«Clinging to Paper Money is similar to Clinging to Gold»

The economist Miles Kimball is one of the pioneers in the field of negative interest rates. He argues that the holding of paper currency needs to be discouraged to allow negative rates to be effective.

Alexander Trentin und Sandro Rosa

Miles Kimball, professor of economics at the University of Michigan, argues in his blog that recessions could be easily fought by allowing interest rates to fall into deep negative territory. Electronic money works fine for that purpose as negative rates can easily be applied. However, paper money still yields zero interest and could be used as an escape from negative rates. In order to reflect the negative rates also on paper money, Kimball argues for a paper currency deposit fee.

Mr Kimball, you argue for a fee when depositing paper currency when cash accounts yield negative interest rates. This is supposed to stop people escaping negative rates on bank accounts. Do you understand that some people find this idea revolting?
This is about the question how to present it. People don’t like the word fee. As there is also a discount when withdrawing money it is analytically equivalent to an exchange rate between electronic money – money on reserve accounts – and paper money. I found that using the word exchange rate would elude the legal authority of the central bank to set a fee. A fee would be in fact a crawling exchange rate peg, which would not be as fluctuating as an uncontrolled exchange rate.

Why do you prefer a deposit fee to a withdrawal fee for paper currency?
At every central bank I visit, I warn about a withdrawal fee. That would alarm people so much more, if they needed to pay to get banknotes from their accounts instead of paying a slowly increasing deposit fee.

If the central bank does not want people holding paper currency, it could also stop printing it.
This would be a fallback position, if this is the only legal authority a central bank had. Paper currency would become an exotic security with a zero interest rate. The price of bank notes would run then on a premium to electronic money. There would a big jump in the price of paper currency and such a premium would be disruptive to the economy. The paper currency deposit fee instead would start at zero and would increase with time as long as there is a negative interest rate. There would never be a big jump.

You propose to introduce electronic money as a legal tender instead of banknotes. In Switzerland, the Vollgeld movement rallies for a monetary reform in which electronic money would be created by the Swiss National Bank, not by commercial banks by lending as it is currently done. It is similar to the idea of full-reserve banking. What is your opinion on this?
Anything which raises the prestige of electronic money is very helpful when introducing it as legal tender. If you have an account you want to have the central bank certifying that this money is really there. Regarding a 100% reserve requirement for bank accounts: In the olden days, people worried that a higher reserve requirement would reduce the money supply, but that is not a problem. We know how to deal with that: The central bank could do money market operations which would easily increase the base money to cancel out any effects of changes to the reserve requirements. At least having some accounts which are covered by 100% reserves is viable. Keeping fractional reserve banking is to leave the revenue of seignorage to commercial banks.

And your electronic money as legal tender would still work in the current world of fractional reserve banking?
Electronic money is all money which is just numbers in a computer. To make it legal tender would need some time. Very important is: what I propose with the paper currency deposit fee, the SNB (SNBN 5680 0%) could do tomorrow. There is no reason to delay until we can do things perfectly. If the Swiss economy is hurt by too high interest rates and the value of the Franc is too high, then you should institute this fee tomorrow. This is what I advise the SNB and I think they seriously consider it.

Would a transition to electronic money and a fee on paper money not let people lose faith in currency? They would know that the government can do whatever it wants with your cash holding, like devaluing it on one key stroke.
It matters how you introduce it to the people. If the SNB wants to set a negative rate of 2% on bank accounts, at first paper currency would be at par and the next day would it be just a tiny bit below par. It would take three month before the paper currency deposit fee would be 0.5%. I do not see that this would let people freak out, if you explain how slow the process works. And it would also not affect shopping in the grocery store, as shops currently accept credit cards even if they have to pay a fee for that.

But how would you deal with the strong emotional attachment to paper currency?
Our societies went through this before. There was a strong attachment to gold and silver. We went off the gold standard, and that was a big deal for people. One should remember that introducing paper money as legal tender was hugely controversial. This was done to raise the prestige of paper money vis-à-vis gold. In that longer historical perspective, paper money was only a way station towards electronic money. If you want to be very traditional, you can use gold – but that will mess up your economy more than paper money. When people now cling to paper money that is similar to clinging to gold.

In Switzerland and Germany the attachment to banknotes seem to be especially strong. Wouldn’t be a fee here most controversial?
This is why the SNB instead of the ECB needs to pave the way, precisely because of the feelings on the side of the Germans. Once Switzerland does it, and I am hopeful for Sweden too, there is a huge benefit to other countries by showing the way. A nice thing about Switzerland is also the sophisticated level of banking. There are many practical questions for a negative interest rate environment and Switzerland would be an excellent place to work out such details. One example: In a positive interest rate environment you want people to pay you early, with negative rates you want people to pay you slowly. If you go deeper into negative interest rates, people around the world would take standard practice from what is done in Switzerland.

As you mentioned, commercial details of doing transactions in a negative interest rate environment would still need to be worked out. Is there not a point where there is a structural transformation of how the economy works after introducing deep negative rates?
The funny thing is that for economists it is not a big deal if rates are positive or negative. By the standard of real interest rates, after the deduction of inflation, we had negative rates before. For the most part, negative real rates, coming from high inflation, have the same effect as negative rates. We understand the effects of negative rates much better than the effects of Quantitative Easing.  And regarding the effects on business practices, firms also need to adapt in the range of positive interest rates.