Doesn’t that have the same effect as lower nominal interest rates? Not really

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"Felix Salmon

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May 27th, 2009

Fed funds datapoint of the day

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Posted by: Felix Salmon

Tags: fiscal and monetary policy

The Taylor Rule ran smack into the zero bound back in October — and kept on falling. Now, according to the Fed’s Glenn Rudebusch, “in order to deliver a degree of future monetary stimulus that is consistent with its past behavior, the FOMC would have to reduce the funds rate to -5% by the end of this year”:

Rudebusch says that when a central bank can’t loosen monetary policy by implementing negative nominal interest rates, then that only serves to lengthen the amount of time that it is forced to keep interest rates at zero:

According to the historical policy rule and FOMC economic forecasts, the funds rate should be near its zero lower bound not just for the next six or nine months, but for several years. The policy shortfall persists even though the economy is expected to start to grow later this year. Given the severe depth of the current recession, it will require several years of strong economic growth before most of the slack in the economy is eliminated and the recommended funds rate turns positive.

But what about all that quantitative easing? Doesn’t that have the same effect as lower nominal interest rates? Not really: it “has likely only partially offset the funds rate shortfall”, says Rudebusch, and in any case the Fed’s balance sheet is going to have to shrink as the crisis abates — which will serve to act as an effective rise in interest rates. And which will only force the Fed funds rate to stay at zero for that much longer. Maybe it’s time for Bernanke to just set rates at zero and head to the beach for the summer — monetary policy seems to be pretty clear for the foreseeable future."

Me:

Let me recommend the following:

“It’s easy to envision such a system with regard to deposits at the Federal Reserve or transactions deposits at banks; for the most part, the technology to implement such a system is already in place. The main difficulty—both technological and political—lies in imposing such a tax on currency. In the 1930s, Yale economist Irving Fisher proposed such a system, in which currency had to be periodically “stamped,” for a fee, to retain its status as legal tender.[1] The stamp fee could be calibrated to generate any negative nominal interest rate the central bank desired.

While the technology available for implementing such a system is more sophisticated today than in Fisher’s time, enforcement still seems a mammoth problem. It would require physical modifications to currency and some means of tracking the length of time each piece spends in circulation.”

See the following:

Irving Fisher (1933), Stamp Scrip (New York: Adelphi). Fisher credits the stamp money idea to the German–Argentine economist and businessman Silvio Gesell.

Here’s what Buiter says:

“2) Tax currency and ‘stamp’ it to show it is ‘current on interest due’. This is Silvio Gesell’s proposal, supported by Irving Fisher and re-introduced into the policy debate by Marvin Goodfriend and by myself and Nikolaos Panigirtzoglou.[2] When the interest rate on currency is positive, the currency must be marked (by stamping or clipping coupons) to make sure the (anonymous) bearer does not present it repeatedly for the payment of interest. When the interest rate is negative, the (anonymous) bearer must (a) be induced to come forward to receive his negative interest (i.e. pay interest to the central bank) and (b) must be able to demonstrate that the negative interest has been received. To ensure (b), the currency must again be stamped or marked (electronically tagged). To get the bearer to come forward to pay the negative interest we can either rely on honesty and a sense of patriotic duty, or we can impose sanctions for non-compliance. I am afraid penalties for non-compliance (fines, a day in the stocks) would be required to make negative interest on currency work. This would require random checks etc. It would be administratively costly and unpleasantly intrusive. This may well endear the notion to our governments. ”

I like it. And from Brendan Brown on the economistsforum on FT:

“The relevant government would announce that existing banknotes were to be converted into new notes at a fixed date, say three years from now, at a discount (for example 100 old dollar banknotes would be converted into 90 new).

In the interim, 1:1 conversion of banknotes into deposits would be suspended. Instead, a crawling peg would be established. At the start, the exchange rate between deposits and banknotes would be virtually 1:1. At the end it would be 0.9 banknotes/deposit.

As the discount grew, retailers would quote different prices for cash or cheque/card settlement. And as to the note switch-over costs, the “experiment” of Europe’s economic and monetary union demonstrates the feasibility.

