Paper Chase

An Interview with Kenneth S. Rogoff

As central bankers struggle to help their economies deal with what seems to be a period of stagnating growth and inflating asset bubbles, economist Kenneth Rogoff argues that a key tool is missing from their kit: rates well below zero. His thought-provoking new book The Curse of Cash demonstrates a close connection between negative rates as an effective policy and the phasing-out of high denomination paper currency. In the interview below, he lays out his views on why negative rates are inevitable, what needs to be done to prepare the ground for them, and where gold fits into the current monetary world.

Getting rid of high-denomination bills will help cut back on crime, argues Kenneth Rogoff.

Flickr. Getting rid of high-denomination bills will help cut back on crime, argues Kenneth Rogoff.

our thoughts on why — and why now — we should get rid of large bills, as you advocate in your new book The Curse of Cash?

Kenneth S. Rogoff: In fact, I wrote my first journal article two on the topic two decades ago, when I already thought it was a compelling idea. So really the question is: why write a book? I think that over time, I came to realize that although the issue superficially seems quite straightforward, it really requires a book-length treatment to address all the huge range of economic, practical, and even emotional issues the topic raises. The basic fact that readers need to know is that even though cash is becoming increasingly vestigial in the legal economy (and now accounts for less than 10 percent of the value of U.S. retail transactions), the quantity of cash outstanding has been growing inexorably, with 80 percent of the cash — over $4,200 per person in the U.S. — in the form of $100 bills.

The idea of getting rid of big notes to fight crime is not new; Richard Nixon got rid of the $1,000 bill (originally mainly used in inter-bank transfers before the age of electronic payments systems) because he believed it had become a tool for criminals and drug smugglers. McKinsey chief economist James Henry broached the idea of calling in $50 and $100 bills back in the 1970’s, though he wanted to do it very suddenly to try to catch criminals and tax evaders off guard (much like India’s Prime Minister Modi has recently done). My view is that for the United States, anyway, doing the phase-out too quickly would be unfair to people who do not closely follow the news and to foreigners who hold at least 40 percent of the U.S. currency (not nearly so big an issue in India, but still) and would just feel too much like a default.

Since the idea seems so completely sensible, why hasn’t it happened? One major pocket of resistance to phasing out large bills is the central banks, who are reluctant to give up the huge direct profits they derive from printing them.  But their perspective is a very narrow, because the government as a whole loses an order of magnitude more money from tax evasion and crime than it makes from seigniorage on currency, by any measure.

Another issue I treat in the book is the way cash can handcuff monetary policy in deep recessions and systemic financial crises. In the 2008 financial crisis (and earlier during the Depression of the 1930’s), central banks found themselves handcuffed once interest rates had been cut to zero. Ideally — at least in the extreme circumstance of deep systemic financial crisis — they would like to have taken interest rates negative to jump start consumption and investment and to literally drive cash out of the banking system and into the economy. But the existence of paper currency, which of course pays zero interest, makes it impossible to take interest rates too negative. If there were no big bills, central banks could probably easily take rates to minus four or five percent for a while (say a year), since the costs of shipping, storage, and insurance with small bills would be prohibitive. (My plan, by the way, would except small depositors anyway.) In fact, as the book explains, there are ways to have significant negative rates without changing the currency supply. Importantly, negative rate policy is not something central banks can really do on their own, as the ECB and the Bank of Japan have discovered. Rather, it takes input from the whole government to make all the necessary legal, institutional and tax changes. All this will take time.

Some of the pushback on negative rate policy comes from people who wrongly think it is horrible for savers, not realizing that effective negative rate policy pushes up very long-term rates and raises the value of other assets. If negative rate policy helps an economy escape more quickly from a deep systemic financial crisis, savers gain, as of course do workers.

And however counterintuitive negative rate policy may seem when you first hear the idea, negotiating the risks and obstacles has to be a far cry better than some of the off-the-wall alternatives being bandied about as a way to deal with the zero lower bound on interest rates.

OR: Such as?

Rogoff: A number of prominent economists are arguing that if central banks don’t have the tools to create expected inflation, then other “real-side” policies should be implemented. Barry Eichengreen at Berkeley has been arguing that protectionism can be a good thing at the zero bound because it raises expected inflation. Higher expected inflation, of course is a way of lowering the real interest rate when the nominal interest rate is frozen. I would argue that this is a very dubious idea, with the long-run costs far outweighing any possible short-term gain. In a similar vein Larry Summers and Paul Krugman have been arguing that we have to be careful not to do things that make the economy too efficient because that will drive prices down, and that raises the real interest rate. Again, even if they are right that there are short-run demand costs to structural reform, that ought to be taken as an argument for timing it carefully — not for abandoning it.

