Thursday, September 24, 2015

Andy Haldane and BOEcoin

The 1995 British two pound "Dove" coin

The Bank of England's chief economist Andrew Haldane recently called for central banks to think more imaginatively about how to deal with the technological constraint imposed by the zero lower bound on interest rates. Haldane says that the lower bound isn't a passing problem. Rather, there is a growing probability that when policy makers need three percentage points of headroom to cushion the effects of a typical recession, that headroom just won't be there.

Haldane pans higher inflation targets and further quantitative easing as ways to slacken the bound, preferring to focus on negative interest rates on paper currency, a topic which gets discussed often on this blog. He mentions the classic Silvio Gesell stamp tax (which I discussed here), an all out ban on cash as advocated by Ken Rogoff, and Miles Kimball's crawling peg (see here).

According to Haldane, the problem with Gesell's tax, Rogoff's ban (pdf), and Kimball's peg is that each of these faces a significant 'behavioural constraint.'  The use of paper money is a social convention, both as a unit of account and medium of exchange, and conventions can only be shifted at large cost. Tony Yates joins in, pointing out the difficulties of the Gesell option. Instead, Haldane floats the possibility of replacing paper money with a government-backed cryptocurrency, or what we on the blogosphere have been calling Fedcoin (in this case BOEcoin). Unlike cash, it would be easy to impose a negative interest rate on users of Fedcoin or BOEcoin, thus relaxing the lower bound constraint. Conventions stay intact; people still get to use government-backed currency as a medium of exchange and unit of account.*

While I like the way Haldane delineates the problem and his general approach to solving it, I'm not a fan of his chosen solution. As Robert Sams once pointed out, Fedcoin/BoEcoin could be so good that it ends up outcompeting private bank deposits, thus bringing our traditional banking model to an abrupt end. Frequent commenter JKH calls it Chicago Plan #37, a reference to a depression-era reform (since resuscitated) that would have outlawed fractional reserve banking. If Haldane is uncomfortable with the Gesell/Rogoff/Kimball options for slackening the lower bound because they interfere with convention, he should be plenty worried about BOEcoin.


I do agree, however, with Haldane's point that the apparatus adopted to loosen the constraint should interfere with convention as little as possible. We want the cheapest policies; those that only slightly impede the daily lives of the typical Brit on the street while securing the Bank of England a sufficient amount of slack.

With that in mind, here's what I think is the cheapest way for the Bank of England to slacken the lower bound: just freeze the quantity of £50 bills in circulation. Yep, it's that easy. There are currently 236 million £50 notes in circulation. Don't print any more of them, Victoria Cleland.**

I call this a policy of embargoing the largest value note. How does it work?***

Say that in the next crisis, the Bank of England decides to chop rates from 0.5% to -2.0%. Faced with deeply negative interest rates, the UK runs smack dab into the lower bound as Brits collectively try to flee into banknotes. After all, banknotes offer a safe 0% return, the £50 note being the chosen escape route since those are the cheapest to store and convey.

Flooded with withdrawal requests, banks will quickly run out of £50s. At that point the banks would normally turn to the Bank of England to replenish their stash in order to fill customers' demands. But with the Bank of England having frozen the number of £50s at 236 million and not printing any new ones, bankers will only be able to offer their customers low denomination notes. But this will immediately slow the run for cash since £20s, £10s, and £5s are much more expensive to store, ship and transfer than £50s. Whereas people will surely prefer a sleek high denomination note to a deposit that pays -2%, they will be relatively indifferent when the choice is between a bulky low denomination cash and a deposit that pays -2%. Thus the lower bound has been successfully softened by an embargo on the largest value note.

Once negative interest rates have served their purpose and the crisis has abated, they can be boosted back above 0% and the central bank can unfreeze the quantity of £50s. Everything returns to normal.

A few conventions will change when the largest value note is embargoed.

1. People will no longer be able to convert £50 worth of deposits into a £50 note. Instead they'll have to be satisfied with getting two £20s and a £10. That doesn't seem like an expensive convention to discard. And if folks really want to get their hands on £50s, they'll still be able to buy them in the secondary market, albeit at a small premium.

2. In normal times, £50 notes always trade at par. Because their quantity will be fixed under this scheme, £50s will rise to a varying premium above face value whenever interest rates fall significantly below zero. For instance, at a -2.0% interest rate a £50 note might trade in the market at £51 or £52.

The par value of £50 notes is a cheap convention to overturn. The majority of the British population probably don't deal in £50s anyways. Those who do use £50 notes in their daily life will have to get used to monitoring their market price so that they can transact at correct prices. But the inconveniences faced by  this tiny minority is a small cost for society to pay in order to slacken the lower bound.

