I recently wrote about alternate currencies as a solution to the financial crisis, specifically to the ineffectiveness of monetary policy at the zero interest rate bound. Well it looks like Greg Mankiw (independently) agrees with me which is quite exciting. When currencies loose value over time the Fed could lower its rate to less than zero (e.g. you give me $100 today, I’ll give you $98 in a year) and still find people who would be willing to lend at those terms:
Reduce the return to holding money below zero. Imagine that the Fed were to announce that, one year from today, it would pick a digit from 0 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.
It definitely is an unorthodox solution that would be difficult to implement in practice but it’s also novel and interesting and it helps us understand why certain solutions work and others don’t:
I understand that this plan is not entirely practical. But you have to give the student credit for thinking out of the box. And his plan does address a fundamental problem facing the economy right now: Given the fall in wealth, increases in risk premiums, and problems in the banking system, the interest rate consistent with full employment might well be negative.
One key challenge to coming up with good solutions to problems is understanding why things are the way they currently are and what an ideal solution would have to accomplish. Coming up with good ideas that don’t quite cut it is an excellent learning process for getting closer to the optimal solution.
Update: The Economist talks about Switzerland charging foreigners a fee to keep their money there in the 1970s – effectively imposing a negative interest rate (this would have to be a percentage of the assets kept there instead of a lump sum).