The (formerly) advanced industrial countries are all in or headed for the liquidity trap `lite'. This is the situation where the short-term risk-free nominal interest rate cannot fall any further. A `heavy' or `deep' liquidity trap occurs when nominal risk-free rates at all maturities are at their lower bound(s). A liquidity trap `lite' may occur even when short-term rates are above zero. It will certainly occur when the short-term nominal interest rate falls to zero. Unless the monetary authorities are willing and able to tax currency holdings, the zero nominal interest rate rate on bank notes sets a floor for all short-term nominal interest rates. I have not seen too many central bankers perusing the works of Silvio Gesell, so for the time being, I will treat a zero short risk-free nominal interest rate as the effective floor for the risk-free nominal interest rate. If zero is the floor, there is no reason not to go there immediately. The recession in the US, the UK, the Eurozone, Japan and the rest of Europe is, with probability verging on certainty, going to be so deep and so prolonged, that the zero lower bound will be reached even by the most anal-retentive gradualist central bank before the middle of 2009. So why not get it over with in December 2008 and possibly do some good in the mean time?
The (formerly) advanced industrial countries are all in or headed for the liquidity trap `lite'. This is the situation where the short-term risk-free nominal interest rate cannot fall any further. A `heavy' or `deep' liquidity trap occurs when nominal risk-free rates at all maturities are at their lower bound(s).
A liquidity trap `lite' may occur even when short-term rates are above zero. It will certainly occur when the short-term nominal interest rate falls to zero. Unless the monetary authorities are willing and able to tax currency holdings, the zero nominal interest rate rate on bank notes sets a floor for all short-term nominal interest rates. I have not seen too many central bankers perusing the works of Silvio Gesell, so for the time being, I will treat a zero short risk-free nominal interest rate as the effective floor for the risk-free nominal interest rate.
If zero is the floor, there is no reason not to go there immediately. The recession in the US, the UK, the Eurozone, Japan and the rest of Europe is, with probability verging on certainty, going to be so deep and so prolonged, that the zero lower bound will be reached even by the most anal-retentive gradualist central bank before the middle of 2009. So why not get it over with in December 2008 and possibly do some good in the mean time?
Financial markets were braced for large interest rate cuts across Europe from Thursday as bad economic figures continued to flow from all leading economies.In the UK, the consensus among economists shifted during the week to an expectation that the Bank of England would reduce its official rate another percentage point to 2 per cent, equal to its lowest rate since the Bank was founded in 1694. The overnight index swap market, one of the best guides to official interest rate expectations, has priced in a reduction of 1.5 percentage points.In the eurozone, the equivalent European financial market has priced in a 0.75 percentage point reduction by the European Central Bank to 2.5 per cent today, a move that would be bigger than any it has made in its near 10-year existence. Although economists are a little more cautious, with inflation risks disappearing fast, they nevertheless believe a three-quarter percentage point reduction is a distinct possibility.Influential voices are calling on central banks to be bold. Willem Buiter of the London School of Economics, a former member of the Bank of England's monetary policy committee and chief economist of the European Bank for Reconstruction and Development, says the recession in advanced economies is "going to be so deep and so prolonged" that zero per cent rates "will be reached even by the most anal-retentive gradualist central bank before the middle of 2009".
Financial markets were braced for large interest rate cuts across Europe from Thursday as bad economic figures continued to flow from all leading economies.
In the UK, the consensus among economists shifted during the week to an expectation that the Bank of England would reduce its official rate another percentage point to 2 per cent, equal to its lowest rate since the Bank was founded in 1694. The overnight index swap market, one of the best guides to official interest rate expectations, has priced in a reduction of 1.5 percentage points.
In the eurozone, the equivalent European financial market has priced in a 0.75 percentage point reduction by the European Central Bank to 2.5 per cent today, a move that would be bigger than any it has made in its near 10-year existence. Although economists are a little more cautious, with inflation risks disappearing fast, they nevertheless believe a three-quarter percentage point reduction is a distinct possibility.
