Miles asks about this on Twitter. Earlier in the year, Matt wrote:
Stop for a moment and ask yourself why the interest rate can’t be reduced much below 1 percent. The trouble is cash. At any given time, relatively little paper currency circulates in the United States. Instead, most of the American money supply consists of bank accounts and other electronic stores of value. People prefer to keep money in bank accounts because it’s convenient and because you get interest on it. If the rates were driven below zero—in effect a tax on holding cash in the bank—people would just withdraw money and store it in shoeboxes instead. But what if you couldn’t withdraw cash? What if all transactions were electronic, so the only way to avoid keeping money in a negative-rate account was to go out and buy something with the money? Well, then, we would have solved our depression problem. Too much unemployment? Lower interest rates below zero, Americans will start spending and investing again, the economic will grow, and unemployment will go back down to its “natural rate.”
Ryan Avent comments. A few points from me:
1. Even pure cash can be taxed, if we are willing to go the goofy route. A stochastic declaration of “counterfeit,” based on serial numbers and scans, is one way to go.
2. Technologically speaking, it is possible to run virtually all transactions without cash, or it will be quite soon. That said, for this to work as stated, you would need to run all transactions without cash or the option of cash. How many millions of Americans do not even have bank accounts much less smart phones? This is more likely to work in Singapore or Denmark, at least for the foreseeable future.
3. You could have currency or some currency equivalent continue to exist in the black market economy, with penalties for ordinary citizens caught holding currency. (Which would probably not be popular on Fox News, and furthermore in Tennessee imagine all that talk of Book of Revelation, “Mark of the Beast,” etc.) Even so, you still end up with a currency-bonds margin and most likely with lower nominal interest rates in that equilibrium; if the law taxes currency holdings there is less need for equilibrium to require a high nominal interest rate. I am not sure why this should be so desirable for monetary policy.
Furthermore, under some views, this proposal would in essence put monetary policy in the hands of the drug trade. Cracking down on drug lords, or easing up on them, would become major monetary policy instruments, at least if you take the Fama-Sumner view that currency has special potency over the price level.
4. I do not myself believe that currency per se has such extreme power over aggregate demand, at least not in such a credit-intensive economy as ours. That means this proposal doesn’t get at the heart of the AD problem, which is closely linked to credit creation. But if you disagree with me on this one, you end up back at #3.
5. What do we really know about money demand anyway? Cooley and Leroy (1981) is still worth reading. Under one plausible view, you get sustainable increases in velocity, aggregate demand and investment when people feel safer and wealthier, not when you tax them more. It’s fine to say “we don’t know,” but I get nervous when macro stabilization policy is relying so directly and so relentlessly on money demand effects.
6. I don’t see how this proposal could work unless it is applied globally, which seems implausible. If your dollars are being taxed some extra amount, just put them in a foreign bank to earn zero or do some kind of funny quasi-repurchase agreement, with a foreign bank, to avoid having formal ownership of the dollars on the days of the tax.
On net, it is an interesting idea, but I wouldn’t actually do it.
Addendum: Scott Sumner comments (I don’t myself think the monetary base is so special, and if pre-2008 wasn’t a problem, that is why).