Got A Blister On Your Pinky? Let's Amputate Your Right Arm

| About: ProShares Inflation (RINF)

There is a rising chorus in the economics community calling for the abolition of cash. The argument is that cash is the cause of the zero bound problem - the fact that nominal interest rates cannot be cut (very far) below zero. And, so it is claimed, this causes weak growth in aggregate demand.

Actually, the severe recession of 2008 had nothing to do with the zero bound, as interest rates were still above zero. It was caused by tight money. And after 2008, Bernanke always insisted the Fed could do more, and that it simply chose not to do more.

I suppose one could argue that during 2009-15, the real problem was that the zero bound led to a need for unconventional monetary stimulus, and the major central banks are reluctant to do enough unconventional stimulus, even if in theory they could buy up the entire planet. But in that case, the solution would presumably be psychological counseling for central bankers, not abolishing cash. Ironically, one of the few central bankers who did recently call for more aggressive monetary stimulus, Narayana Kocherlakota, has now joined the call for abolishing cash.

I believe that this is a bad idea on several different levels:

  1. There is no good theoretical justification for abolishing cash. That's because abolition of cash is strictly dominated by an alternative policy option - a higher inflation target. The usual argument against a higher inflation target is the so-called "shoe leather" cost of inflation, the fact that people will go to ATMs more often with high inflation, and this makes our monetary system slightly less efficient. But this argument makes no sense if the inflation target is being raised due to a fall in the Wicksellian equilibrium real interest rate. The whole point of a higher inflation target would be to simply keep nominal interest rates above the zero bound. And since the nominal interest rate is the opportunity cost of holding cash, a higher inflation target would not hurt cash holders any more than they were hurt during the 1990s, when nominal interest rates were well above the zero bound.

    But let's say I am wrong and inflation hurts cash holders more than I assume. I still say there is no justification for abolishing cash. Try explaining this to the average American: "We are concerned that if we raise inflation from 2% to 4%, you will have to go to ATMs slightly more often, and that will be annoying. So our currency system would be slightly less efficient. And so to spare you from this slightly less efficient currency system, we've decided to abolish all currency. And by the way, those blisters you keep getting on your pinky finger - the doctor suggests amputating your right arm."
  2. Now you might argue that the shoe leather cost is not in fact the major cost of inflation. I agree, the biggest cost is the excess taxation of nominal investment income. But the exact same argument applies there as well. If the inflation target is increased merely to offset a fall in the equilibrium interest rate, then there will be no problem of excessive taxation of nominal investment income, at least relative to the 1990s, when most economists thought the inflation rate (2% at the time) was perfectly fine.
  3. If there is an argument for abolishing cash, it is to reduce tax evasion. But I believe that intellectuals (who mostly live in a near-cashless economy) underestimate the utility of cash. Go to an antique show at Brimfield, Massachusetts, in the summer, and you'll see an entire economy of 5000 small-time "antique" (i.e., junk) dealers, all operating in a cash-intensive economy. The poor often don't have much access to banking facilities and use cash for many transactions. If you are an upper-middle class professional, it's easy to imagine operating without cash. But for many people, it is not.
  4. In a cashless economy with a ubiquitous internet, the government will know everything about you that it wants to know. It will know where you drive your car and what you purchase. We will be living in a giant panopticon.

I'm not so paranoid that I think the government would actually pay attention to most of our transactions, there aren't enough bureaucrats. But the information will always be available, if they want to go after someone. Fortunately, Hillary and Trump would never even think of using this information to go after their enemies. They are not vindictive people, or so I'm told by their supporters. But maybe in the future, a "bad guy" will be elected president.

Most importantly, there are other much better solutions that are not susceptible to the zero bound problem. Replace inflation targeting with NGDP-level targeting, as distinguished monetary economists like Michael Woodford, Christina Romer, and Jeffrey Frankel have suggested. Even some Fed officials have recently pointed to NGDP targeting as an option - it's no longer a "pie in the sky" idea. In contrast, taking away cash would be almost as controversial as taking away guns. This country still has a strong libertarian streak, and the total confiscation of cash is not likely to occur for many decades, by which time we'll have much better options available for the zero bound.

HT: Stephen Kirchner