Lonergan Stops Rogoff Extremism with Dual Interest Rates

This article was first published by me on Talkmarkets: http://www.talkmarkets.com/content/financial/lonergan-stops-rogoff-extremism-with-dual-interest-rates?post=120122&uid=4798

Eric Lonergan, who is credited along with Adair Turner and a few others for keeping the Milton Friedman idea of helicopter money alive, has fascinating views about interest rates. Lonergan takes issue specifically with Kenneth Rogoff, but this concept he courts can be applied to Fed behavior, the ECB, the BOE, and the BOJ.

When I first discussed ECB helicopter loans on Talkmarkets, I emphasized the perpetual aspect of TRTLO's. But what also is important in Lonergan's vision is that dual interest rates makes it all work. 

What Lonergan is saying is that there are different interest rates. He says that the obvious way to stimulate an economy is to use dual interest rates. Lonergan rejects the Rogoff concept of only allowing  negative deposit interest rates that would also force a need for cashlessness due to potential bank runs.

Lonergan makes the need to force cash abolition obsolete. He acknowledges possible crime issues with cash, but many have pointed out the issue of the poor and travelers and their travails, should cashlessness be established, far overshadows crime issues. Longergan calls Rogoff's work, the Curse of Cash, a tome, a humorous reference to a book that is very long and very wordy.

But the important thing that Lonergan is offering is that TLTRO's can be separated from deposit rates. TLTRO's are loans, and they can be perpetual, even negative. They will stimulate buying. They are expansionary. On the other hand, money saved can be given a small positive interest rate so that savers, insurance companies and the like do not violate their own risk tolerance.

And Lonergan makes the case that negative rates on savings are not going to motivate anyone anyway. He gives this example as if physical cash were already history, but it could be done with real cash in existence. Lonergan makes a distinction between digital cash and electronic money:

Let’s think this through. In Rogoff’s futuristic world, we don’t have physical dollars, pounds, or euros in our wallets. Our digital wallets will contain digital cash. Now there are two options, this digital cash could simply be bank deposits – the current world without physical cash – or there could be a new category of deposit, created by the central bank and directly held by households, the quantity of which is determined by the central bank, analogous to bank reserves. This money could be fixed in quantity, would be credit risk free, fixed in nominal value and not convertible. The only substantive difference between this and physical cash, other than its electronic nature, is that bank deposits would not be convertible into electronic money.
In this world, reserves held by households and corporates held at the central bank would be a distinct category of base money. As we have seen with tiered reserves, these holdings could be remunerated at interest rates independent of those held by banks which are borrowed and lent into money markets and determine market interest rates. Surely if we want to boost spending we should set a sufficiently high positive interest rate on digital cash held by households in order to raise their spending? This indeed is a great reason to have digital cash – people would voluntarily swap physical for digital cash if it was remunerated at, say 5%.
So, if physical cash still existed consumers would be given the choice to turn their cash in for deposit, at a positive rate of interest, or keep the cash. It would be base money, not the broad money created by the TLTRO perpetual loans! Unlike Miles Kimball, Lonergan would not penalize people who got cash out of the bank, but just give an incentive to those who chose to to deposit it. This is very, well, normal. Miles and Rogoff are very abnormal, at least when thinking about the economics of cash versus cashlessness.

Lonergan shows that even bank reserves and digital cash (bank deposits) would not have to have the same rates:

Why should the interest rate on bank reserves be the same as the rate on digital cash? In other words the distinction between physical cash and bank reserves, which exists when cash is physical could persist in the fully virtual world – the rate of remuneration would depend on the holder of these reserves. Central banks could set one interest rate on digital cash held by households and another on banks’ excess reserves, which determines money market rates and market lending rates.
This also deals with the basic flaw in Rogoff’s thesis – the assumption that negative policy rates would raise spending. This is a questionable, probably false, assumption.
I would say that Lonergan seems to be a little eager to do away with cash. That is my only fault with his ideas and that seems to be optional. Perhaps economists can sort out the details with him and take seriously his views. He is, at least, thinking outside the box and it appears that the Fed and most central banks will continue to be boxed as long as they fail to seriously consider his views. 

 For further reading:

Now the Bank of England Needs to Deliver QE to the people

Beyond Donuts

Eric Lonergan Precisely Defines Helicopter Money


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