3. Importantly, there will be no need to proclaim a unit of account switch upon the enacting of an embargo on £50s; the switch will be seamless.

Because the £50 was never an important part of day-to-day commercial and retail existence, come negative interest rates no retailers will set their prices in terms of a £50 standard. If they do choose to set sticker prices in terms of the £50 note, they will find that if they want to preserve their margins they will have to levy a small surcharge each time someone pays with £20s, £10s, and £5s and bank deposits. Given the prevalence of these payment options, that means surcharging on almost every single transaction. That's terribly inconvenient. Far better for a retailer to set sticker prices in terms of the dominant payments media—£20s, £10s, and £5s and bank deposits—and provide a small discount to the rare customer that wants to pay with £50s.

It's entirely possible that the majority of retailers will not bother offering any discount whatsoever on £50s. This would effectively undervalue the £50 note. Gresham's Law tells us that given this undervaluation, the £50 will disappear from circulation as it gets hoarded under people's mattresses. For the regular British citizen, never seeing £50s in circulation probably won't change much. And anyone who does want a £50 can simply advertise on Craig's list for one, offering a high enough premium to draw it out of someone's hoard.

In closing, a few caveats. The figures I am using in this post are ballpark. It could be that a policy of freezing the supply of £50 notes allows the Bank of England to get to -2%. But maybe it only allows for a level of -1.75%, or maybe it slackens the bound so much as to allow a -2.5% rate.

Haldane mentions that the Bank of England could need 3% of headroom to combat subsequent recessions. But as Tony Yates has pointed out, in 2008 bank officials calculated that a -8% rate was needed. The Bank could get part way there by not only embargoing the £50 but also the next highest value note; the £20. But that probably wouldn't be enough. As ever smaller notes have their quantities frozen, this starts to intrude on the lives of the people on the street, making the policy more costly. If it needs to slacken the lower bound in order to allow for rates of -8%, I think the Bank of England should be planning for a heftier policy like Miles Kimball's crawling peg. After all, when the sort of crisis that requires such deeply negative rates hits, the last thing we should be worried about is disturbing a few conventions. Until another 2008-style crisis hits, embargoing large value notes might be the least intrusive, lowest cost option. 

*Of these policies, I think Miles Kimball's plan is by far the best one.
**Specifically, the Bank would only print new bills to replace ripped/worn out bills. Otherwise the outstanding issue will wear out and become easier to counterfeit. As for Scotland, which issues 100 pound notes, their quantity would have to be fixed as well.
*** I first mentioned the idea of embargoing large notes in relation to the Swiss 1000 CHF note, and later elaborated on it in the Lazy Central Banker's Guide to Escaping Liquidity Traps.


  1. JP, I recall this from the 1,000CHF note question, too. In the absence of the £50, what is stopping our shopkeeper from accepting €500 notes? Or silver, for that matter? Bloody bitcoins? Are you going to outlaw people working to avoid a -8% interest rate when banks are going insolvent? Outlaw banknote FX exchange? Outlaw banknote importation or exports? Outlaw "sterling" for transactions?

    Seems like a lot of outlaws. Letting people withdraw and use as much cash as they like could be a better solution. At least give it a try, perhaps? If it is as ineffective as you seem to think, no harm done.

    I personally feel much more confident about a bank where I can withdraw my cash whenever I like. I tend to feel suspicious of banks that refuse to redeem their obligations, and charge me for the privilege. Negative rates make outlaws out of savers. Not a way to run an economy.

    1. There already isn't such a bank where you can withdraw cash whenever you like. Banks have cash withdrawal limits.

      You've just uncovered an inconvienient truth: fiat money is a giant scam designed to redistribute wealth under the guise of macroeconomic goals.

    2. Anon, the £50 won't be absent. It will simply trade at a premium. Shopkeepers would be no more likely to accept 500 euro notes, silver, or bitcoin after implementing a £50 embargo than without one, nor would they bother setting their sticker prices in these (volatile) units. Note: you would be able to withdraw cash whenever you want, just not in £50s.

      Peter, in Canada its possible to withdraw large amounts of cash --- you just have to call in advance and prove that its not for illicit purposes. No one is going to stop you from withdrawing $100,000 in cash if the purpose is to stuff it under your mattress. Your comment on fiat money is a bit theatrical.

    3. Both in the case of cash withdrawals, and with the bank note reform, as you yourself point out, the methods to achieve the goals are penalising certain groups of people and benefiting other groups. I think that people need to be reminded of this, as a counterview to the neutral or positive phrases like "deal with technological constraints", "slacken the bound", "policy".

