Sunday, February 1, 2015

SNB and Swiss Francs

I have written a couple of comments on other blogs about the Swiss National Bank's decision to let the Swiss Franc float, and the resulting 20 percent appreciation against the Euro.   The SNB held a substantial amount of Euro denominated assets, and so the result was heavy financial losses.    The rise in the value of the Swiss Franc will result in cheaper imports from the Euro-zone, and so exacerbate  consumer price deflation in Switzerland.   That is inconsistent with the Swiss National Bank's inflation target.

Robert Murphy reproduced a graph that showed a large increase in the Swiss monetary base.   It was approximately equal to Swiss GDP.   I wrote a comment pointing out that creating base money is easy.   What is the problem?

Of course, I do realize the problem is possible losses on the assets that the Swiss National Bank is purchasing.   I discussed that in a comment on a post on Sumner's Money Illusion blog.   He reproduced it in a later post on Econlog.   If the demand for Swiss base money increases temporarily, then the proper response is for the SNB to expand the quantity temporarily.  However, if it finds itself purchasing risky assets to match the added liabilities, then it should lower the interest rate it pays on reserve balances, perhaps below zero.   As Koning pointed out in a post on his blog, if the interest rate on SNB reserve balances falls below zero, then this will create an incentive to hold currency.    This would be an incentive by banks (especially Swiss ones) to hold vault cash and for people to keep currency in safe deposit boxes.   I endorsed Koning's point that if the SNB is charging for reserve balances, then it needs to stop issuing large denomination banknotes convenient for hoarding.   I argued that it should limit its issue of currency to denominations appropriate for retail trade in Switzerland.

Now, I don't believe that the SNB should be targeting the Euro or consumer price inflation.  The SNB should not worry about deflation of import prices, but only the impact on the demand for Swiss exports and the secondary effect of import deflation on the demand for Swiss import competing products.   Well, more exactly, it should be targeting Swiss nominal GDP which includes exports and import-competing (and other) Swiss goods and services.

Given its close trading ties to the Euro-zone, keeping nominal GDP growing on a stable growth path (say 3 percent) would likely result in depreciation of the Swiss franc relative to the Euro as long as the ECB continues with a deflationary policy.   A commitment to allowing the Swiss franc to depreciate in that way would tend to reduce the demand for Swiss francs.   Or at least, it will tend to reduce the demand for currency issued by the SNB and by refraining from raising the interest rate paid on reserve balances, the SNB could reduces the demand for reserve balances.  Swiss banks, similarly could limit the increase in deposit interest rates to limit growth in their deposits.

Murphy's response to my brief comment on his blog was to describe a scenario where the huge increase in the quantity of Swiss francs starts to cause inflation.   The SNB needs to reduce the quantity of base money to prevent the inflation.   But at that same time, the Swiss franc rises relative to the Euro and so the SNB takes large losses on Euro-denominated assets.   More importantly, sales of these lower valued Euro-denominated assets will cause a smaller reduction in the the quantity Swiss base money.   In the extreme, the SNB may not be able to reduce its issue of base money enough to prevent inflation because it lacks sufficient assets to sell.

The first problem with the argument is the presumption that any increase in the quantity of money is inflationary.   While this is true if we start in equilibrium and the demand for money is held constant, it is false if the quantity of money only rises to match an increase in the demand to hold money.   It is supply and demand, not just supply.  

So, the worry isn't some kind of inevitable inflationary impact of an increase in the quantity of Swiss francs, but rather the possibility that the demand to hold Swiss francs might fall.   The SNB must be in a position to sell off assets and reduce the quantity of Swiss francs to match possible reductions in the demand to hold them.

Now, how exactly is it that the Swiss franc is going to appreciate against the Euro in this scenario?   If anything, the reduction in the demand to hold the Swiss franc would cause it to depreciate.   This would increase the value of Euro-denominated assets and make them more able to absorb Swiss francs when sold.

Suppose that the Euro-zones deflationary problem shifts to inflation.   This could cause the Euro to depreciate.   And so now, the SNB has Euro-denominated assets that have lost value.   But is this realistically a situation where the demand for Swiss francs would fall?   Wouldn't inflation in the Euro-zone instead result in a higher demand for Swiss francs?

And finally, as Sumner has pointed out, maybe the SNB should diversify its asset portfolio--don't just purchase Euro-denominated assets, purchase dollar (and yen) assets too.   Remember, the problem isn't that the increase in the quantity of base money is inherently inflationary.   It is to avoid net losses on the SNB's asset portfolio.

Consider a scenario that has been common in history, but far removed from the current situation:

Suppose the SNB was propping up the Euro by purchasing Euro-denominated assets.  The problem is that the Euro zone is suffering from inflation and the SNB is responding to concerns by Swiss exporters.   A higher Swiss franc will hurt their sales and profits.    The SNB is purchasing Euros with newly-created Swiss francs, causing an excess supply of Swiss francs.   Eventually (after the long and variable lags,) this excess supply of Swiss francs will lead to inflation in Switzerland.   It would be  a classic case of imported inflation.   If and when the SNB gives up on the policy and no longer supports the Euro, the Euro will fall.   Just when Switzerland needs to reduce the quantity of Swiss francs, its Euro-assets will have fallen in value.