There are also more reasonable ideas such as leaning more heavily on fiscal policy when monetary policy is paralyzed. But this can lead to massive volatility in fiscal spending, and it is folly to pretend fiscal stabilization policy in a crisis will not be distorted by politics. Another idea is to have the central bank intervene in private credit markets, for example as the the European Central Bank is doing with its corporate bond buying program — now on track to soak up 20 percent of the supply. This kind of policy is called “directed credit” because the government is effectively choosing winners and losers. This again gets into very political territory, ultimately undermining central bank independence.

OR: In our November issue, Mervyn King explains that he thinks not even perpetually low rates will stimulate demand — what is needed are perpetually falling rates, and that therefore QE is never as effective as its advocates hope. Do you agree with that?

Rogoff: I don’t really understand why anyone would expect QE to be terribly effective. In essence, having the central bank issue overnight bank reserves (a form of debt) to buy government bonds is smoke and mirrors in a liquidity trap when money and short term debt are essentially the same things.  Let’s not forget that the government fully owns the central bank. Of course, if the central bank buys private assets, as the European Central Bank is doing or as the Fed did early in the financial crisis, that is going to have an effect.  But again, this is directed credit: it implicitly gives taxpayer subsidies to some sectors.

Setting aside QE, there are are really only two ways for monetary policy to remain effective at the zero bound. One is to raise the inflation target (say to four or five percent), while the other is negative interest rate policy.

Raising the inflation target is much more likely to happen in the near term, but I think it is much the inferior approach. The most obvious problem is that it undermines central bank credibility. The central banks have been telling people for a couple of decades that they are targeting two percent inflation. You have a lot of 20- and 30-year bonds and contracts built on this promise. Changing the target deeply undermines credibility, and it may take a generation to get it back. If you change your mind once, why won’t you change it again? There are a whole number of transitional problems. For example, they are already have a hard time creating two percent inflation.  What instrument are they going to use to get to four percent?

Higher inflation also leads to distortions in the economy that advocates of four-percent inflation targets are far too quick to dismiss. Let’s remember that the cost of the distortions has be borne all the time, not just during deep systemic financial crisis. Another concern Stan Fisher has expressed: that there will be more indexation if you have a higher inflation rate, and that in turn would make monetary policy less effective

Simply put, the negative interest rate solution is vastly more elegant.

There are a lot of approaches, but I do think if you ask realistically what’s more likely to happen in the nearer term, it’s high inflation targets — and not because central banks think that’s the better idea. I’d say they definitely don’t. But because they can do it on their own, whereas my plan requires cooperation at least from the Treasury, and better yet from the entire government, and that’s obviously more difficult to achieve.

As for the political side of that difficulty, let me say again that with negative rates you’re certainly hurting someone who sits in short-term deposits and refuses to move, but most older fixed income people (for example) are holding longer-term assets, not just shorter-term assets. If you look at the whole profile, obviously housing and stocks will go up, but also longer-term interest rates will go up. In a deep recession, if you could use negative interest rate policy, you are recovering faster because you’re raising expected inflation and it is not bad for savers. That’s very naïve. It’s bad for somebody who throws all their money in a bank account — and my plan excludes small savers in any case.

OR: Do you think that the anti-elitism of the current political climate would let this plan gain traction?

Rogoff: If we are talking about phasing out large notes, Europe recently decided to phase out the 500-euro note. And by the way, arguments such as mine are influential in pushing back on plans to create large notes for the United Sates. That said, the use of paper currency continues to be falling steadily in the legal economy (as noted, it is already under 10 percent of the value of retail transactions) and there will eventually come a tipping point where resistance will melt away.

If you are talking about negative interest rates, I can only say that this is coming the next time there is a deep financial crisis, even in the United States. If you want to put your head in the sand, you can read the financially illiterate discussion out there by supposed experts who say it is unnatural. If you want to understand what is coming and how effective negative interest are policy might work in the future, you can read The Curse of Cash.

OR: Do you are worry that there could be a populist backlash against expert advice, as Sebastian Mallaby argues in our November issue?

Rogoff:  Yes, but it will be a sad day if American academics can no longer discuss new research ideas out of fear that some kind of Red Guard will emerge to crucify all intellectuals who fail to follow politically correct thought. Unfortunately, in this day of social media, there are a lot of people on the Left and on the Right who seem to wish we lived in just such a world.