The looming conversion would provide an essential degree of freedom for monetary policy. In terms of our illustrative arithmetic, the risk-free interest rate could fall to a negative 3.33 per cent a year without triggering cash withdrawals from the banking system.

Is the exercise worth it?”

I say, emphatically, yes. Let’s give this idea a try.

- Posted by Don the libertarian Democrat

The proposal for negative interest on reserves that Bill Woolsey and I have been discussing for months

From The Money Illusion:

"Krugman on negative insider trading

If markets are efficient then the expected loss on Fed purchases of long term debt is roughly zero. On the other hand if the Fed has inside information about its future policy, then the Fed could use that information to make expected profits or losses. In a post today, Krugman argues that the Fed may be using the inside information in a perverse way, to generate expected losses. His argument (which is technically correct and which I discussed here in an earlier post) is that the Fed might actually persevere and produce more inflation (and I would add more real spending growth as well) than the markets currently expect. Because markets are skeptical about the ability or willingness (probably the latter) of the Fed to carry through on a reflationary policy, long bond yields do not currently price in the sort of inflation or nominal spending growth that the Fed presumably wants. What do we make of this?

1. My initial thought a few weeks ago was that the Fed should buy assets that are likely to appreciate if they are successful, which they would insure by announcing a nominal target and doing whatever was necessary to hit the target. Who cares if traders who doubted the Fed’s word lose money? It’s a good way to build credibility.

2. The Fed may think my idea is too risky, and they may be right. The markets may actually know the Fed better than it knows itself. I.e. the markets may be able to predict future Fed behavior better than the Fed. Think of the Fed as like a powerful but lumbering woolly mammoth, surrounded by agile saber-tooth tigers. The markets are very good at sensing which policy targets are credible. In Japan, the markets correctly sensed that the BOJ’s promise to end deflation was a sham, and deflation got priced into bond yields. And they were right; the BOJ tightened policy twice while deflation was still occurring.

3. Neither Krugman nor Bernanke seems to have noticed yet that we could get by with far less QE than is currently being discussed. The proposal for negative interest on reserves that Bill Woolsey and I have been discussing for months has finally been discovered by Harvard University (according to a recent post in Mankiw’s blog–and with a wacky idea for negative interest on cash that is not a part of our proposal here.) It would end the problem of excess reserve hoarding, which has been by far the biggest factor in boosting demand for base money (and hence limiting the effectiveness of QE.) Let’s see how long it takes for the idea to get to Princeton (Krugman and Bernanke’s University.)

4. On a serious note, I actually do agree with Krugman:

a. QE is worth trying.

b. By itself QE may not work (in my view due to positive interest on reserves.)

c. And if it does work it may expose the Fed to some capital losses.

The reason that I have been prodding people like Mankiw and Krugman in recent posts is to try to raise the visibility of the proposal for negative interest on excess reserves. I strongly believe this issue is important, and hope to attract the attention of someone who can publicize the issue much more effectively than I can."

Me:

1. Don the libertarian DemocratYour comment is awaiting moderation.
   20. March 2009 at 19:22

   Back in November, we had this post in the FT which I endorsed:

   http://blogs.ft.com/economistsforum/2008/11/the-case-for-negative-interest-rates-now/#more-259

   “The case for negative interest rates now
   November 20, 2008 12:35pm
   by FT

   By Brendan Brown

   A conundrum has long been known to monetary economists, but only comes into the open during the once in a quarter-of-a-century type of recession apparently plaguing the global economy.

   The quandary is how, in a conventional monetary economy, to bring interest rates down to the negative levels essential to speedy recovery during periods when there is a sharp decline in spending propensities.

   If interest rates fall below zero, the public would simply seek to transfer their savings into hoards of banknotes.

   The interest rate under discussion is the risk-free nominal rate as quoted on short-maturity government bonds, most obviously US T-bills or short-dated German government bonds.

   Over the course of decades, particularly during the Japanese “lost decade” of asset deflation, suggestions have emerged as to how to solve the conundrum.

