Cena Pieniądza

Negative nominal interest rates

Michał Gamrot / 2015-09-16

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Interest rates are a key instrument in modern monetary policy. If inflation rises, rates go up. If there is a recession, rates are cut. However, most economists believe there is a limit to all this fun. They assume that nominal interest rates can’t go below zero.

What I will argue today, is that this conventional wisdom is wrong.

The problem

First of all, it needs to be stressed that we are talking about nominal and not real rates.

A -5% nominal interest rate means that after a year of holding 100 zlotys at the bank you will get 95 zlotys. Clearly, not a good deal. However, from the macroeconomic perspective, negative nominal rates can be a cure for a serious economic illness.

So what’s the problem? Why do so many economists believe rates can’t go below zero?

Well, the problem with negative rates is that bank deposits can be freely converted to base money (banknotes and coins). And today, base money bears no interest or, in other words, it bears 0% nominal interest. And since, clearly 0% is better then -5%, if the central bank decides to lower rates below zero, people will convert their deposits into cash. And this is the crux of the so called zero lower bound argument.

I believe this problem is greatly exaggerated and there are 3 ways to solve it.

Eliminating cash

The most straightforward way is to get rid of physical money. If rates can’t be lowered because people will exchange deposits into cash, the problem can be solved by withdrawing all cash from circulation.

This solution has few advantages. Since all bank transfers leave a trace, a ban on cash would limit tax evasion, and make transacting in the underground economy much harder. However, it also has disadvantages. There are still people, mostly poor, who do not have access to debit / credit cards. However, these disadvantages will likely loose in significance with technological progress.

The Gesell solution

The second option, introduced by Silvio Gesell and later described by John Maynard Keynes and Willem Buiter, is to introduce a “tax on money” and attach “expiration date” to each banknote. So, what does it mean in practice?

It means that a banknote would be valid only for a limited period of time, after which it would need to be stamped for a charge. For example if the interest rate is -5%, a 100 zlotys bill issued today, would need to be stamped after one year to still be valid. The stamp would cost 5 zlotys (at -5% rate). In this scenario, there is no much difference between holding cash and deposits.

Compared with the first option (a ban on cash), the “money tax” achieves the same result without getting rid of paper currency. However, the operation of such system is probably costly, as all notes need to be periodically stamped. And although this was tried with success in the past, by today’s standards it might seem arcane.

The Eisler’s solution

The last solution is a little bit different. It’s a kind of modern version of a famous Gresham-Copernicus law. The law states that with a fixed exchange ratio between the two types of money, the “good money” will be hoarded and the “bad money” will circulate. This is what is meant by “bad money drives out good money”.

And although most economists believe Gresham law is of only historical interest, today’s banking system is based on a 1 to 1 relationship between two types of money: private bank’s deposits and the government issued monetary base.

In this solution, first proposed by Robert Eisler and later Willem Buiter, central bank introduces a variable exchange rate between deposits and currency. So how would such system work?

As the central bank lowers the nominal rates below zero, the monetary authorities announce that currency can be deposited in commercial banks only at a discount. If the nominal interest rate is equal to -5%, then after a year a 100 euro note can be deposited for only 95 euro. 1 euro in currency now is thus worth only 95 euro-cents in deposits in one year, and about 90 euro-cents in two years.

The advantage of this approach is that, compared with the two previous methods, it does not eliminate physical currency and does not change much the way the currency is used. However since the price of currency in terms of bank deposits changes in time, calculation of prices becomes much harder.


To conclude, economists have already laid out the theoretical foundations of negative nominal interest rates. For sure, the methods I’ve described seem novel and even strange at first. They also all require changes in law.

So why bother with such strange topic? Well, recent developments in monetary policy around the world, made me believe that there are no longer any certainties in monetary policy. And I think we should expect negative nominal interest rates to be implemented widely by major central banks in coming decades.