This is a review of Ken Rogoff's "The Curse of Cash," forthoming in Business Economics.
Kenneth Rogoff has written an accessible and informative book on the role of currency in modern economies, and its importance for monetary policy. Rogoff makes some recommendations that would radically change the nature of retail payments and banking in the United States, were policymakers to take them to heart. In particular, Rogoff proposes that, at a minimum, large-denomination Federal Reserve notes be eliminated. If he could have everything his way, currency issue would be reduced to small-denomination coins, and these coins might at times be subjected to an implicit tax so as to support monetary policy regimes with negative interest rates on central bank reserves.
The ideas in “The Curse of Cash” are not new to economists, but Rogoff has done a nice job of articulating these ideas in straightforward terms that non-economists should be able to understand. The book is long enough to cover the territory, but short enough to be interesting.
Why is cash a “curse?” As Rogoff explains, one of currency’s advantages for the user is privacy. But people who want privacy include those who distribute illegal drugs, evade taxation, bribe government officials, and promote terrorism, among other nefarious activities. Currency – and particularly currency in large denominations – is thus an aid to criminals. Indeed, as Rogoff points out, the quantity of U.S. currency in existence is currently about $4,200 per U.S. resident. But Greene et al. (2016) find in surveys that the typical law-abiding consumer holds $207 in cash, on average. This, and the fact that about 80% of the value of U.S. currency outstanding is in $100 notes, suggest that the majority of cash in the U.S. is not used for anything we would characterize as legitimate. Rogoff makes a convincing case that eliminating large-denomination currency would significantly reduce crime, and increase tax revenues. One of the nice features of Rogoff’s book is his marshalling of the available evidence to provide ballpark estimates of the effects of the policies he is recommending. The gains from reforming currency issue for the United States appear to be significant – certainly not small potatoes.
But, what about the costs from making radical changes in our currency supply? There are two primary factors that, as economists, we should be concerned with. The first is implications for government finance. In general, part of the government’s debt takes the form of currency – the government issues interest-bearing debt, which is purchased by the central bank with outside money (currency plus reserves), and then the demand for currency determines how much of the government debt purchased by the central bank is financed with currency. Currency of course has a zero interest rate, so the quantity of currency held by the public represents an interest saving for the government. This interest saving is the difference between the interest rate on the government debt in the central bank’s portfolio and the zero interest rate on currency. This interest saving reverts to the government as a transfer from the central bank. Therefore, if steps are taken (such as the elimination of large-denomination currency) to make currency less desirable, the quantity in circulation will fall, and it will cost the government more to service its debt.
The second key cost of partial or complete elimination of currency would be the harm done to the poor, who use currency intensively. Rogoff discusses the possibility of government intervention to ameliorate these costs, including the subsidization of alternative means of payment for the poor (debit cards or stored value cards) or central bank innovation in supplying electronic alternatives to cash. Costs to the poor of withdrawing currency should be taken seriously, particularly given recent experience in India and Venezuela. In both countries, announcements were made that there would be a brief window in which large-denomination currency would remain convertible (to other denominations or reserves) at the central bank, after which convertibility would cease. The old large-denomination notes would then be replaced by new ones. In India and Venezuela, this led to long lines at banks to convert notes, and a partial shutdown of cash-intensive sectors of the economy. Though these currency reforms differed from what Rogoff is suggesting, in that neither reform involved a permanent withdrawal of large-denomination currency, these experiments demonstrate the serious disruption that can result if currency reforms are mismanaged.
Rogoff makes a strong case that the net social benefits from a partial reduction in the use of currency could be large, considering only the positive and negative effects discussed above. I agree with that conclusion. However, a significant portion of Rogoff’s book makes the case that the partial or complete elimination of currency would also have large benefits in terms of monetary policy. In that case, I think, his conclusions are questionable.
Rogoff’s argument as to why currency impedes monetary policy is, for the most part, consistent with conventional New Keynesian (NK) thinking. In NK macroeconomic models (see Woodford 2003, for example) policy acts to mitigate or eliminate the distorting effects of sticky prices, and the zero lower bound (ZLB) on the nominal interest rate is a constraint for monetary policy. Typically, in NK models, the central bank conducts policy according to a Taylor rule, whereby the nominal interest rate increases when the “output gap” (the difference between efficient output and actual output) goes down, and the nominal interest rate increases when inflation goes up. But, if we accept the NK framework, there are good reasons to think that the ZLB will be a frequently binding constraint on monetary policy for some time. In particular, the well-documented secular decline in the real rate of return on government debt implies that the average level of nominal interest rates consistent with 2% inflation is much lower than in the past. This then leaves much less latitude for countercyclical interest rate cuts in future recessions.
Given the NK framework, one proposed solution to the ZLB problem is to simply relax the ZLB constraint. How? Miles Kimball of the University of Colorado-Boulder is currently the most prominent proponent of negative nominal interest rate policy as a solution to the ZLB problem. This problem, according to Kimball, exists only because asset-holders can always flee to currency, which bears a nominal interest rate of zero. But, if the government eliminates currency, or devises schemes to make currency sufficiently unattractive, then there is an effective lower bound (ELB) on the nominal interest rate that is lower than zero. Rogoff appears to be on board with this idea, and thinks that reducing the role for currency in the economy could produce large welfare benefits, because of a relaxation in the ZLB constraint.
Rogoff thinks that negative nominal interest rates are an extreme measure that will increase inflation when it is deemed to be too low. In this respect, I think Rogoff is wrong, but he’s in good company. A typical central banking misconception is that a reduction in the nominal interest rate will increase inflation. But every macroeconomist knows about the Fisher effect, whereby a reduction in the nominal interest rate reduces inflation – in the long run. What about the short run? In fact, mainstream macroeconomic models, including NK models, have the property that a reduction in the nominal interest rate reduces inflation, even in the short run (see Rupert and Sustek 2016 and Williamson 2016). This is the basis for neo-Fisherism – the idea that central bankers have the sign wrong, i.e. reducing inflation is accomplished with central bank interest rate cuts. This is consistent with empirical evidence. For example, the central banks that have experimented with negative nominal interest rates – the Swedish Riksbank, the European Central Bank, the Swiss National Bank, and the central bank of Denmark – appear to have produced very low (and sometimes negative) inflation.
So, I think Rogoff is correct that currency reform would be beneficial on net, and that the gains in terms of economic welfare could be significant. But those gains are unlikely to come from unconventional monetary policy in the form of negative nominal interest rates.
In summary, Ken Rogoff’s The Curse of Cash is an accessible and provocative book – one of the best I have read on economic policy. I do not agree with all of his recommendations, but this is a good start for the policy debate.
Greene, C., Schuh, S., and Stavins, J. 2016. “The 2014 Survey of Consumer Payment Choice: Summary Results,” Research Data Report 16-3, Federal Reserve Bank of Boston.
Rupert, P. and Sustek, R. 2016. “On the Mechanics of New Keynesian Models,” working paper.
Williamson, S. 2016. “Neo-Fisherism: A Radical Idea, or the Most Obvious Solution to the Low-Inflation Problem?” The Regional Economist 24, no. 3, 5-9, Federal Reserve Bank of St. Louis.