   These include the periodic stamping (for a small fee) of banknotes (without the stamp they would not be valid). The idea is that by imposing a running tax on banknote hoarding, nominal risk-free rates could fall to negative levels.

   In the age of the information technology revolution, surely the authorities could devise a simple and practical method of effective taxation of banknote hoards?

   There are two cues to a practical method of taxing notes. The first comes from what happened during US financial crises in the 19th century.

   Banks under stress of cash drains (depositors withdrawing funds) suspended temporarily the 1:1 link between cash and deposits, so their notes sold at varying discounts. The second comes from the launch of the euro; a conversion of old banknotes into new.

   These cues lead to the solution.

   The relevant government would announce that existing banknotes were to be converted into new notes at a fixed date, say three years from now, at a discount (for example 100 old dollar banknotes would be converted into 90 new)…..”

   I don’t remember anyone being interested in this at the time.

   “Then, Interfluidity offered this:

   http://www.interfluidity.com/posts/1229908180.shtml#comments

   Since the current Fed loves bold and unorthodox action, I thought I’d end this with a (sort of) constructive suggestion. As the composition of the monetary base changes from mostly currency in circulation to largely electronic reserves, the zero-bound on nominal interest rates can be made to disappear. How? Simple: Rather than paying interest on reserves, the Fed can tax them. If banks were taxed daily on their reserves, banks would compete to minimize their holdings, and interbank lending rates would go negative. With a high enough tax, banks could be made desperate to lend, even though in aggregate the banking system has no choice but to hold the reserves. Presumably, banks would pass costs to depositors by eliminating interest on deposits, increasing fees, and ceasing to offer term CDs. Money in the bank would go from what everyone wants to something nobody can afford to hold. People would strive to minimize transactional balances, and invest any savings in money markets or stocks or bonds, anything not subject to the tax. (This is similar in spirit to a suggestion by Arnold Kling.)”

   Then, I asked Nick Rowe this:

   “Nick, I might ask something else, but this puzzles me:

   “because the domestic and foreign central banks want to push interest rates lower, but can’t.’

   I don’t understand why the Fed couldn’t”
   1) Add a fee to these bonds
   2) Discount them over time

   In other words, add a disincentive to buy and hold them.

   Posted by: Don the libertarian Democrat | February 03, 2009 at 04:51 PM

   Hi Don: it’s technically possible. But people would just hold cash under the mattress, or in safety deposit boxes, and get zero interest rates that way. (There are various schemes always floated to tax cash, or make it expire, etc., but they always come across as a bit sci-fi.)

   Posted by: Nick Rowe | February 03, 2009 at 05:27 PM”

   Are you advocating the same thing, or are these ideas somewhat different?

And:

Don, Thanks for the link, I need to link to that blog, as he has the same idea as I do. The FT idea of interest on cash, however, is probably a nonstarter. If I understand your idea, it is for negative rates on T-bills (once nominal rates had fallen to zero.) Is that right? If so, I am afraid that Nick Rowe is right, it wouldn’t work because of private currency hoarding. It is the same logic as my idea, and is a good idea, but here is the difference. The Fed cannot police the public and prevent them from hoarding cash as a way of avoiding negative rates. But the Fed can police commercial banks and prevent them from hoarding vault cash as a way of avoiding the tax on bank reserves.

"Let the printing presses turn and the helicopters fly, but please don't confiscate my gold."

Interfluidity has a response to the Hamilton post:

"Fedthink

James Hamilton has an excellent post on the Federal Reserve and its changing balance sheet today( IT WAS EXCELLENT ). If you haven't been following this stuff obsessively, it's probably the single best primer to get up to speed( TRUE ).