Well, that would be a bad policy.   But that is not what is happening.   The demand for Swiss francs has risen.   And the SNB needs to accommodate the higher demand to hold its liabilities by issuing more or else come up with a way to dampen the increase in demand by lowering the interest rate paid (or raise the amount charged) for deposit balances.   As for hand-to-hand currency, it can quit issuing denominations convenient for large scale hoarding.   I believe that the SNB, like other central banks, should get out of the hand-to-hand currency business, so that this would not be a policy matter, but rather a decision by private banks to limit their issue of hand-to-hand currency when they find it profitable to do so.

Saturday, January 31, 2015

Audit the Fed!

I support an Audit of the Fed.

I just read a short newspaper article criticizing Rand Paul's Senate bill.   The article noted that Senator Cruz has jumped on the bandwagon.

When Ron Paul began calling for an audit of the Fed, I was a bit irritated.   I am well aware of the crazy conspiracy theories regarding the Fed.   The secret international banking cabal is making huge profits from its ownership of the Fed, with some kind of confused notion that each dollar created is a profit for the Fed's owners.   I even wrote a short paper debunking these views.    Part of the conspiracy theory is that the Fed isn't audited.

As I said, giving credence to these crazy views is irritating.   Sadly, any audit of the Fed would likely do little good in debunking the conspiracy theories, because these crazies won't believe the audit anyway.    Still, that there was a special major audit of the Fed, sponsored by the son of Ron Paul, would require the conspiracy mongers to go further off the deep end.   Good.

Of course, after the Fed got into the business of making loans to particular banks and other financial firms in big way in 2008 and 2009, an audit became especially justified.   Who was bailed out and why?    This is government money.   Should central bank officials know that they will have to justify their decisions later?   Yes, of course.   Will this make them more cautious in an emergency?   Most likely.   Should they be more cautious because they understand that their decisions will be subject to "Monday morning quarterbacking?"   Yes.   It is much better than the alternative of bailouts with no accountability.

And finally, I fully support having the Fed's monetary policy actions reviewed.   Should Fed officials understand that they will have to justify what they have done?   Yes, of course.    Might the need to do so make them more cautious?    Yes.     Might that result in some errors where a Fed that was less accountable would take an appropriate action?   Maybe.    And, of course, it might also avoid other errors due to irresponsibility.   More importantly, it is better than the "rule" of no accountability.

Now, I admit that I think the Fed went way too far in 2008 and 2009 in bailing out politically connected financiers.

Further, I think the Fed's monetary policy is bad and needs fundamental change.

I think the Fed should have much less discretion, and that the Fed should have a rule imposed upon it that works tolerably well in all circumstances.

What about Fed independence?   Well, I don't favor having the Treasury Secretary setting interest rates every six weeks, much less some crazy policy of just fixing them for long periods of time.    Nor do I think the Treasury should determine the scope of open market operations on a day to day basis.   Neither do I think Congress should be setting interest rates or targets for base money.  And I also don't favor having the Treasury Secretary or Congress directing Fed lending.  Political favoritism would shift from a concern to a certainty.

I do think Congress should legislate the target for monetary policy--preferably a growth path for nominal GDP.   And I think the Fed should be given discretion in determining the current monetary conditions consistent with hitting the target.   The Fed should expect to have its decisions reviewed, and most obviously if it misses the mandated target.   And that will probably happen frequently.   Here is what base money and short term interest rates did over the past year, and nominal GDP ended up off target.   And Fed officials will have to explain why they thought their decisions about base money and/or interest rates were justified.  

And then I read Paul's bill.   It is difficult to connect Paul's bill to what the reporter said.   Did the reporter even read the bill?

Friday, January 16, 2015

Program Manager needed for Market Monetarist Program at Mercatus

Here is the add for a Program Manager at the new Market Monetarism program at Mercatus.

Please share with people who may be interested.

Sunday, January 11, 2015

Some Aggregate Supply and Demand Diagrams

Scott Sumner has been surprised by those economists who are surprised by slower wage growth along with faster increases in employment.   He pointed out that if the supply of labor increases, then wages go down while employment increases.   He says that the puzzled economists seem to be just looking at a supply curve, so that a higher quantity of labor must mean a higher wage rate.  

Sumner this time copies a simple aggregate supply and demand diagram showing the short run and long run effects of a decrease in aggregate demand.   In the short run, both prices and output decrease, pushing real output below potential output.   In the long run, the short run aggregate supply curve shifts right, so that real output recovers, while the price level falls even more.

