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Overcoming the zero bound on nominal interest rates with negative interest on currency : Gesell's solution

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  • Willem H. Buiter

Abstract

An economy is in a liquidity trap when monetary policy cannot influence either real or nominal variables of interest. A necessary condition for this is that the short nominal interest rate is constrained by its lower bound, typically zero. The paper considers two small analytical models, one Old-Keynesian, the other New-Keynesian possessing equilibria where not only the short nominal interest rate, but nominal interest rates at all maturities can be stuck at their zero lower bound. When the authorities remove the zero nominal interest rate floor by adopting an augmented monetary rule that systematically keeps the nominal interest rate on base money (including currency) at or below the nominal interest rate on non-monetary instruments, the lower bound equilibria are eliminated, thus allowing an economic system to avoid the trap or to escape from it. This rule will involve paying negative interest on currency, that is, imposing a ‘carry tax’ on currency, an idea first promoted by Gesell. The administration costs associated with a currency carry tax must be set against the benefits of potentially lower shoe-leather costs and lower menu costs which are made possible by the its introduction. There are also output-gap avoidance benefits from eliminating the zero lower bound trap.

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File URL: http://eprints.lse.ac.uk/848/
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Bibliographic Info

Paper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 848.

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Date of creation: Oct 2003
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Publication status: Published in Economic Journal, October, 2003, 113(490), pp. 723-746. ISSN: 1468-0297
Handle: RePEc:ehl:lserod:848

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Keywords: Liquidity trap; Gesell; stamp scrip; inflation targeting; multiple equilibria. JEL classification codes: B22; E41; E31; E32; E51; E52; E58; N12; N13; N14.;

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  1. Hondroyiannis, George & Swamy, P. A. V. B. & Tavlas, George S., 2000. "Is the Japanese economy in a liquidity trap?," Economics Letters, Elsevier, vol. 66(1), pages 17-23, January.
  2. Bennett T. McCallum, 2000. "Theoretical Analysis Regarding a Zero Lower Bound on Nominal Interest Rates," NBER Working Papers 7677, National Bureau of Economic Research, Inc.
  3. Jag Chadha & Andrew Haldane & Norbert Janssen, 1998. "Shoe-leather costs reconsidered," Bank of England working papers 86, Bank of England.
  4. Arthur M. Okun, 1975. "Inflation: Its Mechanics and Welfare Costs," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 6(2), pages 351-402.
  5. Buiter, Willem H., 1977. "`Crowding out' and the effectiveness of fiscal policy," Journal of Public Economics, Elsevier, vol. 7(3), pages 309-328, June.
  6. Karl-Heinz Todter & Gerhard Ziebarth, 1997. "Price Stability vs. Low Inflation in Germany: An Analysis of Costs and Benefits," NBER Working Papers 6170, National Bureau of Economic Research, Inc.
  7. Chan, K C, et al, 1992. " An Empirical Comparison of Alternative Models of the Short-Term Interest Rate," Journal of Finance, American Finance Association, vol. 47(3), pages 1209-27, July.
  8. Bryant, Ralph C, 2000. "Comment on Overcoming the Zero Bound on Interest Rate Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(4), pages 1036-50, November.
  9. Baumol, William J & Tobin, James, 1989. "The Optimal Cash Balance Proposition: Maurice Allais' Priority," Journal of Economic Literature, American Economic Association, vol. 27(3), pages 1160-62, September.
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