September 10, 2011


Mr. Banker, Can You Spare a Dime? (JOE NOCERA, 9/09/11, NY Times)

Not long ago, I received an e-mail from David Rynecki, an old friend and former colleague who left journalism a half-dozen years ago to become a small businessman. David's firm, Blue Heron Research Partners, does research for investment professionals; he was writing to share his frustration in trying to build a business in the aftermath of the recession.

"Like many small businesses," he wrote, "we were socked by the recession. Rather than cut back, however, we chose to be aggressive." He and his wife, Marcia, invested everything they had in the firm. They refused to lay off their three employees. During an especially bad stretch, they used their credit cards to stay afloat.

Their risk-taking paid off. "We're hiring again," David's note continued. (Indeed, he's now got a full-time staff of nine.) "Business is strong. Our receivables are unbelievable. We have long-term contracts with established investors."

His problem was -- and is -- the same one facing millions of small businesspeople. With lending standards extraordinarily tight in the wake of the financial crisis, banks simply aren't making small business loans, not even to perfectly creditworthy people like David. Which means he can't expand -- and hire -- the way he would like to. Yes, he said, he could continue to plow his cash flow into the business and grow it slowly. But to get the firm to the next plateau, he needs a bank loan.

"Banks say they have credit to offer," he wrote. "And they make you go through all the motions. But then they offer nothing."

It May Be Time for the Fed to Go Negative (N. GREGORY MANKIW, 4/19/09, NY Times)
So why shouldn't the Fed just keep cutting interest rates? Why not lower the target interest rate to, say, negative 3 percent?

At that interest rate, you could borrow and spend $100 and repay $97 next year. This opportunity would surely generate more borrowing and aggregate demand.

The problem with negative interest rates, however, is quickly apparent: nobody would lend on those terms. Rather than giving your money to a borrower who promises a negative return, it would be better to stick the cash in your mattress. Because holding money promises a return of exactly zero, lenders cannot offer less.

Unless, that is, we figure out a way to make holding money less attractive.

At one of my recent Harvard seminars, a graduate student proposed a clever scheme to do exactly that. (I will let the student remain anonymous. In case he ever wants to pursue a career as a central banker, having his name associated with this idea probably won't help.)

Imagine that the Fed were to announce that, a year from today, it would pick a digit from zero to 9 out of a hat. All currency with a serial number ending in that digit would no longer be legal tender. Suddenly, the expected return to holding currency would become negative 10 percent.

That move would free the Fed to cut interest rates below zero. People would be delighted to lend money at negative 3 percent, since losing 3 percent is better than losing 10.

Of course, some people might decide that at those rates, they would rather spend the money -- for example, by buying a new car. But because expanding aggregate demand is precisely the goal of the interest rate cut, such an incentive isn't a flaw -- it's a benefit.

The idea of making money earn a negative return is not entirely new. In the late 19th century, the German economist Silvio Gesell argued for a tax on holding money. He was concerned that during times of financial stress, people hoard money rather than lend it. John Maynard Keynes approvingly cited the idea of a carrying tax on money. With banks now holding substantial excess reserves, Gesell's concern about cash hoarding suddenly seems very modern.

Posted by at September 10, 2011 8:47 AM

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