Sumner's point is that the slower wage growth and expanding employment is related to the simultaneous deflation and recovery of real output that is part of the basic textbook analysis of aggregate supply and demand.   It is the adjustment of the long run.   That Market  Monetarists typically advocate that Aggregate Demand shift back to the right, so that prices and output both recover doesn't mean that we forget what happens if Aggregate Demand remains stable.

Sumner then point out that the more modern approach replaces the price level with the inflation rate and the the levels of real output and potential output with the growth rates.   This approach is used in Cowen and Tabarrok's text.    Unfortunately, that approach is unable to show problems with levels.

It is possible that the growth rate of real output equals the growth rate of potential output, but the level of real output remains below the level of potential output.

Pretty complicated, I know.   The shift in LRAS is supposed to be 3%.    Aggregate demand is growing 5%, inflation is on target at 2%, and real output is growing 3%.   But potential output is growing at 3% as well, so the output gap remains constant.    In this diagram, it is 5%, but that is an assumed starting place rather than an implication of the arithmetic.  

Now, the natural rate hypothesis says that this cannot be a true equilibrium.  The Short Run Aggregate Supply curve cannot continue to shift to the left enough to keep inflation at 2%.   Sumner's theory, which I think is correct, is that wages will grow more slowly which will cause the SRAS to shift a smaller amount "up."   The result will be lower inflation.

However, it seems to me that recent evidence suggests that the better anchored inflation expectations, the less effective this process.   Ideally, in this example, the short run aggregate supply will shift to the right enough to cross the second Aggregate Demand curve where it intersects the second Long Run Aggregate Supply curve.   That would imply substantial deflation of prices.   Strongly anchored expectations of 2 percent inflation makes this more difficult to accomplish.   If the Fed convinces everyone that everybody else will raise their prices 2% next period, cutting them substantially, (3 percent in this example) would not be optimal.

Most Market Monetarists have been arguing for more rapid growth in Aggregate Demand.   It is simply an implication of level targeting.   The result would be an Aggregate Demand curve that shifts much further to the right, crossing the second Long Run Aggregate Suppply curve, where it crosses the second Short Run Aggregate Supply Curve.   Unfortunately, that results in higher than 2 percent inflation.

Here is a diagram that attempts to describe something like the status quo.   Notice that inflation is a bit lower than 2%, real output is only growing 3%, but the output gap is closing because potential output is growing more slowly.

If the SRAS curve shifted less to the left, or even shifted to the right a bit, inflation would be even lower, real output would grow more rapidly, and the output gap would shrink more rapidly.   A rapid recovery with continued slow, (4.5% in the example) growth in Aggregate Demand would require a large rightward shift in the Short Run Aggregate Supply curve.   To do it all at once would require 6 percent real growth.   With 4.5 percent nominal income growth, that implies 1.5% deflation.

Saturday, January 10, 2015

Politics, Ideology, Micro and Macro

Peter Boettke and Noah Smith have discussed whether economics is becoming more leftist.

Some of those commenting on the debate have insisted that "macroeconomics" is especially driven by ideology.   Microeconomics is held out as a more value-free, scientific enterprise.

Of course, "more" is a matter of degree.  Still...

I would suggest that macroeconomics has three major areas of concern--inflation, the business cycle, and growth.    Inflation, particularly when it is high, and the business cycle, particularly the recession phase, are of major political concern.    While the economists who  study these matters, like everyone else,  probably consider these things important, it is really the focus of other academics, intellectuals, politicians, and the man on the street that results in ideology being thrust into the study of inflation and the business cycle.

What about other areas of economics?

Industrial organization is a field of microeconomics.   Anti-trust especially, but other ares of regulation policy are involved.    There is no consensus.   Economists can be lined up according to their views-- more "market-oriented" or interventionist.

Labor economics is a field of microeconomics.   Labor unions and various regulation such as the minimum wage are dealt with in this field.    There is no consensus.   Economists can be lined up according to their views-- more "market oriented or more interventionist.

I find it incredible when microeconomists hold up macroeconomists to criticism or even ridicule for the inability to come to a consensus.   Come on!  The minimum wage?

Public finance is an area of microeconomics.   Writ large, it obviously relates to growth theory.    The micro effects that would apply to a special excise on tires have obvious macro implications for a  general tax on income.   Keynes and his followers have long advocated the use of fiscal policy to manage aggregate demand to moderate the business cycle, or perhaps more specifically, to generate or hasten recovery from recession.     But even leaving aside whether Keynesian fiscal policy is useful, there is no consensus about public finance whenever the implications are politically controversial.

Come on.  Supply-side economics?   All economists agree?

What about international trade theory?    I am not sure whether anyone neatly has it in the micro or macro category.  And while there is a near consensus among economists in favor of free trade, the area is very controversial because of all of the special interests that can benefit from trade restrictions.   There is always great interest in the work of economists who can find the special cases where trade restrictions are beneficial.   And, of course, there is no consensus about what policy is best exactly--unilateral free trade, negotiated trade agreements, fixed or flexible exchange rates--all areas of political controversy and no economic consensus.

