. But yes, "hot potato" is what it is usually called.

There seems to be a considerable amount of "stickiness" about that negative rate. Banks are very reluctant to pass it on to depositors. I'm not sure why this is, but I suspect that - given how unpopular banks are already - they are afraid of a political backlash.

Clearly, though, if they did impose negative rates that were deep enough to drive people to physical cash, we would see disintermediation and a return to a cash-based economy. That would reduce the effectiveness of monetary policy, unless steps were taken to impose the negative rate on physical cash as well. Your reference to Gesell money is therefore timely.

If, as a result of banks passing the negative rate on, people started to switch to physical cash, and the central bank responded by imposing a negative rate on physical cash - thus driving people back to banks - then banks collectively would be unable to avoid the negative rate on reserves.

[Nick Rowe]

Hi Frances C! Good to see you here.

You can't use "Musical Chairs", because Scott Sumner has already sat down on that metaphor and is using it for something quite different! Sorry, I'm getting silly.

"There seems to be a considerable amount of "stickiness" about that negative rate. Banks are very reluctant to pass it on to depositors. I'm not sure why this is, but I suspect that - given how unpopular banks are already - they are afraid of a political backlash."

You might very well be right, and if so it's important. I don't understand it either. It might be something like the zero lower bound on nominal wage changes. One weird thought: there's this very very old anti-usury sentiment, going back at least to Aristotle, which doesn't like positive interest rates because "money is barren". I wonder if we are seeing some sort of mirror image of that??

[Frances Coppola (@Frances_Coppola)]

Nick,

I think you are right that this is similar to wage stickiness. Since negative rates are usually imposed in order to counter zero to negative inflation, we are clearly in the realms of money illusion. But I also think we are touching on "entitlement". People have come to believe that money in banks should return nominal par or (preferably) much better. I've had lots of arguments with savers about this. They expect their money to be safe AND to receive a positive return on it. They see transaction and savings accounts as a public service, and are indignant at the very idea of having to pay for safe storage of their money. And they vote.

[Nick Rowe]

Frances C "But I also think we are touching on "entitlement"."

Sounds plausible. Funny, I was just chatting with Frances W at lunch about this. People feel there's some sort of magic investment tree out there somewhere, that banks have access to, that always grows at rate r%, so the banks take your money, invest it in that investment tree, take a cut for themselves, then give you back what's left. Something like Knight's "Crusonia plant" IIRC. Except it doesn't exist. And it takes real management, as well as luck and skill, and the right circumstances, to find positive safe returns. They aren't always out there to be found.

[Frank Restly]

Frances,

"But I also think we are touching on entitlement. People have come to believe that money in banks should return nominal par or (preferably) much better. I've had lots of arguments with savers about this. They expect their money to be safe AND to receive a positive return on it."

As a saver, I expect that if I am putting my money at risk, I should have a say in how that money is deployed (who gets a loan / who doesn't). If Joe Blow off of the street is entitled to a bank loan without talking directly to me (as saver) first, then I am entitled to some protections from my bank making an ill advised loan to Joe.

The money returned at nominal par or better is really a compromise. Both parties (saver and borrower) gain an entitlement.

[Frances Coppola (@Frances_Coppola)]

Frank,

my experience of savers is that when they put their money in banks, they DON'T think they are putting their money at risk. In common parlance, if you say you "bank on" something, you mean you rely on it. And if you "bank" something, you've stored it somewhere safe.

The problem is that savers have come to expect positive nominal returns on savings in banks, but without risk. In these days of zero interest rates, positive risk-free nominal returns are very hard to come by.

[JKH]

OT

Nick,

I think your "CPI standard" idea might be helpful in this debate:

http://www.coppolacomment.com/2016/02/the-problem-with-words.html

[Frank Restly]

Frances,

I get what you are saying. However, savers also have come to expect that they have no say in how their money is put at risk - what loans get made / what loans don't get made. My point was that this is a double edged sword - if we expect savers to accept losses then we should also expect savers to take an active role in the deployment of their savings.