Influential voices are calling on central banks to be bold. Willem Buiter of the London School of Economics, a former member of the Bank of England's monetary policy committee and chief economist of the European Bank for Reconstruction and Development, says the recession in advanced economies is "going to be so deep and so prolonged" that zero per cent rates "will be reached even by the most anal-retentive gradualist central bank before the middle of 2009".
STUPID ?!!!!! In the end, might makes right. Nothing has changed since the caveman.
why the interest rate cannot fall below zero percent.
The reason is entirely academic, a supposition that unearned income is always a real rather than irrational number, financial "loss" is a heinous moral to relative measurement systems, and in natural language expressions some variation of euphemism "negative equity" (-1 + 1) sufficiently conveys the social construct that effective income (real purchase power of money spent) compared to forecast or expected ROI is somehow not zero. Not gone. Not consumed. Not unrecoverable. Not irreversible. As well as burned in a bonfire as eaten on a skewer. With condiment.
It's all quite neurotic. Diversity is the key to economic and political evolution.
Unless you design some super clever banknotes that have an adjustable ink so that it will lose nominal in the process. Until then, negative interest rates won't work. Earth provides enough to satisfy every man's need, but not every man's greed. Gandhi
I suppose that for large sums on current accounts, banks could start charging large fees, but the risk of seepage to actual cash is real, and brings other problems (as in: run on the bank), which can only then be avoided by confiscatory policies, which is a whole other ballgame. In the long run, we're all dead. John Maynard Keynes
I am not being a wise guy, I seriously am confused about this.
But the killer situation is to borrow for holding.
Compared to not doing anything, here is what happens: At T=0, you borrow $100. You don't change your spending patterns in any way. Then, at T=1, you repay your loan with a mere $95. Yes, those $95 are worth more than the $100 you borrowed at T=0. But simply holding the cash made those $100 of yore turn into $100 of today -more valuable. So you are still left with $5 more than in the situation where you did not borrow, at zero risk (in fact, at negative risk, since the institution might collapse and never require those $95), for not doing anything.
OK, it's not quite true: somebody may steal those banknotes in the meantime. So you need someplace safe to hold them. But any rate negative by more than the risk of theft won't work. Earth provides enough to satisfy every man's need, but not every man's greed. Gandhi
Case 1: Inflation rate is 5%, interest rate is 10%. I loan somebody $100; at the end of a year he or she pays back $110. I have gained $10 of cash due to interest, and lost $5 of value due to inflation. Net gain of $5.
Case 2: Inflation rate is 0%, interest rate is 5%. I loan $100; get back $105. I have gained $5 in cash, not lost or gained any value. Net gain of $5.
Case 3: Inflation rate is -5%, interest rate is 0%. I loan $100, get back $100. I have not lost or gained any cash, but have gained $5 of value due to deflation. Net gain of $5.
Case 4: inflation rate is -10%, interest rate is -5%. I loan $100, get back $95. I have lost $5 of cash, but have gained $10 in value due to inflation. Net gain of $5.
What is wrong with this argument?
Case 5: Inflation rate is -10%, interest rate is now adjusted by the government to -10%. I loan $100, get back $90. I have lost $10 of cash, but have gained $10 in value due to inflation. Net gain of $0 and there is risk. So I don't make loans in this case, either...
Hmmm.
It is possible to impose that cash must flow, by replacing bills with stamped vouchers that lose their value if they are not stamped (change of hands) at a set frequency.
It is an "out of the box" tinkering with the velocity of money. Was tried locally in Germany during the great depression. Could be tried today, thinking big and using new "enforcement" technologies like e-wallets, e-cash, etc... Pierre
He proposed that international (centrally issued quasi special drawing right) "Bancor" trade balances would incur a charge on both positive and negative balances.
What we got was the US IMF/World Bank approach with the dollar as global reserve currency and giving the US a free ride to unlimited "seigniorage".
Worse than that, the fact that the interest charges are made only on negative balances has created a one way flow from poor to rich nations. This is a form of positive feedback that has ended up - which as mathematically it had to in a world of finite resources - in continual instability and, eventually, our current terminal meltdown.
My understanding is that the concept of "money that rusts" was that of Gesell, and that Keynes was a big fan of Gesell's. "Any economic unit can emit money. The serious problem is to get it accepted" Hyman Minsky