I am sure that there are some areas of microeconomics where hardly anyone can see any policy relevance and it is all about complementing each other on mathematical elegance or looking at the significance of some empirical test.   What is the cross price elasticity of demand for corn relative to soybeans?   I am sure there are "practitioners" that are very interested in an accurate answer to that question.   But unless it starts having policy significance--perhaps regarding farm subsidies--who is going to get worked up about it?

As for the dominant ideology among economists, I think Boettke is correct.   Samuelson's political views were center left.   He was the dominant figure in economics in the second half of the twentieth century.   And the dominant economists before and after Samuelson were much the same.

It is necessary to go back to the nineteenth century to get to a point where maybe most economists were more libertarian and less social democratic.

The more modern free market economists--Friedman and Hayek along with their predecessors in the twentieth century and successors more recently-- became influential, but were always very much a minority in economics.  Self-identified "Austrian" economists, including Hayek, were very much a minority among the minority of free market oriented economists.

Now, for  hard-left quasi-Marxists, Samuelson is a conservative.   As far as I know, Samuelson was highly skeptical of any effort to replace a market order with a new kind of society.   He just favored (lots of) piecemeal reforms to "improve" the market system.   For a hard left radical that amounts to effort to delay the day of reckoning for a system that should and will be surpassed by a new sparkling and wonderful future.

Also, I have never exactly understood the meaning of the term "neo-liberal" but for many on the left, Samuelson would seem to fit the bill.

But when I do read leftist attacks on neo-liberalism, they often use Friedman or Hayek as their foil, and then mischaracterize their views.    Friedman and Hayek are made out to have the policy views of Mises, or even Murray Rothbard.   (Noah Smith holds up Hoppe, a Rothbard acolyte and philosopher as an example of Austrian economics.   Right.)

As for the policy economists that work in Republican administrations, they are certainly to the right of Samuelson, but the majority have been what is called "conservative Keynesians" with only a minority being followers of Hayek or Friedman.    Of course, it always helps when the leading politicians, like Thatcher or Reagan sing the praises of some leading free market economist, but they, or their followers, hardly win the battles over policy.   (Though economists of every stripe know that all sorts of policies are implemented by politicians against their advice.)

I don't know that we should have any confidence in Noah Smith's opinions on what any economists think other than himself, but surely it is possible that within the center-left mainstream, those slightly more to the left feel slightly more emboldened to defend or develop more extreme positions.   Perhaps those who favored a return to 70% or 95% marginal tax rates had feared that such proposals would make them marginalized, and they now are emboldened.

But Boettke is correct about the big picture--an economics absolutely dominated by the center-left.   The free market wing has always been a minority.   The "Austrians" are a minority of that minority and approximately as marginalized as the hard left.

Saturday, January 3, 2015

Tony Yates Slams Nominal GDP level targeting

Tony Yates has been rather rudely attacking nominal GDP level targeting and Market Monetarists  in general.   Nominal GDP level targeting is "silly."   Market Monetarists mostly are criticized for failing to write down models.   In other words, all that is valuable in monetary theory has been developed in the last twenty or thirty years using Yates' methods.

Anyway, he claims that that the "theoretical case" against nominal GDP level targeting is much stronger than implied by simple work-a-day new Keynesian models.   He explains:

If we relax these restrictions, optimal policy becomes a much more complicated beast.  It involves [actually this is an informed conjecture not an assertion of analytical fact] a weighted sum of deviations of inflation, nominal wages, consumption by borrowers and lenders (entering separately), interest rate spreads, the capital stock, the real exchange rate…  and with weights on inflation of prices and nominal wages an order of magnitude greater than the rest.

So, central bankers are supposed to implement and the general public find credible a rule that sets short term interest rates according to deviations of all of those things?   From what, exactly?   Estimates of natural levels?   Past averages? 

And, while I agree with Yates that all of those complications are very relevant, there are many, many more.   

The rule Yates proposes is really simple.   Maximize social welfare.  But there is a distinction between rule and act utilitarianism, and always act to maximize utility doesn't count as a rule.

A monetary authority needs to be subject to a rule that its "bosses," the voting public, can understand.

One interesting point of agreement between Yates and many Market Monetarists would be that he argues that heavy weight should be given to nominal wage inflation.    

Anyway, Yates argues that the welfare cost of inflation is that prices are stuck away from equilibrium levels and this reduces welfare.   Oddly enough, he then adds that when that occurs people must work and produce too little or too much, and so the opinion of the uneducated masses that "unemployment" is a problem is really a problem with inflation.   And so, that is why inflation should be weighed more heavily (by a factor of 20 or something) than deviations of output from potential.  

Perhaps I am missing something, but surely people working too much or too little is the same thing as deviations of output from potential.   The "costs" of inflation must somehow relate to the changes in prices that actually occur, not the problems that develop because the prices fail to adjust enough.   

