Adrian Pietrzak, Domestic Affairs
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By: Adrian Pietrzak

How another recession might require some creative solutions.

Central Bankers have become awfully familiar with the concept of zero. Over the past two decades, sluggish growth and two recessions have forced central banks to slash their key interest rates to near zero. While the Fed may be cautiously nudging interest rates up, most of the developed world still has yet to budge. The ECB has yet to raise their key rates, and have continued to push its Quantitative Easing policies a full nine years after the Recession. The BOJ continues to wrestle with low inflation, and we’re not likely to see a departure from zero anytime soon.

Zero interest rates are thought of as necessary to promote economic growth after a large shock, yet, Central Bankers may be playing with fire. In the United States, the current recovery is the longest period of economic growth the economy has ever experienced. While growth rates may still be unimpressive, growth cannot and will not occur forever. If a new Recession were around the corner, Central Banks would be caught in a situation where they’ve exhausted all the tools in their toolkit. Yet, this doesn’t mean they have zero ways to encourage growth; Central Banks may simply have to be much more creative in their approach to stabilize the economy. One such method is the abolition of all paper currency. A cashless society might be able to avoid some of the perils of an economy stuck at zero.


The idea behind scrapping cash comes out of some classic theories of how people behave at zero interest rates, what economists call the zero lower bound. At the zero lower bound, people view holding cash and holding bonds equivalently; both earn no real returns. As a result, many simply hoard money. Holding onto money with expectations of deflation reinforces the effect; if people think each dollar they hold will be worth more tomorrow, they have little reason to spend. Central Banks try to get out of this by pushing real interests negative through inflation. But if people view cash and bonds as equivalent, no amount of money introduced into the economy will cause inflation. The economy becomes stuck in the awkward position called a liquidity trap; people hoard their cash, refusing to spend or invest, and the Central Bank is powerless to inflate.

Trying to eliminate the zero lower bound is not a new idea. In the 1930’s, many economists floated around ideas to create stamped currency, currency that would have a stamp doubling as a tax to forcibly devalue the currency. The idea was popular enough to be featured in Keynes The General Theory, however, governments were wary that the measure would be highly unpopular and that the anonymity of cash would mean nobody ever paid the tax. Such a negative interest rate would only really be feasible if all payments were made on a common ledger, such as through a commercial bank. Indeed, both the ECB and BOJ (along with other Central Banks like the Swiss Central Bank) have experimented with negative interests at their participating commercial banks. However, these banks haven’t passed on the negative rates to most customers for fears that this would cause mass withdrawals of deposits.


Withdrawing deposits into cash is a loophole that, theoretically, a government could eliminate. In effect, government issued paper guaranteeing a zero nominal rate acts as a floor on the interest rate. Eliminating cash, and forcing all people to have their money in some online system with a common ledger would allow a Central Bank to charge a negative rate with no zero-return cash alternative.

A cashless society would be one where all money could be subject to these negative rates, and people would be forced to spend their money before its value deteriorates. However, there are many concerns with going completely scrapping paper. Quite obviously, the move would likely disadvantage those who rely on cash. The consequences are twofold. One, this may be beneficial to discourage illegal activities such as drug dealings or tax evading practices. However, this may also spell bad news for older and poorer individuals who may not be as comfortable with online currency. That said, cash transactions made up only some 24% of all transactions in the United States in 2016.

While most consumers already rely on online forms of currency, and many other consumers may simply move their cash into an online account, there are concerns that the lack of anonymity would cause some users of money to look for other ways to store their wealth. Cryptocurrencies like Bitcoin are attractive for this reason, but their lack of government backing and volatility make them impractical as legitimate currencies. During periods of negative interest rates, people may look for other stores of wealth; such as moving money around zero-fee credit cards or prepaying their taxes. While plausible, such evasion of a negative interest rate would also reduce people’s liquidity, and on-demand exchangeability is a key feature people demand from their currency.


While the complete elimination of paper currency has its concerns, central bankers should give it a fair hearing. The next Recession might require expansionary measures in excess of the already unconventional policies we’ve recently witnessed. Rather than eliminating paper, perhaps Central Bankers should take a gentler approach. Charging commercial banks a fee for transactions occurring in cash could effectively create a negative interest rate on paper currency. The fee creates an effective exchange rate between paper and online currency; the Central Bank would guide the exchange rate depending on how it wants the interest rate to move.

When the economy sputters, the Central Bank could slash interest rates, charging depositing institutions negative rates. When depositors go to deposit or withdraw, they’d be charged a fee larger than the negative interest charged on sitting deposits in the bank. The fee would, in theory, cause differential rates in the valuation of either paper or electronic currency. And the comparative difference from the unattractive fee would encourage people to spend rather than hoard their income, increasing aggregate demand to the point where increased investment makes sense. An economy like this might be able to break away from the zero lower bound faster than otherwise.

Paper currencies, while less and less common, are still a fundamental part of many people’s lives. And even if they’re not, they are often a point of national pride and a clear symbol of the credibility and power of a government. Doing completely away with paper currencies may not be the best move, however, allowing for an exchange rate between cash and online currency might help mitigate some of the perverse consequences of an economy stuck at zero interest. It’d add a powerful tool to the Central Banker’s toolkit, leaving him or her prepared to respond and make sure that economic growth is anything but zero.

Works Cited

Agarwal, R. & Kimball, M. (2015). “Breaking Through the Zero Lower Bound.” International Monetary Fund Working Paper No.15/22.

Buiter, W.H. (2009). “Negative Nominal Interest Rates: Three Ways to Overcome the Zero Lower Bound.” NBER Working Paper No. 15118.

Krugman, P. (1998). “It’s Baack! Japan’s Slump and the Return of the Liquidity Trap.” Brookings Papers on Economic Activity 1998(2): 137-187.

McAndrews, J. “Would Elimination of Currency Remove the Zero Lower Bound on Nominal Policy Interest Rates?” Presentation to the Federal Reserve Bank of New York Monetary Economics Conference, 2015.

Rogoff, K. (2014). “Costs and Benefits to Phasing out Paper Currency.” NBER Working Paper No. 20126.

Swift, A. & Ander, S. (2016). “Americans Using Cash Less Compared with Five Years Ago.” Gallup.

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