Monday, January 15, 2007

And stop the Great Depression, with negative interest rates:

Can nominal interest rates be less than zero? Many people would argue not, reasoning that no one would invest $100 today with a promise of receiving only, say,$99 in one year, given the alternative of simply holding the $100 in cash. Yet, rates on short-term Japanese government bills [in 1998] were negative, and several foreign-owned banks in Japan have paid negative nominal interest rates on yen deposits.

Is there a paradox? Not really. The claim that the nominal interest rate cannot be negative assumes that holding currency is costless. In the real world, however,holding cash is risky and costly. Like any valuable, cash can be lost, stolen or destroyed. Just as people pay depositories a fee for safekeeping other valuables, individuals are willing to pay a fee on deposits rather than bear the risk associated with holding cash.

In addition, there are costs associated with moving and storing cash. While these costs are trivial for a small amount of currency, they are not for large amounts.

Consequently, individuals may prefer to maintain deposits at banks or hold Treasury bills rather than transport and store cash, even when these assets have negative rates of return. In effect, the negative nominal return represents a fee that individuals pay to hold deposits or Treasury bills rather than bear the risks and costs of holding cash.

....In addition, deposits offer advantages over holding cash or other investments. For example, checks or electronic transfers from deposit accounts are more convenient and less costly, especially for large payments or payments to distant points. Furthermore, banks often bundle services, so deposit holders may gain access to certain bank services or to better prices on those services than non depositors.

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