I thought that the theoretical result of the traditional one consumer good with a sticky price model  is that keeping that price at its current value is the best policy.   The two percent trend inflation actually pursued by central banks leaves about 1/2 of the firms with prices too low and 1/2 with prices too high all the time.  

With a zero inflation target, if somehow the price changes, then that is sad, but nothing can be done about sunk costs.   The least bad option is to leave the price where it is rather than bear the cost of changing it again.   This is the logic of inflation targeting.    Stabilize the price level wherever it happens to be rather than trying keep the price level on a constant target by reversing deviations.

That people might want to plan for the future is not really taken into account.   That would be much more complicated.   But common sense suggests that a price level rule is superior to an inflation target in that context.   If I know that the price level will be 100 for the net 10 years, I have more certainty than if every time the price level changes it will be stabilized at its new level.    (Perhaps that is where the complications that Yates believes relating to borrowers and lenders would occur.   Perhaps he should look at Eagle's math showing that utility is maximized with level targeting and nominal income is better than the price level.)

Calvo pricing is unrealistic.   We have a single good, and a portion of the representative agents get to adjust their prices each period.   The others are stuck with prices that may be too high or too low until they have their chance to adjust prices.    The result is that changes in aggregate demand impact both prices and output.   Prices adjust some, but not enough to clear markets so that real output remains equal to potential.   

Well, I agree that prices and wages are sticky and that changes in spending on output impact prices and wages and output and employment, but the notion that Calvo pricing should ever be taken literally is silly.

I have never understood how Calvo pricing  is an argument for inflation targeting.   Say aggregate demand falls and 20%  of the firms get to lower their prices in an optimal fashion   and the other 80 percent have prices that remain too high.   The price level actually falls, but not enough to clear the market.   With inflation targeting, that new price level is made the new target.   Now, the other 80% of firms need to lower their prices too.   As each cohort lowers their prices, the target price level falls a bit more.    All the firms know this, and so only the last set of firms actually lower the prices enough so that markets finally clear at the new lower price level.

  Say the price level is 100, and there is an aggregate demand shock that makes the equilibrium price level 105.   If 20 percent of the firms immediately raise their prices 5% and the other 80% of firms leave their prices unchanged, then we have one firm pricing optimally and 80% of the firms with prices that are too low.   The price level rises to 101.    With inflation targeting, the price level will be set at 101 permanently.   The first firm will now have a price that still too high, roughly 4%.   And the next set of firms get to adjust their prices, and so they set it at a level consistent with a price level of 101.   

Now, let's instead suppose that aggregate demand falls, and 20 percent of the firms lower their prices.   The actual price level falls below 100, but aggregate demand is increased so that the equilibrium price level is again 100.   The 80 percent of firms that did not have an opportunity to lower their price in the first period have no need to make any adjustment in their prices.    This certainly seems to minimize the cost of adjusting prices for the entire economy.  The cost would be that the firms that have an opportunity to lower prices, lower them by less than with inflation targeting, and so prices fall even less than would be desirable to clear the market.  

But suppose that some prices are flexible and others are sticky.   The 20 percent of firms that adjust prices haven't just happened to reach their turn, it is rather their prices are set on auction type markets.   If aggregate demand increases enough to raise the price level back to the initial value, then those firms are not unhappy that their prices are stuck too low until their turn comes to adjust prices.   Rather, they are happy because demand increased again and their selling prices and profits have recovered.   And the other 80 percent of firms with sticky prices, while sadly having suffered a loss in demand, see demand recover without ever having to bear the costs of price adjustment.

With the scenario where prices are flexible but wages sticky, then a decrease in aggregate demand results in lower prices and lower output.   If the temporary decrease in the price level is made permanent, then wages must be reduced.   If the decrease in the price level is reversed, then real output and employment recover with no need to adjust wages.

In my view, the problem with price level targeting is with supply shocks.    If "price level shocks" are included as part of the quasi-phillips curve, then if the price level is shocked up, and then later it must be lowered, then in Yates' framework, the problem is that only a certain proportion of firms can lower their prices each period, and those who have not had a chance to lower their prices yet will have them too high.

In my view, if the price of some particular good, such as corn, increases due to a bad harvest,  then the inflation in prices is not "bad" at all.   The high price signals the greater scarcity of corn and provides an incentive to conserve on its use.   Creating a monetary disturbance to force down other prices enough so that the price level returns to target is a bad thing.   That some of these prices, including wages, are likely sticky, so output falls below potential, is adding insult to injury.  

The benefit of inflation targeting is that if the supply shock is unanticipated, the impact of the higher price of corn on the price level is ignored.   However, what is the impact of an anticipated increase in the price of corn?    Does an inflation target require that aggregate demand decrease enough so that inflation does not increase?   