To my mind, there are three signal facts about the brave new balance sheet:

1. The size of the Federal Reserve's balance sheet has ballooned, more than doubling over a period of three months. If we take the FOMC at its word for it, it's not going to shrink anytime soon. Given new programs already announced, we should expect the Fed's balance sheet to continue to grow. ( OK )
   
2. On the asset side, only a small fraction of the Fed's holdings are now US Treasury securities. Excluding securities lent to dealers, just 12.5% of the Fed's assets are Treasuries. The Fed has expanded the scope of its lending, from depository institutions, to primary dealers, to money-market funds and commercial paper issuers, to issuers of asset and mortgage backed securities, and very soon to private investment funds that invest in asset-backed securities. The Fed also periodically lends to support firms in, um, special circumstances, such as JPM/Bear and more recently AIG. ( OK )
   
3. On the liability side, the Federal Reserve has dramatically increased the degree to which it funds its activities with zero-maturity bank reserves, upon which it is now paying interest( YES. I'M NOT AS HAPPY WITH THIS ).

The Federal Funds rate is now effectively zero. We have hit the so-called "zero bound".

There are many ways of trying to make sense of all this. One broad-brush view is that for all its radicalism, the Fed is just a thermostat. As the private sector delevered, the Fed had to lever up (McCulley). As foreign central banks shift their portfolio from agencies to Treasuries, the Fed has to shift its portfolio from Treasuries to agencies (Setser)( TRUE ). More broadly, as the private financial sector has become unwilling to issue short-term, liquid liabilities against long-term illiquid assets, the Fed has had to do so to avoid a disorderly collapse of asset prices (see Kling)( OK ). One might imagine a canoe carrying a wild beast (that would be our "rational" private markets). The beast writhes and bends, and the Fed must throw its weight in the opposite direction to force the tipping craft upright despite all the upheaval.

"Stability" — price stability, financial stability — are to my mind like "liquidity": qualities widely considered virtues that are often actually vices. Nevertheless, the Fed pursues these goals, and in the immediate term, the thermostat analogy works pretty well. I don't doubt that we'd have tipped into steep deflation, outright collapse of core financial institutions and an in-the-streets economic crisis without the Fed's extraordinary measures( I AGREE ). Had the Fed not played thermostat from 2001-2003, perhaps( MAYBE ) the beast would have been chastened by a mild dunking, and today's heroics might have been less inevitable. But it was stability über alles then, when the bubble first tried to burst, and now we are where we are.

So, thanks to the Fed, things are better than they might have been. But I think there is as much to squirm about than to celebrate in how the Fed has comported itself.

On the asset side, as has been widely noted, the Fed has been taking on extraordinary levels of credit risk. We do not know against precisely what collateral the Fed is extending its trillions in loans, and how conservatively that collateral is being valued( TRUE ). We wish Bloomberg luck in their lawsuit. (ht CR, Alea).

We do know that the Fed is becoming ever more brazen about its risk-taking( YES ). When the Fed made a non-recourse loan in connection with the collapse of Bear Stearns, Chairman Bernanke was summoned by Congress to discuss the unusual move. A non-recourse loan is economically something between lending and purchasing. The Fed has the authority to lend to whomever it pleases under "unusual and exigent" circumstances, but it is not empowered to spend outright what are in the end US taxpayer dollars. Anticipating objections, Dr. Bernanke was very careful during the Bear debacle to ensure that since the taxpayer would "own" most of the downside, it would also capture the upside. Still, he was called to account for what was widely understood to be an unusual move of very questionable legality. But now, under TALF, the Fed will extend non-recourse loans to just about anyone. The Fed will assume much of the downside, while private investors capture the upside. In my view, it is not quite legal for the Fed to extend non-recourse loans, and the practice should be curtailed. Non-recourse loans should be approved by Congress and executed by the Treasury department. The recipients of loans from the Federal Reserve should be bankrupt before taxpayers take losses( HERE I AGREE ). Remember, the Fed is an an unelected technocracy "cognitively captured" (as Willem Buiter puts it) by the sector it purports to regulate. Yes, Congress sucks. But the Fed sucks too, and the rule of law does matter.

For all of that, it is the liability side of the Fed's balance sheet that is most interesting. The Fed is financing its gargantuan balance sheet expansion by conjuring unsterilized bank reserves. A year ago, there were less than $18B of reserves deposited at the Fed. Today there are $800B. A year ago the Fed wasn't paying interest on bank reserves. Today it is.

