Kenneth Rogoff: Negative interest rates are an emotional topic, too

Presenting the second post in a blog series by Kenneth Rogoff, author of The Curse of Cash. If you missed the first installment, read it here.


The book continues to create a vigorous debate about moving to a less-cash (not cashless) society with only smaller denomination bills; you can see various TV and radio discussion here. Below I’d like to respond to a provocative review in the Wall Street Journal.

But first a few other points that have come up: the gun lobby continues to seem particularly exercised about losing large bills. Perhaps the concern is that without convenient large notes, the government might have an easier time enforcing registration and background checks on people who buy firearms. A broader take is the American Thinker piece “Washington’s Endgame: First Your Guns Then Your Cash.” I can only say that I am not very sympathetic.

I try in the book to efficiently cover every possible misconception that people might have about where all the missing big bills are (even the spirit world), but I am afraid I missed one. Writing in the Numismatic News, Patrick A Heller suggests that we all should know “that a sizeable percentage of this (missing cash) is held by central banks as reserves.” Well, not really. Foreign central-bank dollar holdings are almost entirely in the form of electronic bills and bonds. Some foreign banks do hold physical U.S. dollars to meet customer demand, but most world holdings of dollars are in the underground economy (crime and tax evasion). As the book discusses extensively, foreign demand mostly likely accounts for less than 50% of total U.S. dollars outstanding.

In his thoughtful Finance and Development review, Peter Garber asks why not just make $100 bills larger and bulkier, then we don’t need to get rid of them. Well, if we make them ten times heavier and ten times bulkier, yes, that would be another approach (albeit not equivalent to mine, because tenfold oversized notes would be easier to tabulate, and you could probably pack them tighter unless the bills are larger still). But seriously, what is the difference, the symbolism? Anyway, I have no objections to leaving a giant $100 bill for collectors. Garber also argues that if the physical dollar becomes less prominent internationally, the electronic dollar will suffer. Maybe once upon a time that was true, but it is almost irrelevant today in the legal tax-paying world, domestic or foreign. Also, let’s not forget my plan leaves plenty leaves small bills, so the symbolism is still there.

This takes us to Jim Grant’s Wall Street Journal review. Several people I respect think Grant is a very smart guy who likes to be provocative, but I would to take up some of his simple errors and profound misconceptions.

Grant has little interest in the main part of the book, which argues that the large notes, which dominate the currency supply, do far more to facilitate tax evasion and crime than legal transactions. He posits that it would be so much simpler to legalize narcotics and simplify taxes, and that “Mr. Rogoff considers neither policy option.” In point of fact, I address legalizing marijuana on page 69, and the book goes on to detail the many other ways cash is used in crime besides drugs: racketeering, money laundering, human trafficking, extortion, corruption, you name it. Simplifying taxes is a great idea with lots of efficiency benefits I have written often about. But to think that any realistic simplification plan would end tax evasion is delusional.

Grant focuses his ire almost entirely on negative interest rates, saying “You rub your eyes. You can recall no precedent. There has never been one in 5,000 years of banking.” Well, Grant is known for his interesting historical analyses, but this statement is misleading at best. Before paper currency, governments routinely paid negative interest rates on metallic currencies by calling in coins and shaving them (as I discuss at some length in chapter 2). That might not immediately imply a negative rate on other debt instruments, but if your debt is repaid in physically debased pence that have much less silver than the ones you lent, it is a negative interest rate in any meaningful sense.

In modern times, the existence of paper currency prevents any significant negative rate on other government debt because of fear of a run on cash, though Europe and Japan have managed to get away with slight negative rates. So the statement that this has not happened until now is, well, hardly profound. Besides, there have been countless episodes of significant negative real interest rates on government bonds, that is when the nominal (face value) interest rate is not nearly enough to keep up with inflation, for example in the 1970s, when inflation went over 13% in the U.S. and over 20% in the U.K. and Japan.

In any event, my plan excludes small savers. And if effective negative-rate policy were possible, it would likely be quite short lived, and would probably cause a lot less problems that a decade of zero rates or high inflation. If the Fed could engage in effective monetary policy in a deep recession, most savers will gain far more than they will lose. It would bring back jobs more quickly, restore house and stock prices faster, and it would actually raise nominal rates on long-term bonds through restoring expected inflation to target. The suggestion that negative rates are just a policy to rob savers is empty polemic.

In chapter 12, I discuss populist perspectives on central banking, including Ron Paul and a return of the gold standard. Grant, evidently, was tapped to be Paul’s Fed Chairman had his 2012 presidential campaign been successful. On CNBC Squawkbox, Grant compares Fed chair Ben Bernanke to the head of Zimbabwe’s central bank, because he is just sure that all the “money printing” Bernanke was doing would lead to high inflation. Of course, what Bernanke was doing was not so much printing money as exchanging short-term central bank reserves for long-term government debt, as a reader of chapter 9 would understand. (And critically, the government fully owns the central bank.) I am not a big believer in the wonders of quantitative easing, but those who predicted that it would lead to very high inflation made an epic wrong call. Grant not only hates negative rates, he says he doesn’t like zero rates, and said back then the Fed should promptly raise them. Many other central banks, including the European Central Bank, tried just that—the results were disastrous.

Lastly, it is worth mentioning that by and large the financial industry lobbies heavily against negative rates. Leading financial newspapers regularly publish articles by banking industry proponents that argue how negative rates will deter governments from pursuing structural reform. Some of their arguments—about the problems with implementing negative rates today, having to with institutional, tax, and legal issues that need to be fixed before negative rates can be effective—are legitimate. The Curse of Cash addresses all that, and explains that it will take a long time even if the problem of a run into cash is taken off the table. Ultimately, banks make money off the difference between the rates they pay to borrow and the rates they charge to lend, and once the preparations are made, they will not have cause to complain.

In the end, if global real interest rates stay low for the next decade, there will likely be occasional periods of negative rates during recessions in most advanced economies, whether we like it or not. Part II of the book explains how to make negative rate policy better and more effective. Anyone who wants to understand it should read The Curse of Cash.

Kenneth S. Rogoff, the Thomas D. Cabot Professor of Public Policy at Harvard University and former chief economist of the International Monetary Fund, is the coauthor of the New York Times bestseller This Time Is Different: Eight Centuries of Financial Folly (Princeton). He appears frequently in the national media and writes a monthly newspaper column that is syndicated in more than fifty countries. He lives in Cambridge, Massachusetts.