Since real world aggregate supply shocks typically impact both prices and output in opposite directions, nominal GDP level targeting ameliorates this problem of price level targeting.   If the demand for the particular good suffering an aggregate supply shock is unit elastic, then total spending on that good remains unchanged, and so no adjustment in monetary conditions are needed to keep total spending unchanged. 

Interestingly, if demand is not unit elastic, so that spending on a good with an aggregate supply shock changes, then depending on the elasticity of supply for the good, changes in spending in the rest of the economy is coordinating.   For example, if the supply of corn decreases, and demand is inelastic, what that means is that buyers prefer to spend more on corn and pull resources from the rest of the economy.   Reduced spending on other goods is coordinating.   

And so, I agree with Yates that nominal GDP level targeting is not optimal compared to an omniscient central bank.   But real world central banks are not able to keep track of the elasticity of supply and demand of each and every good that has some shift in supply. 

Tuesday, December 30, 2014

Cancelling Currency According to Cochrane

Rogoff has a paper discussing the costs of and benefits of a cashless payments system.   Cochrane responded with the following:

So, quiz question for your economic classes: Suppose we have substantially negative interest rates -- -5% or -10%, say, and lasting a while. But there is no currency. How else can you ensure yourself a zero riskless nominal return?  
  • Prepay taxes. The IRS allows you to pay as much as you want now, against future taxes. 
  • Gift cards. At a negative 10% rate, I can invest in about $10,000 of Peets' coffee cards alone. There is now apparently a hot secondary market in gift cards, so large values and resale could take off. 
  • Likewise, stored value cards, subway cards, stamps. Subway cards are anonymous so you could resell them. 
  • Prepay bills. Send $10,000 to the gas company, electric company, phone company. 
  • Prepay rent or mortgage payments. 
  • Businesses: prepay suppliers and leases. Prepay wages, or at least pre-fund benefits that workers must stay employed to earn. 

Here are the ones I can think of:  
Comments section: how many more can you think of? 
He goes on:

So, bottom line, we cannot have strongly negative nominal rates without a legal revolution essentially negative-indexing the entire economy and payment system, and upending centuries of law giving you the right to pay bills at face value.

I suppose a finance academic would focus on a zero riskless nominal rate of return.   As a monetary economist, I focus on the supply and demand for money.   

If there is a shortage of money, it is very disruptive and fixing it is a good idea.   The solutions are to increase the quantity of money or reduce the demand to hold money.   Most money usually pays relatively low nominal interest , and so reducing that yield is one obvious method of reducing the demand to hold money.   Shifting from paying people to hold money, to a zero nominal yield, to charging them to hold money seems pretty straightforward.  Money provides services, and people would be willing to pay for them.  In some situations, they should pay for those services.

Of course, the other method of fixing a shortage of money is to expand the quantity of it.   And the lower the yield paid on money, the more profitable that approach would be.   However, if the interest rates banks can earn by lending money, including holding various sorts of bonds, are exceptionally low, then it is possible that monetary equilibrium would require a negative nominal interest rate paid on money balances.   The interest rates on other sorts of assets, especially those assets banks buy, would be somewhat higher.    

With extremely low credit demand and a very high demand for money, it might be possible that equilibrium would involve banks earning negative yields on at least some of their assets.  That implies that someone is able to borrow at negative rates, while the banks pay still lower yields to their depositors.

While I don't see much value in a monetary regime that generates a 10% trend deflation rate, I think it is likely that equilibrium would require that nearly all nominal interest rates be negative.   And further, zero nominal interest rate currency would be very disruptive.

If hand-to-hand currency was privately issued, since it is hardly practical to charge people for holding it directly, then in a very low credit demand environment, banks would stop issuing currency.   The result would be a cashless payments system.   

Now, I don't have any problem with banks issuing currency at a loss if that is what they want to do.   But I don't think they should be forced to do so.   And if no one wants to issue a zero nominal interest rate asset, then there won't be one for people to hold.   

Of course, that isn't the world we live in.   The government issues a zero-nominal interest rate asset--hand-to-hand currency.   And it declares that it is legal tender for all debts.   This is especially relevant because all of the bank issued money must be paid off on demand with government currency.   The entire monetary order is based upon the government currency.  

Since holding government currency--effectively lending to the government at  a zero nominal interest rate--is always possible, this government intervention creates a floor on the nominal interest rate-the cost of storing paper currency.   

On the other hand, the evolved commodity money systems of the past also had a similar zero nominal bound--the cost of storing the monetary commodity.  

Anyway, the point of my digression is twofold   First, the purpose of negative nominal interest rates on money isn't to prevent people from having a riskless nominal rate of return.   It is to reduce the demand to hold money so that it will be in balance with the quantity of money supplied.   

And second, there is no problem with people being able to hold assets that other people want to issue.  The problem is limiting the demand to hold assets when there is a shortage of them.

