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Negative nominal interest rates: history and current proposals

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Abstract

Given the renewed interest in negative interest rates on base money—or equivalently ‘taxing money’—as a means for overcoming the zero bound on short-term nominal interest rates, this article reviews the history of negative nominal interest rates starting from the ‘taxing money’ proposal of Silvio Gesell up to current proposals that received popular attention in the wake of the financial crisis of 2007/2008. It is demonstrated that ‘taxing money’ proposals have a long intellectual history and that instead of being the conjecture of a monetary crank, they are a serious policy proposal. In a second step, the article points out that besides the more popular debate on a Gesell tax as a means to remove the zero bound on nominal interest rates, there is a class of neoclassical search models that advocates a negative tax on money as efficiency enhancing. This strand of the literature has so far been largely ignored by the policy debate on negative interest rates.

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Notes

  1. See Buiter (2009a) for a suggested distinction between the two.

  2. Note that a periodic “tax on money” can also be interpreted as a ‘negative interest rate’ on base money holdings. However, one has to distinguish this from negative short term lending or borrowing rates or the short-term policy rate. We will do this by referring to all the latter rates as negative short-term rates and when we use ‘negative interest rates’ we refer primarily to negative rates on base money—which are the policy instrument for setting negative short-term nominal interest rates.

  3. See Bartsch (1994) for the history of the free-economy movement.

  4. A short history of these experiments can be found in Blanc (1998).

  5. For a concise introduction to Gesell’s utopia of an ‘akratic’ society see Bartsch (1989, pp. 24–31).

  6. See Werner (1990) and Onken (1999) for overviews on Silvio Gesell’s life and work. Ilgmann (2009) offers a short discussion on Gesell’s place in the History of Thought.

  7. He called this money Freigeld (free money) because his monetary reform was designed to create a truly competitive economic system, which he called the “Manchester System”, the economic order which has been the ideal of all true lovers of freedom—[…]’ (Gesell 1958, p. 12). See Ilgmann (2009) for a summary of Gesell’s political economy.

  8. Dullard established striking theoretical similarities between Keynes, Gesell and the Proudhon (Dillard 1942b, pp. 75–76), with Gesell ‘primarily interesting as the link between the other two’ (Dillard and Roemheld [1940] 1997, p. 6). In a further article on Keynes’ political economy, Dillard (1946, p. 149) argued that ‘Keynes’ judgement of the relative merits of Marx and Gesell, […], would seem to reveal much more about Keynes than it does about either Marx or Gesell’ and in his book on Keynes, Dillard (1948, pp. 322–323) maintained that studying Gesell indeed furthers the understanding of Keynes’s theoretical innovations.

  9. See also Michael Herland (1977) and Jérôme Blanc (1998, 2002). The most radical view is put forward by Guido Preparata (2002) who accuses Keynes of plagiarism of Gesell’s idea of a monetary rate of interest. Darity (1995) comments on the similarities in their political economy.

  10. This interpretation of the General Theory is suggested in Ilgmann (2009). It is supported by various statements made in defence of the General Theory, e.g. Keynes (1937a, p. 216): ‘The rate of interest obviously measures […] the premium which has to be offered to induce people to hold their wealth in some other form than hoarded money.’ He also defended his view in an article in The Economic Journal where he stated ‘[…] the rate of interest is that rate at which the demand and supply of liquid resources are balanced. Saving does not come into the picture at all (Keynes 1937b, p. 668) (Keynes and Robertson 1938, pp. 318–319): ‘Now that we have got away from the idea of the rate of interest being depended on saving and have reached the idea of its being in some sense a monetary phenomenon, the remaining difference of opinion cannot be fundamental and agreement should be within reach.’ Such an interpretation is not entirely new. Several Post Keynesian authors have underlined their interpretation of Keynes by referring to Keynes’ praise for Gesell. See, for example, Argitis (2008, pp. 251–253), Davidson (2000, p. 49), and Cowen and Krozner (1994, pp. 387–388).

  11. The following paragraph draws on the interpretation of Gesell and Keynes’ embracing comments as suggested by Ilgmann (2009).

  12. Gesell’s matter of concern was the achievement of price stability in an environment where money keeps circulating steadily and interest rates are low. His periodic tax on money was meant to disincentive the hoarding of money without recurring to high interest rates or positive inflation rates. Therefore, it is not comprehensible that Gesell was labelled an ‘inflationist’ by Ludwig von Mises (1952F), F.A. Hayek (1976) and other Austrian economists.