[Majromax]

@Frank Restly:

We don't expect savers to accept risk-based losses on nominal deposits held at banks. That's why banks carry mandatory deposit insurance, and why bank failures that result in depositors losing anything are both rare and avoided by policymakers.

This psychological barrier might impact consumer responses to negative deposit rates, however.

[Frank Restly]

Majromax,

"This psychological barrier might impact consumer responses to negative deposit rates, however."

This is not a psychological barrier. This is a bi-directional convenience. If you want bank depositors to be treated as share holders that bear risk, then you should expect that those shareholders are going to want greater control in the day to day operations of the bank. It doesn't matter if that risk comes from exposure to loan defaults or negative deposit rates.

[Tom Brown]

Nick, thanks, that makes sense. Is there a similar example out there with no free disposal? I don't see any slopes > 0 out there in general.

[Majromax]

@Frank Restly:

You're not using "risk" in a consistent sense of the word. Since negative interest rates on reserves would be assessed regardless of a bank's loan activity, any transfer of those negative rates to depositholders does not convey a stake in the bank's loan activity or other day-to-day operations.

[Frank Restly]

Majromax,

"..any transfer of those negative rates to deposit holders does not convey a stake in the bank's loan activity or other day-to-day operations.."

Unless the deposit holders (and their elected representation in Government) insist that negative interest rates do convey a stake in the bank's day to day operations. The U. S. central bank has stayed away from negative interest rates precisely because they are on shaky legal ground. If the banking industry tries to push towards negative rates on reserves and deposits, I would expect some push back from depositors.

[dlr]

Good post Nick. Apologies in advance for all the noise I'm about to make.

Minor points:

(1) One issue that doesn't get enough explicit attention is how the both the price level and price path are affected by a particular monetary regime, like IOR. As you say, a lower IOR, assuming that the naturally reduced future M from lower or negative IOR is offset by additional future OMO, should increase V. But it should not increase future P, or at least might not. So this is "expansionary" in the sense of putting upward current pressure on the price level, but not in the sense of expectations about a higher future price level; but whether this kind of expansion works compared to increasing future P depends on how you think about the sticky price or other friction that causes nominal disruption in the first place. In an extreme example, we could imagine steeply negative IOR combined with a somewhat lower future M (or implied price level target than before) putting immediate upward pressure on the current price level while yet lowering expectations for the price level in 18 months. Whose version of sticky price or alternative frictions does this scenario alleviate? Not everyone's. Compare this to an IOR regime where we assume future P actually increases in tandem with the lower or negative IOR, similar to a standard reverse stock split. This puts no upward pressure on the current price level (V is unchanged) but does increase the future expected price level as the split(s) occur (i.e. as M increases relative to its counterfactual expectations amid lower IOR). Again, this may alleviate some frictional stories but not others.

(2) A third way to increase V in your story is to make people expect lower IOR in the future. This works only in case (a), where the lower IOR comes implicit with an unchanged future M. In that case, V increases immediately even if the lower IOR expectation is purely in the contingent futures curve.

More on topic:

(1) It's worth noting that it is possible for your IOR story to both work well and avoid ruining banking even if banks don't lower deposit rates in response. Banks could payer higher rates on deposits, accept lower net interest margins, but charge higher fees in other areas (not simply on deposits) or provide fewer services. As long as those other areas were mostly stuck within the banking system, this is a sustainable equilibrium (though it could have perverse effects on industry structure similar) and doesn't necessarily prevent transmission of the IOR effect to the price level via the expectations channel. This is where monetary policy gets unavoidably complex, because the contingent reaction function of the CB is always in play. What happens if the CB helicopters out a bunch of money but it all lands in a bottle that can't be opened? The policy might still work if people think they'll find a way around the bottle eventually.