So, I am going to start with Cochrane's second example.    People could supposedly get a riskless zero nominal rate of return by purchasing gift cards.    Cochrane even notes that there is already a secondary market in gift cards.    My wife tells me that you can sometimes buy a $100 card on sale for $90.   That is a pretty good rate of return, I guess.   

First, if retailers want to issue gift cards at face value, and so provide investors a zero nominal return, that is fine.   Of course, there is a risk--suppose the retailer fails?    Did Cochrane forget that?    

Under usual circumstances, when a retailer sells a card it is getting a loan.   Leaving aside discounting the cards, it is a zero interest loan.    And so, now the retailer has the money.  What do they do with it?   If the interest rate on money is sufficiently negative, then the retailer will find borrowing money at a zero interest rate and then paying to hold it  unattractive   Of course, perhaps the retailer can invest by purchasing assets that have a positive yield.   Or maybe they will accumulate inventory to be prepared for the greater sales when the cards are spent.   It doesn't matter.    As long as the retailer doesn't hold the money, the lower (below zero) nominal interest rate has done its job.   

Now, if this becomes too burdensome for the retailers, then they might stop issuing the cards.  Or, they might issue them but charge a premium and require that they be used by a certain date.   

In my view, in a privatized system, if banks quit issuing private hand-to-hand currency because it was not profitable, then I would expect that retailers would expand their sales of gift cards.     They might even issue paper currency.   For example, Walmart might issue something like Walmart currency that can only be "redeemed" for products at Walmart.    But in the end, Walmart would only issue gift cards or currency if it wanted to--found it profitable.    

And what does Walmart do with the money it receives?   If it holds it, that is a problem.   But that is what the below zero interest rate on money aims to deter.   If Walmart purchases other assets or purchases inventories of goods, constructs new buildings, or whatever, the problem is solved.

Consider Cochrane's fourth example--pre-paying utilities.   Now, my utility companies vary the amount billed according to use.   If you prepay, then you get a credit balance on your account.   And then, at the normal billing time, they debit the balance.   You get a bill that says that you don't owe anything this month and it tells you your new, lower credit balance.    If you have a debit balance, they add to it as each bill comes  due.   They charge penalties, of course, if you are too late.

Now, few people intentionally hold credit balances with utilities.   I am not sure if it is illegal for utilities to pay interest on such balances.   I suspect if some utility started to do so and began to finance its operations with the credit balances of customers, they would run into legal problems. (Industrial firms operating banks is frowned upon.)  Regardless, if the utility had to pay to keep money in its checking account, I think they could figure out a way to charge people for holding credit balances.   

Just because many firms will allow for credit balances in an account hardly means that they have some kind of legal obligation to allow people to do so.  I have had a credit balance sometimes with my dentist.  Does that mean that anyone can come in off the street and open an account with the dentist?   Can they later come in and say that they are switching dentists and they want their money back?   

Regardless, even if the utility companies allowed people to have credit balances on their accounts and didn't charge any fee, the question remains, what does the utility do with the money?    All the negative yield on money is supposed to do is reduce the amount people want to hold.   If the utility spends the money on other financial assets or spends it to construct a new plant, the negative yield on money has done its job.

Cochrane also says that people could prepay their mortgages or their rent.   Now, I hardly count regulations allowing the refinance of mortgages without penalty to be some tradition from the centuries.   Regardless, if someone pays down their mortgage, what they have is not a riskless asset but more equity in their home.   They are bearing more risk.   

But what are the monetary consequences?   Paying down bank mortgages tends to contract the quantity of money.  However, any single bank receiving such repayments will accumulate reserves.   And the interest rate on that form of money is negative as well.  

For most institutional setups, that is what is driving the negative yields on deposits.   Banks are motivated to purchase other assets due to these negative yields on reserves.   (My own preference is for the interest rate on reserves to float at a  few basis points below the interest rate on  short Treasury securities.)

Further,  I don't see why a landlord would need to say, "you are paid up for 6 months," rather than credit a account with a prepayment and then debit it as the rent comes due.  In other words, like my electric company does.  

Of course, if landlords want to allow people to do this at a zero interest rate, that is fine.   What does the landlord do with the money?   If they find borrowing at a zero interest rate desirable and then spend the money on financial assets or buying more houses, then the problem is solved.  The point of the negative yields on money is to reduce the demand to hold money.

Businesses are going to prepay suppliers?    Well, I guess.   But if this is a spot transaction, then the likely result of prepaying in an environment of negative yields on money, is that the price you pay will be higher.   I will give you $100,000 now and how much copper will you give me in six months?   Less than if I took delivery now?   Maybe I should buy now.  

But again, if the suppliers will accept deposits on their account, then that is fine  What do the suppliers do with the money?   Prepay wages?    What do the workers do with the money?    Prefund benefits?   What does that mean?   A firm pays an insurance company early?   What does the insurance company do with the money?

