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Tuesday, June 03, 2003

Technological Solutions to the Zero Bound?

Thanks to Brad Delong for putting up this link to a zero bound article by two economists at the Dallas Fed. It is clear that, with a little imagination, the technology exits to overcome this as a technical problem. But if the deflation problem is not, essentially, a monetary one, the substantive problem still remains: what to do about it? Let's just hope there's a learning curve in there somewhere, and these are esperiences we have to go through before we get to grips with the real problem. Question is: how much time have we got?

The most daring suggestion for escaping the zero-interest-rate trap is one that eliminates the zero lower bound altogether. How can this be done? As noted in the first part of the presentation, the zero bound on interest rates exists because money pays a sure nominal interest rate of zero. No one would be willing to hold any asset that pays a negative nominal rate, as long as zero-interest money is available as a store of value. The strategy for eliminating the zero bound, therefore, is to make money pay a negative nominal interest rate, by imposing some type of "carry tax" on currency and deposits.

It’s easy to envision such a system with regard to deposits at the Federal Reserve or transactions deposits at banks; for the most part, the technology to implement such a system is already in place. A tax or fee on Reserve deposits of 1 percent per month, for example, would mean that those deposits, in effect, pay a nominal interest rate of roughly minus 12 percent. The technological difficulty lies mainly in imposing such a tax on currency. In the 1930s, Irving Fisher of Yale University, one of the greatest American economists, proposed such a system, in which currency had to be periodically ‘stamped’, for a fee, in order to retain its status as legal tender. The stamp fee could be calibrated to generate any negative nominal interest rate that the central bank desired. While the technology available for implementing such a system is more sophisticated today than in Fisher’s time, enforcement still seems a mammoth problem, involving physical modifications to currency and some means of tracking the length of time each piece spends in circulation.Given the technological hurdles involved in its implementation, a carry tax on money may not be feasible as a response to any events that might transpire in the next year, though it certainly merits study as a possible response to events that might transpire in the next decade. This is particularly the case if achieving and maintaining price stability makes bumping up against the zero interest rate bound a more frequent event.
Source: Federal Reserve Dallas

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