Interest rates are, for the moment, excruciatingly low. But a subsidy to the banking system, once put into place, will be quite hard to dislodge( IT'S A PROBLEM ). So, let's imagine that the Fed will pay interest on bank reserves in perpetuity, that it will pay such interest at or near the risk-free short-term interest rate, and that the expansion of the Fed's balance sheet is more or less permanent. How large a subsidy to the banking system do the interest payments on reserves represent? Some problems are arithmetically challenging, but not this one. The present value of a perpetual stream of market-rate interest payments is precisely the amount of the principal. Therefore, the present value of the Fed's de facto commitment to pay interest to banks on $800B of freshly created reserves is $800B. We fought and wailed and gnashed our teeth over potentially overpaying for TARP assets. Meanwhile, we are quietly allowing the Fed give away, as a direct, literal subsidy, more than the entire $700B that Paulson was allowed to play with. Note there is no question about this being an "investment": The interest payments that the Fed is now making to banks on its suddenly expanded balance sheet are not loans. The banks owe taxpayers absolutely nothing in return for this windfall.

Now the bankers will object, as they always do. Bankers have forever cried that they are required to hold reserves at the Fed, that to be forced to lend their cash interest-free to the central bank is a hidden tax. I hope we all understand by now that the pronouncements of the banking industry are about as reliable as a monthly statement from Bernie Madoff. The reserves in the banking system are created by the Fed, and the quantity outstanding is now enough to cover banks' regulatory and settlement needs many times over. This is not in any sense "their" money. It is money the Fed printed in order to pursue its own objectives. The banks have no right whatsoever to earn interest on this money( TRUE ), and absolutely do not merit an $800B subsidy. Further, the core rationale for paying interest on reserves has disappeared entirely. Originally, the Fed wanted the power to pay interest on reserves so that it could expand its balance sheet to pursue "stability" goals without stoking inflation by letting the short-term interest rate fall to zero( TRUE ). Now the short-term interest rate has fallen to zero, and the dominant concern is that we are in a "liquidity trap". Yet we are still paying the banks 25 basis points to hold this freshly created money at the Fed. James Hamilton, towards the end of his piece, points out that this is counterproductive. I want to point out that it is also obscene( OK ).

Now I have to admit that, personally, I feel a bit caught out, bent out of shape, gypped, by the whole paying-interest-on-reserves thing. A long while back, I argued against giving the Fed this power, because I knew they would abuse it. During the TARP debate, I did a one-eighty. At least the Fed, I reasoned, would only lend taxpayer money. If we took losses, the institutions that shoved them onto us would go down first. Paulson clearly wanted to assume bank liabilities outright by overpaying for toxic assets. Having the Fed lend taxpayer money seemed like a better deal than letting Paulson give it away. The cost of paying interest on reserves, when I had written about it previously, was about only $11B in present value terms, insignificant in the grand scheme of things. (By the end of September, when I flipped, reserves had already grown to $100B... but I missed that.) Now we have the worst of all worlds: Not only has our corrupt, dysfunctional banking system won the small subsidy it has long lobbied for, but the size of that subsidy has grown by almost 8000%. The Fed is no longer lending only to financial institutions that would have to go under before taxpayers eat their losses. Under TALF, the Fed will lend to anyone who owns the kind of securities whose prices the Fed wants support. The borrowers will take the upside, while taxpayers eat the downside( A PROBLEM, YES ). (Does anybody know what kind of leverage the Fed will support under TALF? I've looked, but haven't found.) The non-recourse lending that was extraordinary and barely legal when Bear went down is now the new normal, except that the Fed no longer bothers to ensure an upside for taxpayers. By institutionalizing non-recourse lending, the Fed has arrogated the power to do everything the original TARP would have done, except without the opportunity for people like me to write Congress in anger.