(2) Finally, my main point. I think the negative rate ramifications for banking is even more complex than Frances implies in her good post, and the equilibrium result is very difficult to capture by building up mechanical puts and takes such as whether lending increases in response to lower rates and how this might then affect banks' risk and capital profiles. This point is a combination over my above points, because a negative current IOR is just a component of the new expected future price path and rate curve, while banking industries across countries are complex and heterogenous. It is extremely difficult to take much from deposit rate responses at Dankse or Nordea, because so many things happen simultaneously and hidden from view. For example, bank returns on equity should decline as capital levels increase all else equal, and we have seen notable risk adjusted capital increases in Denmark, Sweden and most other place during these same negative IOR periods. In my view, the expected risk adjusted returns on equity for 2016 have not declined more for banks in countries with negative IOR than those without, even though current NIMs have declined somewhat more, though this is a near impossible argument to make comprehensively. Some effects can be strange or country-specific such as mortgage margins increasing for Danish banks like Jyske, TotalKredit and Nykredit amid interest rates going negative. I am not saying there is nothing to the sticky-wage analogy when it comes to reluctance to impose negative deposit rates -- I think there is -- but rather that it very debatable how much of this effect is quietly offset in other areas that are not obvious because they are merely counterfactual changes as opposed to absolutes.

[Tel]

Each individual wants to get rid of that extra money, and can get rid of the extra money by spending it, though this is impossible in aggregate, though their attempts to get rid of it by spending it cause PT to rise. We call this the "hot potato" effect.

This is just wrong. As I keep pointing out, the majority of our money exists in the form of debt, not as cash notes being handed around. Debt can be created (we know that, because there's a whole lot more debt now, both private and public, than there was 50 years ago) and because the rules of accounting are linear and reversible, debt can also be destroyed, just as easily as it was created.

People can get rid of money "in aggregate" by two possible methods: either pay back the debt a little at a time, or else go bankrupt and default on the debt causing a write-off.

Since we are talking about aggregates here, there is a natural churn as new debt is created while old debt is destroyed. The balance depends on which happens faster.

[Nick Rowe]

dlr: Thanks. And good comment.

Your minor points:

1. I *think* you are saying: if we assume zero OMO, then the growth rate of M equals the rate of interest paid on M. Assume perfectly flexible P, for simplicity. Normally, if we increase the growth rate of M, we get a one-time jump in P plus higher inflation thereafter. But if we increase the growth rate in M by paying interest on M, we lose that one-time jump in P, but still get higher inflation. If we assume sticky prices, it's more complicated, and we might initially get a fall in inflation, depending on the sort of stickiness.

Is that what you are saying?

Yep. I ignored that point in this post, for simplicity. I was implicitly assuming that OMO is used to offset any effects of changing interest on the growth rate of M. But what happens to expectations in reality....I don't know.

2. I think I get you there. Because it changes expected inflation? Good point. I missed seeing that one.

Your major points:

1. In a competitive commercial banking system, wouldn't fess on transactions be determined by the bank's costs of doing those transactions? An interest on deposits equal the returns banks earn on loans, net of costs?

2. I need to think about that one.

[Nick Rowe]

Tel: if one person hands the hot potato back to the bank that created it, the bank will turn around and re-create it, putting the hot potato back into circulation. Because the bank has its own hot potato problem.

[Frances_Coppola]

Hi dlr,

Great comment. Couple of things:

1) fees are a way of imposing a negative rate without being seen to do so. Imposing fees on anything other than serives associated with demand deposits - for example, hiking arrangement fees on working capital finance - could significantly interfere with the transmission of monetary policy.

2) there's obviously considerable scope for idiosyncratic conditions to mask the macroeconomic effects of negative interest rates. My general objection to negative rates is not so much that they are contractionary - though they could be - as that they are seriously distortionary and their effects are almost impossible to predict.

[Tel]

... the bank will turn around and re-create it, putting the hot potato back into circulation.

That's hardly an absolute rule. Your statement was, "this is impossible in aggregate" with emphasis on impossible being quite a strong constraint, I would say.

