Pandemics, Cashless Economies, and Negative Interest Rates

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One indirect consequence of COVID-19 is to add to pressure for a ban on cash. That could create the potential for central banks to adopt deeply negative interest rates.

NRPLUS MEMBER ARTICLE I n the face of the pandemic shutdowns, many have been speculating about the direct consequences(whether we will see recession with inflation or recession with deflation) and debating what the appropriate economic-policy response is. Meanwhile, a subtle shift in the discussion is under way. It could have dramatic long-term consequences for monetary policy, as some take the opportunity presented by the pandemic to renew their arguments for considering the elimination of cash (or something close to it). Many retailers, vendors that transact in cash, such as restaurants, and even Las Vegas casinos are now considering or have already eliminated the use of paper currency from their business, sometimes citing (not necessarily accurately) this measure as a way to combat the spread of COVID-19. Payment-technology firms in Silicon Valley are also more than willing to take advantage of the movement toward digital and fewer cash payments.

How would the elimination of cash matter for monetary policy and central banks, including the Federal Reserve? So long as cash is an acceptable form of currency, individuals can lock in a 0 percent return and avoid negative interest rates (another policy option now being deployed internationally and being debated over here too) simply by putting their money in paper currency and, figuratively or otherwise, stashing it under the bed.

While central banks in Japan and Europe have in some instances put in place negative interest rates over the past decade, recent research shows that commercial banks there have (with limited exceptions, such as in Denmark, for larger depositors) been unable to pass through negative central-bank interest rates to depositors, who can still move to cash. As a result, the central banks have avoided going into significantly negative territory (beyond roughly negative 1 percent) with their policy rates, knowing that they won’t be as effective at stimulating demand (by forcing individuals to spend or invest more aggressively) as they would hope.

The option of maintaining a 0 percent return would go away, however, if cash were all but eliminated, as some have argued, including Harvard economist Ken Rogoff. (Indeed, the option would also go away if, as some might prefer, cash were taken out of circulation altogether.) Under the circumstances (or so the argument runs) of a cashless society, deep negative interest rates become an implementable policy tool by a central bank.

Rogoff and others would argue that this is a desirable result, since the zero lower bound on interest rates, at which central banks have more or less been stuck over the past decade, would be no more. (In addition, it would likely cut down on corruption and other illegal activity in which the anonymity of cash is a useful tool for the criminal.) Central banks could push nominal interest rates into deeply negative territory, something that, in the event of a recession, would — the theory goes — encourage borrowing, encourage spending, and (perhaps) even “pay” people to borrow to spend even more.

Critics of a cash ban, including myself, would argue that it is unlikely to succeed in the objective of eliminating all mechanisms under which an individual can hold “cash” without paying a fee, whether by, say, buying prepaid cards or by buying cryptocurrency stablecoins, which have exchange rates pegged to major currencies such as the U.S. dollar or other “stable” assets.

Wisely, Jay Powell, chairman of the Federal Reserve Board, has quashed any speculation that it might adopt negative interest rates, arguing that it is not “appropriate” policy. However, judging by some tweets, the President disagrees, and some on Wall Street who participate in the federal-funds futures markets have been betting that these statements by Powell won’t be the end of the matter, and that negative interest rates are on the way.

I would encourage Powell to stay the course with quantitative easing and other asset-purchase programs. They have a demonstrated ability to lower long-term nominal interest rates, as my research has shown. They lower borrowing costs, and that in turn can induce spending by consumers and businesses, uplifting the economy. Taking the next step, into heavily negative interest rates, would, insofar as it must involve the elimination (or near-elimination) of cash, entail massive disruption — for questionable upside and, it should be added, would represent a major assault on privacy. That’s not where we should want to go.

Jon Hartley is a master’s student at the Harvard Kennedy School and a Visiting Fellow at the Foundation for Research on Equal Opportunity. He formerly served as a senior policy adviser to the Congressional Joint Economic Committee.

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