In my article on NGDP Targeting, I argued – among other things – that traditional monetary policy transmission mechanisms are now ineffective, and the banking system stops any ‘hot potato’ effect in its tracks. I felt the nature of which alternative monetary transmission mechanisms we might use to target NGDP was not always made clear by market monetarists; however, they proved me wrong with responses that discussed just that.
But I am still not satisfied.
The problem here is that their suggestions, which imply transcending ‘traditional’ monetary policy, may simply undermine the role of money in the economy. Market monetarists sometimes display a tendency to believe that those who conduct monetary policy simply don’t ‘get it‘, or are just constrained by petty politics. I’d instead suggest that policymakers just realise they’ve come up against some fundamental, inescapable constraints, implied by the nature of monetary policy itself.
One unconventional monetary policy tool was suggested by commenter J P Koning: negative interest rates on reserves. When I said that this would simply induce people to hold cash, he suggested that the central bank could stop 1:1 conversion of cash to deposits, making cash just as unattractive as deposits as the ‘price’ between cash and deposits adjusted to reflect the negative rates. Yet one of money’s fundamental roles is a store of value, and you undermine that by charging people to hold it. If you charge people to hold money, they will no longer see it as a desirable asset and will simply reject it. It is also worth noting that ‘floating’ deposit conversion rates could potentially play havoc with the value of bank’s balance sheets (bubble in deposits anyone?), as if these didn’t need more disruption.
Another suggestion, which I’ve seen before, is that the central bank could buy other assets than government bonds. First, I don’t really see why this would result in actual spending rather than people simply depositing or (assuming J P’s idea is not in play) holding cash. Second, this seems to undermine what it means to have somebody invest in your business – why bother having a business plan if the central bank will just buy up your bonds? I could set up ‘Unlearning Economics PLC’ and sell millions of pounds worth of bonds to the central bank – free money! Obviously this would quickly undermine the scarcity of, and trust in, money.
I suppose the central bank could screen who it invests in, but that just makes it another bank. This might help somewhat if the central bank were more willing to lend than private banks, but it doesn’t change the fact that banks aren’t lending for a reason: there’s just not much demand for goods and services in the economy, and businesses will have limited success.
Obviously, even the proposed introduction of such changes would likely meet widespread political opposition. However, if they were implemented I simply see it undermining the value of money and the workings of the financial sector, possibly resulting in widespread instability. I’m not talking about ‘the money is coming!!!’ gold bug style instability; more ‘what is going on, why is the central bank buying my house and the local branch of KFC?’ or ‘why am I not allowed to save money safely any more?’ type instability.
My basic view is that that monetary policy can primarily alter the costs in the economy, but not the demand conditions. This is why it can often effect changes in NGDP and other variables, albeit indirectly. However, when those costs go as low as they can go (0), beginning to tamper with the fundamentals only risks completely undermining the term ‘monetary policy’ and how it should ensure that money retains its traditional roles, including that as a reliable store of value.