Tuesday , October 15 2019
Home / S. Sumner: Money Illusion / My new Mercatus paper on IOR

My new Mercatus paper on IOR

Summary:
I have a new Mercatus policy brief discussing interest on bank reserves. Here’s an excerpt: After the Fed adopted a policy of IOR in late 2008, I argued that the interest rate should be set at a negative level. At the time, many scoffed at this suggestion, doubting whether the effect would be expansionary. After all, negative IOR is a tax on reserves, and we normally think of taxes having a negative impact on the economy. But money is very different from other goods. Less demand for goods is contractionary for the economy and often leads to higher unemployment. Money is just the opposite. Less demand for money is expansionary for the economy, boosting employment. That’s because money is the other side of any transaction. People can reduce their holding of money only by

Topics:
Scott Sumner considers the following as important:

This could be interesting, too:

Tyler Cowen writes Abhijit Banerjee reminiscenses

Tyler Cowen writes Monday assorted links

Scott Sumner writes The US is losing the trade war, and that’s good

Scott Sumner writes A warning for Democrats

I have a new Mercatus policy brief discussing interest on bank reserves. Here’s an excerpt:

After the Fed adopted a policy of IOR in late 2008, I argued that the interest rate should be set at a negative level. At the time, many scoffed at this suggestion, doubting whether the effect would be expansionary. After all, negative IOR is a tax on reserves, and we normally think of taxes having a negative impact on the economy.

But money is very different from other goods. Less demand for goods is contractionary for the economy and often leads to higher unemployment. Money is just the opposite. Less demand for money is expansionary for the economy, boosting employment. That’s because money is the other side of any transaction. People can reduce their holding of money only by purchasing goods, services, or financial assets. Thus, a tax on bank reserves (negative IOR) will tend to boost spending on other goods, services, and assets. Indeed, asset markets reacted to announcements of negative IOR in Europe and Japan as if negative IOR were an expansionary monetary policy shift.

On the other hand, people should not expect too much from negative IOR. Central banks have been reluctant to push IOR too far negative, and thus far the program has only had a modest expansionary impact, where it has been tried. In that respect it is sort of like quantitative easing (QE)—a useful tool, but often employed as a defense mechanism where the overall policy regime has failed and pushed the economy deep into recession. A better policy would be to adopt a monetary regime that did not require emergency measures such as QE and negative IOR. One such alternative policy is nominal GDP (NGDP) level targeting, at a trend rate of NGDP growth high enough to keep nominal interest rates above zero.


Tags:

 
 
 
Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment".

Leave a Reply

Your email address will not be published. Required fields are marked *