  13. Gesell was comparatively well-known pre-World War II, as is shown by Dillard’s (1942a, p. 348) list of works referring to Gesell and by his appearance in the Encyclopedia of the Social Sciences (Garvy 1975, p. 392).

  14. ‘Now I range myself with the heretics. I believe their flair and their instinct move them towards the right conclusion. [….] There is, I am convinced, a fatal flaw in that part of orthodox reasoning […] due to the failure of the classical doctrine to develop a satisfactory and realistic theory of interest’ (Keynes 1935, p. 36).

  15. Krugman (1998), in his seminal work, argued that Japan faced a liquidity trap-like situation at that time. We use the term in the sense of Krugman (1998, p. 137), who defines it as ‘that awkward condition in which monetary policy loses its grip because the nominal interest rate is essentially zero, in which the quantity of money becomes irrelevant because money and bonds are essentially perfect substitutes’. A deflationary spiral is described as a situation, ‘where inflation and expected inflation fall, nominal interest rates at some point come up against the zero bound, real interest rates rise, aggregate demand and expected inflation fall even further, real rates rise by yet more, and so on’ (Yates 2004, p. 427).

  16. Benhabib et al. (2002, p. 559) have rightfully pointed out that for a liquidity trap to persist, the existence of some lower bound is a sufficient condition, given that the central bank conducts a Taylor-type monetary policy.

  17. ‘One of the most striking features of the economic landscape over the past twenty years or so has been a substantial decline in macroeconomic volatility.[....]Similar declines in the volatility of output and inflation occurred at about the same time in other major industrial countries, with the recent exception of Japan, a country that has faced a distinctive set of economic problems in the past decade’ (Bernanke 2004).

  18. Some authors even questioned whether liquidity traps had developed at all during the Great Depression (Bordo and Filardo 2005, p. 817), although the latter is widely held as the textbook case (Ullersma 2002, p. 276).

  19. At the time of writing (October 2010), the Federal Funds target rate is still between 0Z% and 0.25%, the Bank of Japan target rate is at 0.1%, the Bank of England’s rate is 0.5% and the ECB main refinancing operation is 1%.

  20. van Suntum et al. (2010) propose long-term central bank lending as way for reducing the floor-to-market rates against zero.

  21. A more throrough treatment of this proposal is given in van Suntum et al. (2010).

  22. Buiter (2009b, p. 223) concludes therefore that ‘the only domestic beneficiaries from the existence of anonymity-providing currency are the underground economy’.

  23. The idea of a “hot potato effect” of inflation goes back at least to Diamond (1984). See Liu et al. (2009) for some empirical evidence.

  24. See for example Rupert et al. (2000, chapter 4) and Shi (2006) for an extensive overview over the literature based on the search–theoretic approach.

  25. Kocherlakota (1996) establishes that necessary conditions for the essentiality of money are the lack of complete memory and of full commitment to future actions. The latter follows from the usual assumption of random-matching and rules out the use of credit, while the former inhibits the use of punishments to trigger gift-giving equilibriums. See also Corbae et al. (2002) for models with directed search where money remains essential as long as agents are restricted to one bilateral trade per period.

  26. The use of simulation methods to keep track of these distributions is very cumbersome. See Molico (2006) and Molico and Zhang (2006).

  27. Most monetary search models deal only with the spending aspect and do not treat the possibility of lending idle balances.

  28. See also Liu et al. (2009) as an excellent formal treatment of money taxes in the first generation model of Li (1995).

  29. Note the resemblance to the proposal of Mankiw (2009) to induce a carrying cost on notes through the withdrawal of all notes of a randomly selected series or denomination.

  30. Moreover, Liu et al. (2008) provide also a formal treatment of money taxes in a second generation search model.

  31. Note, however, the various contributions to study the effects on inflation in these environments, e.g. Lagos and Rocheteau (2005), Rocheteau and Wright (2005), Ennis (2009), Nosal (2008), Liu et al. (2008, 2009).

  32. This is done following Cogan et al. (2010) who study government spending multipliers in a New-Keynesian macro-model.

  33. See Woodford (2003) as an example of a large literature on optimal monetary policy with this view.

  34. See for example Yates (2004, pp. 446–449) discussion on the merits on ‘money rains’ to overcome the zero bound.

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  1. Department of Economics, University of Muenster, Münster, Germany

    Cordelius Ilgmann

  2. Department of Economics, Universidad de Alicante, Alicante, Spain

    Martin Menner

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CAWM Discussion Paper No. 43—January 2011

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Ilgmann, C., Menner, M. Negative nominal interest rates: history and current proposals. Int Econ Econ Policy 8, 383–405 (2011). https://doi.org/10.1007/s10368-011-0186-z

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