OR: Do you see a crisis in the offing? Do you think that central bankers, in keeping rates down to unclear effect, have damaged in intellectual circles or in the financial market their credibility?

Rogoff: The biggest thing which has damaged central bank credibility is that their forecasts have been very bad. They have been too optimistic again, and again, and again — and they have miscalibrated policy accordingly. Alan Greenspan once told me that the most important thing in setting monetary policy is your forecast. If you don’t get the forecast right, it’s very hard to set policy right.

There is little doubt that central bankers struggled with the zero bound. The Japanese case is, of course, particularly dramatic.

OR: Do you see our low-rate world as continuing? Or do you see us about to enter into a more inflationary long-term environment?

Rogoff: Most forecasts of the real interest rate do suggest that it’s going to go on for a while. However, I believe that there’s a tendency to think that whatever is going on today will go on forever. I’m old enough to have seen many cycles like this, for example in the 1970s when people thought inflation would be high forever. My guess is that in 10 years, people will have completely forgotten about secular stagnation.

OR: What do you role do you see for gold in the monetary system?

Rogoff: I see a growing role for gold as a tertiary transactions medium, particularly as cash fades. Whether or not my exact policy proposal ever come to fruition, you are going to see greater restrictions on cash usage across the world in the next decade. It is already happening in Europe. In addition, gold looks very attractive in a world of safe assets.

It’s a profound puzzle for me that emerging markets haven’t shifted more out of the dollar and into gold. I wrote an op-ed on the subject a few months back.

In my book, I actually argue with people who say gold should have no monetary role, that it is a historical bubble. In fact, it has and has always had unique properties that give it a special place.

OR: Are you worried about asset bubbles in general? Do you think negative rates would mitigate asset bubbles, or would a rush for yield drive real estate, inter alia, through the roof?

Rogoff: The point is you’re only doing it when the world is falling apart. You’re not going to -5 percent on a sunny day when the economy is booming. In general, in monetary policy (particularly after the financial crisis) you have to pick your poison. We have a very high stock market which does seem to rest a lot on the fact people think real interest rates will be low for a very long time.

OR: What is your view on bitcoin and other cryptocurrencies?

Rogoff: Bitcoin is a bit of a non sequitur here. I get emails: “I’m a criminal, I use bitcoin.” I literally got an email like that. I’ve gotten a couple. What’s the problem? The point is that the government has a lot of power to prevent these alternative currencies from being used in the legal economy. They already make it difficult for banks, and they can ban banks from accepting it. That would prevent retail stores from accepting it. They’ve done that in some countries, and that’s probably coming everywhere. At the moment they do it to some significant degree by hassling you with record keeping and tax issues when you bring a lot of bitcoin to a financial institution.

If you can’t buy ordinary goods with bitcoin, if all you can do with your bitcoin is buy drugs or hire a hitman, it’s never going to substitute for cash. People want to be able to recirculate their illicit gains. The same thing goes for uncut diamonds, gold coins — cash really is special in its total anonymity and liquidity.  By the way, I favor keeping physical currency forever. The question is not whether we should have a physical currency. The question is: how do we regulate its use?

OR: Your plan, as you said, has a 15-year time scale. How likely are either of its two components actually to occur over the medium term?

Rogoff: As I stated earlier, negative interest rates are coming next time there is a massive recession or deep systemic financial crisis.  On big bills being phased out, arguments such as I make in my book are likely to block the printing of larger notes in most countries, even as inflation gradually eats away at the real value of existing ones. But will more governments actually phase out large bills, as for example the ECB has done with the 500 euro note?  My guess is that over the next, say, five to 10 years, paper currency is going to become so inconsequential in any kind of retail transaction over, say, $10 or $20 that you’ll reach a tipping point where when you bring your $100 bill, they just won’t take it. It will just be so clear it’s come from the underground economy. And then suddenly the political resistance will, as I said, melt away.

I view The Curse of Cash first and foremost as providing history, data, and context for thinking about the pluses and minuses of paper currency. The exact plan I give helps frame the ideas but there is more than one way to skin a cat. For example, we may see greater restrictions on large scale currency transactions, more frequent updating of notes (which also makes hoarding more costly) and the introduction of tamper-proof cash registers that make it harder for retailers to misreport income. Between governments starved for revenue, Justice Departments worrying about crime, Homeland Security Departments worried about terrorism, and immigration authorities worried about the use of cash to hire illegal workers, we can be pretty sure that there will be significant changes over the next decade. Until now, the study of currency has been a sleepy backwater in academic research, but it is starting to change dramatically as people wake up to just how important a problem it is.