Despite all this, I am becoming rather Zen about the Federal Reserve lately. I have some sympathy( AS DO I ): They are dancing to a tune that they no longer call, struggling to keep pace with an accelerating beat. The Bernanke Fed is clever and inventive, delightful as spectator sport. So many trillions of dollars have been spent or committed or guaranteed, that the amounts have gone meaningless( THAT'S HOW I FEEL ). I think that the current financial system and the Fed itself are quite doomed, and I'm less inclined to get bent out of shape by the particular ordering of the death throes( HERE I DON'T AGREE. WE'LL GO BACK TO BAGEHOT. I GUESS THIS MAKES ME A CONSERVATIVE OF SOME SORT.). There will be a great crisis. Hopefully it will only be a financial crisis. I'd prefer it to be an inflationary rather than a sharp deflationary crisis, both because I think that a great inflation would be less destructive( I AGREE ), and because that's the way my own portfolio tilts. So really, I should root for the Fed. Let the printing presses turn and the helicopters fly( THAT'S MY POSITION ), but please don't confiscate my gold.

Since the current Fed loves bold and unorthodox action, I thought I'd end this with a (sort of) constructive suggestion. As the composition of the monetary base changes from mostly currency in circulation to largely electronic reserves, the zero-bound on nominal interest rates can be made to disappear. How? Simple: Rather than paying interest on reserves, the Fed can tax them( WE'VE PREVIOUSLY CONSIDERED THIS AND STAMPING ). If banks were taxed daily on their reserves, banks would compete to minimize their holdings, and interbank lending rates would go negative. With a high enough tax, banks could be made desperate to lend, even though in aggregate the banking system has no choice but to hold the reserves. Presumably, banks would pass costs to depositors by eliminating interest on deposits, increasing fees, and ceasing to offer term CDs. Money in the bank would go from what everyone wants to something nobody can afford to hold. People would strive to minimize transactional balances, and invest any savings in money markets or stocks or bonds, anything not subject to the tax. (This is similar in spirit to a suggestion by Arnold Kling.)

Of course there would be tricky consequences: Gresham's law would kick in, as people would hoard physical cash to avoid the tax. Coins and bills would cease to be used for exchange, but would be held as stores of value. That would introduce some friction into small transactions: we'd end up using debit cards to buy candy bars, accelerating our transition to a cashless economy. But electronic money would be legal tender, and the appreciation of paper money would be no more relevant to the overall price level than the fact that older "wheat pennies" are worth much more than 1¢. With a sufficiently large electronic monetary base, there need be no zero-bound on nominal interest rates, and we can use "conventional" monetary policy to fight deflation by letting nominal rates go negative. I laugh in the maw of your liquidity trap."

I'm letting this go( ALTHOUGH IT IS FUN TO THINK ABOUT ), because I see a different future for the Fed and banks.

"If interest rates fall below zero, the public would simply seek to transfer their savings into hoards of banknotes."

Brendan Brown in the FT confronts this buying of basically interest free bonds:

"A conundrum has long been known to monetary economists, but only comes into the open during the once in a quarter-of-a-century type of recession apparently plaguing the global economy.

The quandary is how, in a conventional monetary economy, to bring interest rates down to the negative levels essential to speedy recovery during periods when there is a sharp decline in spending propensities.

If interest rates fall below zero, the public would simply seek to transfer their savings into hoards of banknotes.

The interest rate under discussion is the risk-free nominal rate as quoted on short-maturity government bonds, most obviously US T-bills or short-dated German government bonds.

Over the course of decades, particularly during the Japanese “lost decade” of asset deflation, suggestions have emerged as to how to solve the conundrum."

So, you want interest rates to decline so that businesses, say, can borrow more cheaply, and hire workers, etc., in order to increase buying, and come out of a recession. But what happens when no one is buying and yet interest rates are as low as they can get.

Well, are there any incentives or disincentives to combat this problem, largely associated with the fear of risk and flight into safe investments, such as US Treasuries, that are guaranteed by the government? Now, it's important to understand that this is also an incentive.

One thing you can use are disincentives. Here's one:

"These include the periodic stamping (for a small fee) of banknotes (without the stamp they would not be valid). The idea is that by imposing a running tax on banknote hoarding, nominal risk-free rates could fall to negative levels."

So, this a purchase fee added onto the bond. How about taxes?