The bank may choose to lend out new debt (presuming they can find a worthy borrower), or may choose to park excess reserves at the Fed (as they are doing), they could even choose to hand back deposits and close shop. The mystical "money multiplier" may get a bit larger or smaller... but all outcomes are strictly possible. The amount of leverage the banks want to extend themselves out to, and the type of assets they are willing to take a risk on are all variable choices, indeed those are the very crux of banking. If we could write iron rules for any of that, then we could replace the entire banking industry with a perl script. Perhaps that's a nice outcome to aim at, but we aren't quite there yet. Besides, maybe it could turn out better to keep the bankers, and replace the economists with a perl script... I'm just throwing ideas around here.

At any rate, I remain immovable on my position that it is possible to pay down debt (and/or write it off), and thus effectively siphon money out of the system. It may not happen that way, depending on various individual choices, but that's a different question.

By the way, it is also possible for a government to run many years of surplus and thus siphon even the cash notes out of the system. After all, fiat currency is ultimately only redeemable as tax payments, so with sufficiently high taxes and low government spending all of it will be redeemed. This too is possible although admittedly highly unlikely. At any rate the debt-money is larger and more elastic than the cash notes, so it would be the more significant factor in any aggregate shift.

[rafaminos]

nick,

long-time reader of your blog and first post here.

did you ever think of helicopter money you can't hoard,say gift certificates with expiration date available anywhere, as a mean to solve the paradox of hoarding ?
I reckon it would increase the hot potato effect compared to tradional helicopter money.

let's say the central banks hands over an USD 1000 gift certificate to all households with a fixed expiration date.
It will, of course, be spent.
You might say that ricardian equivalence will induce people to save that amount (hoarding their usual medium of exchange) , because of expectations of higher taxes.
In that case, make it sufficently big and the hoarding that people can make on the usual medium of exchange won't be enough to offset it.

[Nick Rowe]

rafaminos: then welcome to the comments!

I have vaguely thought about it. At first sight it puts a lower limit on velocity of circulation: spend it or lose it. Trouble is, the person who gets it when you spend it has to spend it even more quickly, and so on. Money that expires sooner would be worth less than money which expires later, so the seller would want to check the expiration date of each note. The whole thing could unravel backwards, with money being worthless on the expiration date, and so worthless one second before,.....and so on, so it's worthless immediately. Nobody will accept it, because they know they won't be able to pass it on to the next person.

[rafaminos]

nick,

for my trick to work, the seller should not be able to refuse the gift certificate for payment (as it is the case for say the USD)
in the end, it looks a lot like a gesell tax that goes from o to infinity with a vertical jump just before expiration.

[rafaminos]

I realize that it is better to just setup a gesell tax.
It has the same effect on V but lets the market forces do the heavy lifting with incentives to consume more.

My idea is a bit too extreme and requires a great reduction in freedom to work as you pointed out.
I assume people would not be too happy to receive money that is worthless for sure.

[Frank Restly]

Tel,

"At any rate, I remain immovable on my position that it is possible to pay down debt (and/or write it off), and thus effectively siphon money out of the system."

One other thing to note is that presumably existing debt arrangements would remain fixed while negative interest is being paid on currency / demand deposits. This would effectively raise the net interest that an individual would pay on an existing loan.

Today I have $100 and $200 of debt.
Assuming that the negative interest rate on money is 5% annual and the loan rate is 5%.
Next year, if I do nothing I have $95 and $210 of debt.

Facing a rising debt cost that was not contractually agreed to - which is the more likely scenario - individuals with existing debt rush to buy goods (Nick's hot potato hypothesis) or rush to pay off existing debt?

[Too Much Fed]

JKH, does the lender of last resort function rely on the commercial bank(s) being solvent?

[Too Much Fed]

Nick said: "The central bank decides to retain a monopoly on the money-in-pockets business"

Nick, does money-in-pockets business mean currency (including coins) and vault cash?

"it will allow the commercial banks to keep the central bank money they own in a shoebox at the central bank, if they want."

Does that mean what I call central bank reserves (others may say just bank reserves)?

"Several competing commercial banks take over the money-in-shoebox business, issuing their own (virtual) notes that are only allowed to be kept in shoeboxes at the issuing bank."

Does that mean demand deposits of the commercial banks?