    4. Peter, for some inexplicable reason, JP spends a lot of time pushing negative rates and eliminating banknotes.

      You see, if debt markets hit a iceberg, banks will need to steal your savings. Banks will steal quickly (in a bail-in), or slowly (with negative rates). To keep your savings available to them and "on board", they first machine-gun the lifeboats (banknotes).

      All for your own good, of course. You will be so much better off locked in below decks.

      Funny how it's never quite convincing.

    5. Peter, the inconveniences faced by the small group of individuals who use 50 pound notes on a regular basis would be far outweighed the benefits that everyone (including that small group) enjoys by having a flexible monetary policy.

      Anon, this post isn't about 'eliminating banknotes'. It is about freezing the quantity of 50 pound notes. As for the rest of your comment, I'm not sure what you're trying to say.

    6. JP, I'll clarify. I'm concerned over the growing call for negative rates and elimination of large banknotes. Bankers offer one and only one solution to low nominal growth, that of negative interest rates -- which necessitates eliminating or hobbling currency. I hear little or no "insider" discussion of the political or economic disadvantages, unintended consequences, or legality of such a radical re-orientation of monetary policy. This is intellectually dishonest at best, and abetting financial fraud on the public at worst.

      For the public, swapping deposits for banknotes is a very valuable option -- as Robert Sams points out "your bank deposit, which is an unsecured loan to a highly leveraged deposit-taking institution". Deposits are clearly vulnerable to counterparty risk in a way that banknotes are not.

      Yes, the group of individuals who use 50 pound notes on a regular basis is small now, but this could change overnight. The option to convert unsecured leveraged bank loan into a secured loan to the central bank is not trivial or a matter of simple-minded convenience. The convertibility option is profoundly valuable: pointing at the number of current 50 bill users is laughably misleading; promising marvelous "benefits to everyone" shows contempt for your audience.

      You clearly protest that you are not eliminating currency: just "freezing the quantity of 50 pound notes", but this is obfuscation and semantics. Bottom line, negative rates necessitates eliminating currency as a vehicle for transferring large volumes of savings. I don't think you'd dispute this.

      You know, there exist profound arguments against negative rates: I suggest you address them. It's a gold mine -- sorry, bank reserve -- of prospective blogging material. You might even persuade!

    7. If you haven't read any "insider" discussion of the economic disadvantages, try John Cochrane or Steve Cecchetti.

      "For the public, swapping deposits for banknotes is a very valuable option...Deposits are clearly vulnerable to counterparty risk in a way that banknotes are not."

      Agreed. But embargoing the largest value note doesn't prevent you from swapping your deposits for safe 20s, 10s, and 5s. You still get the option of obtaining a secured loan to the central bank at par.

      "Negative rates necessitates eliminating currency as a vehicle for transferring large volumes of savings. I don't think you'd dispute this."

      I am disputing this. The 50 pound note stays in circulation. Anyone who wants one can simply buy it in the secondary market. Anyone who wants smaller denominations can convert their deposits into 20s, 10s, or 5s.

    8. JP, the "inconveniences of a small group" are merely the most visible aspect of the redistribution. The other aspects are hidden, and the task of economics is to expose precisely those unseen consequences of actions. For example, another negatively affected group are those who hold money in a bank deposit, which is hardly a small group. I would also like to remind you that some competition is prohibited in this area (for example, private companies cannot issue banknotes themselves like they used to in the past).

    9. Anonymous, to be fair, I don't think JP is "pushing", rather I think he is being too neutral. I actually don't mind that at all, I just think that people need to be reminded of different ways of phrasing the same thing. See

    10. "...another negatively affected group are those who hold money in a bank deposit."

      Yes, I mentioned that in my post. But they'll still be able to get 20s, 10s, and 5s. Again, the small set of changes required to get more space below zero imposes a relatively small set of burdens relative to the benefits it allows.

      As for private companies, Peter, they wouldn't dare issue a 0% yielding note in a negative rate environment. They'd quickly go bankrupt... as I wrote here. So no need to clamp down.

    11. JP, as money is neither a consumer nor a producer good, monetary policy can at best be a liquidity-redistributing mechanism, a zero-sum game. With respect to the tools evaluated in this post, in addition to redistributing liquidity they also increase transaction costs, therefore are a net loss.

      As for the privately issued bank notes, in a system with negative interest rates, what makes more sense would be to issue full reserve backed electronic cash system. That could be funded by transaction fees rather than fractional reserve banking. However, that area is heavily regulated.