"In the age of the information technology revolution, surely the authorities could devise a simple and practical method of effective taxation of banknote hoards?

There are two cues to a practical method of taxing notes. The first comes from what happened during US financial crises in the 19th century.

Banks under stress of cash drains (depositors withdrawing funds) suspended temporarily the 1:1 link between cash and deposits, so their notes sold at varying discounts. The second comes from the launch of the euro; a conversion of old banknotes into new.

These cues lead to the solution."

Basically, change their price after being purchased.

"The relevant government would announce that existing banknotes were to be converted into new notes at a fixed date, say three years from now, at a discount (for example 100 old dollar banknotes would be converted into 90 new).

In the interim, 1:1 conversion of banknotes into deposits would be suspended. Instead, a crawling peg would be established. At the start, the exchange rate between deposits and banknotes would be virtually 1:1. At the end it would be 0.9 banknotes/deposit.

As the discount grew, retailers would quote different prices for cash or cheque/card settlement. And as to the note switch-over costs, the “experiment” of Europe’s economic and monetary union demonstrates the feasibility.

The looming conversion would provide an essential degree of freedom for monetary policy. In terms of our illustrative arithmetic, the risk-free interest rate could fall to a negative 3.33 per cent a year without triggering cash withdrawals from the banking system."

As time goes on, the bond becomes worth less, making it a less desirable product.

"Is the exercise worth it?

The main reason for believing it is stems from an appreciation of how the bursting of a global credit bubble influences the equilibrium level of risk-free interest rates relative to risky rates of return and in absolute terms.

Most of us would agree that the bursting process ushers in a period during which soberly-measured risk premiums increase sharply.

This means that the risk-free rate must plunge to be consistent with an average overall cost of capital which reflects the new glut of savings.

So, in terms of our illustrative arithmetic, it is plausible that the neutral risk-free nominal rate of interest in the US and Europe, especially taking account of a likely near-term drop of the price level, is significantly negative.

The central bank and government, by devising a system in which such negativity can express itself, can give a big fillip to the recovery process.

The most direct channel for this fillip most likely passes through the equity market.

Pervasive negative risk-free rates across the advanced economies would underpin equity market levels.

Investors faced with certain substantial nominal loss on risk-free holdings would bid up the price of equity which could offer rich risk premiums even at a presently feebly level of prospective earnings.

And it is equity market developments which hold the key to the economic recovery."

As these looming losses approach, investors will shift from the bonds to stocks, spurring investment and new business and job growth, and I suppose there will be a kind of wealth effect as well.

"As consumers across the globe retrench, the forces of equilibrium should (if not thwarted by zero rate traps) bring about a redistribution of economic output, away from the production of consumer goods and towards capital goods (including technological know-how).

A higher rate of business investment matched by lower consumption now will have a counterpart in higher-than-otherwise consumption in the far-off future.

A resilient equity market with its counterpart in a low cost of equity capital is the key motor behind that transformation.

Firms across much of the global economy would respond to the combination of squeezed profit margins, low equity capital costs and continuing technological progress by “capital deepening” (increasing the ratio of capital to labour).

That would mean a challenging increase in frictional unemployment and pressure for increased social insurance of the losers.

Losses and losers are an inevitable consequence of the big credit bubble which is bursting. In the equity markets these losses reflect swathes of now obsolescent capital stock in the wrong place at the wrong time.

The key to rapid progress towards re-building wealth is to nurture the golden egg of the equity market, in which the coming capital spending upturn will be financed and to minimize monetary disequilibrium in the meantime.

The scheme proposed here for sharply negative interest rates promises much on both objectives."

So, basically, if investors do shift from bonds to stocks ( Or buy corporate bonds, I suppose )

1) Businesses will borrow ( Spending on capital goods, building things )

2) Creating jobs

3) People will spend more

4) The economy will grow

What's with the Golden Egg? It's been used now by McTeer, Becker, and Brown.

Will this work? I have to admit to liking it, because it involves using incentives to refocus the look of risk to the investor. And I believe that combating fear and aversion to risk is the main problem facing us.