And finally, there is Cochrane's first example.   Nominal interest rates cannot fall below zero because the IRS allows people to pre-pay their taxes.   What does the U.S. Treasury do with the money?   If it uses it to pay off government bonds, then there is no problem.   Holding onto money at a negative yield would hardly be attractive to the Treasury.   And those receiving it in exchange for the government bonds would have the money.  What do they do with it?   The point of a negative yield on money is to reduce the demand to hold money.

If the Treasury were to receive money to prepay taxes, then it is borrowing money at a zero interest rate.   It should be no surprise that the Treasury is usually happy to do this, since it is usually funding most of the national debt with interest bearing bonds.   If the interest rate on money is negative, and there are no more government bonds to pay off, and the Treasury simply holds onto the money, then the Treasury takes a loss.   It is borrowing money at a zero interest rate and then lending it at a negative interest rate by holding money.   

And this would be a problem.   The demand for money would not fall.  Those prepaying taxes would reduce their demand to hold money, but it would be just matched by an increase in the balances the government holds.   Traditional conventions for measuring the quantity of money would count this as a decrease in the quantity of money.   

Again, if there is no national debt to be repaid, then unless Congress can be convinced to lower taxes or raise outlays, the Treasury would take a loss.   And the demand to hold money would not be reduced.  (Again, this would actually show up as a decrease in the quantity of money.)  

And, of course, maybe, just maybe, the Treasury would provide taxpayers with a credit account for pre-paid taxes and charge them interest on it--maybe something like what the taxpayers would have to pay if they kept their funds in their own checking account.

In a world where the interest rate on money is negative, or really, a world where those receiving payments have no good investment opportunities, then making some open ended commitment to allow unlimited prepayment would be costly to those parties choosing to provide that opportunity.   They will likely stop.

And, other than the government, it is obvious that none of these transactions create a riskless asset.   These are all loans to private institutions that could fail. 

In my view, there is really little value in assets with no nominal risk.   The value is in assets with no real risk.   Reducing the real risk of nominal assets requires a decent monetary regime.   One that just holds the nominal quantity of money stable and allows the price level to adjust so that the real quantity of money accommodates the real demand to hold money implies real risk   A monetary regime that adjusts the nominal quantity of money to the demand to hold money at a stable price level or growth path of nominal GDP is not free.   There should be no expectation that the monetary regime must create a monetary asset that has little real risk and a zero, much less positive, real yield.    It depends on the cost of operating the regime and the demand for credit.  

Government bonds do have a low credit risk under most circumstances, and with a good monetary regime, the real risk due to aggregate supply shocks and aggregate demand shocks is dealt with reasonably well.   If the demand for government bonds becomes so high that a negative nominal yield is necessary to clear the market for government bonds, then a negative nominal yield on government bonds is the least bad option.    Creating a monetary disturbance so that there is a sufficient liquidity effect to keep the nominal interest rate on government bonds above zero would be a foolhardy.

Now, if the real interest rate on government bonds is negative, then it certainly seems that running  budget deficit would be sensible. Not because it would raise the yield on government bonds to benefit the government's creditors--charging them less for this low risk asset.   But rather because government spending programs would cost future taxpayers less than current taxpayers.   That this would provide investors with a low risk asset at a lower charge should not be the goal of fiscal policy.   

While government bonds may have little credit risk for the lenders, this can be nothing other than a shift of risk to the taxpayers.   Suppose destructive government regulations cause real output to fall ten percent.    How are government bond holders protected from this disaster?   The taxpayers must pay more taxes for fewer services. 

And so, budget deficits and a national debt are adding risk to future taxpayers.   If the interest rate on the national debt was negative forever, then that would be a good reason to expand the national debt.  However, what if the interest rate on short government bonds is negative right now, but likely will turn positive in the near future.   Should the government refinance the national debt immediately, borrowing short rather than long?   This should make the interest rate on short term government bonds less negative and so provide investors a better return.   Or should the government try to lock in relatively low long term rates?    

Should the government cut taxes or increase government spending, running a deficit now?  To me, I am much more confident that if the government is purchasing long lived assets, and the long interest rate at which it can borrow is lower, then it is reasonable to buy assets that would be purchased in the future anyway right now.   Start the project now, when financing costs are low.

I don't have the answers exactly as to how the government's fiscal policy should respond to low or even negative nominal and real interest rates.   I am sure that the monetary regime should not be held hostage to the answer to these questions.   I favor a monetary regime that will allow the yields on government bonds to turn negative when there is a sudden increase in the demand for government bonds.   I favor a monetary regime that will allow the interest rate paid on money to turn negative if necessary to keep the quantity of money demanded equal to the quantity of money supplied, as what might happen with a large drop in credit demand.   

Having the monetary system based upon a zero nominal interest tangible government currency seems inconsistent with those principles.

By the way, I don't favor outlawing government currency.   People should be free to do what they want with old Federal Reserve notes, just like they are free to do what they like with old Confederate currency.   I just favor demonetizing it.