    12. Given that prices are rigid, monetary policy isn't just a zero-sum game, A central banker who keeps money too tight can trigger a recession, one who loosens can soften a recession. That's why tools must be adequate. A small net loss incurred by those who use 50s is probably worth incurring given the ability to offset recessions, which hurt everyone.

    13. Even if prices were rigid, it does not automatically follow that that is the reason for a recession. If for example the reason is, as austrians argue, the prior increase in the quantity of money, then a loose monetary policy does not solve the problem, it cures symptoms.

      The rigidity could also be caused by transaction costs rather than psychology, in which case again a loose monetary policy is not a a solution to the problem.

      Last but not least, none of that refutes my argument that this is just a redistributive mechanism, rather it would mean that the judgement of "price setters" is erroneous and that makes the redistribution an appropriate countermeasure.

    14. If you'd said this at the outset, you'd have saved us plenty of arguing! This post assumes the standard framework, not the Austrian framework, and its usefulness should be judged with that in mind.

    15. Yes, the "standard framework" makes a lot of dubious assumptions.

  2. JP,

    i am not sure if you describe these crazy ideas just for academic purposes (which makes sense), but as Peter already suggested maybe we should be focusing on the scam this system supposes for the general population exploited by the elites.

    Money (fiat also) should be stable over time and none of these experiments by economists will make help to solve the situation from my point of view. I think it is very unlikely that a return back to normal would happen, unless you mean with return to normal as after having confiscated purchasing power via negative interest rates for everyone bailing out governments.


    1. Alex, I agree that money should be stable over time, that's exactly why the system needs to be able to enact negative interest rates. When everyone wants to own money, the value of money is destabilized to the downside. ie we get deflation. This instability can be counterbalanced by reducing the return on money via negative interest rates, thus returning the purchasing power of money back to its stable path.

    2. Thanks JP - I read every blog you post and enjoy them deeply, but this idea of supporting negative interest rates and cash abolition you are supporting doesn't make any sense to me. The problem from my point of view is not the action of people, but the issue is with the supposed safe keepers of money (central banks) not doing their job and creating these situations as government and economic system tools. Having the system taking away my hard earned "money" is not social nor is it likely to take us to a path of growth without someone paying the bill (the overall population).

      As a reference if you not familiar with them I did read recently Walter Eucken's book from the 50s about economic order and Günter Schmölders also explain this quite well.

      Keep the great work in sharing your insights.


    3. Glad you like the blog, Alex. I just want to point out that while I support the idea of temporarily negative rates, I don't support cash abolition, especially not the abolition of small value notes as they are a large part of the regular circulation. If you reread this post, you'll see it advocates the freezing the the quantity of 50 pound notes, not their abolition.

    4. Thanks for pointing that out, sorry for misrepresenting it. The issue, from my point of view, is that freezing 50 pound notes is not that far away from abolition or can be just an intermediate step. Now that we are in this monetary mess there might be no other ways for the CBs to solve the issue by having everyone else paying for it. It would be great to read more posts from you, if not done already (please point me to them if possible), on how monetary policy should be managed and how it interacts with the legal and state system. I find Walter Eucken's ideas very interesting in that regard, but I am not an economist to have a full view on how ideas have evolved since 1950 in that regard.

    5. Think about it this way. Let's say a large financial crisis hits, maybe something like the Asian Financial Crisis of 1997. To deal with the ripple effects of a crisis like that, a central bank will typically need some room to cut interest rates, say by 2%. This is easy to do when interest rates are already at 4%, just cut to 2%. Problem solved.

      However, the European Central Bank (we'll use Europe as our example rather than the UK) currently maintains an interest rate oft -0.25% (which isn't loose, by the way, as it continues to undershoot its inflation target.) Can the ECB safely cut rates to -2.25% to counteract the crisis? No. Once it reduces rates to around -1.5%, everyone will rush into the 500 euro note for safety. The system needs to be altered in a way that allows a -2.25% rate. This post proposes what I think is a relatively simple alteration that allows us to get there. But of course, there are many other ways to address the problem.

    6. I agree with you, but that is only the solution to the problem we are already in and someone always has to pay the price (in this case the majority of the population again). Assuming this would then put our fiat system back into shape, after having paid the price, how could we be confident that our monetary managers would not mess it up again. My personal response so far to this question is that the only way to avoid more of these situations (and almost any system) is to make the understanding of the monetary system clear to a critical mass of people so that they create a counter movement to those abuses.

  3. Or, make the notes thicker proportionally to their value (take 'note' BoE new plastic note designers) - a 20 twice as thick as a 10. Better yet, exponentially thicker for bigger denons.

    1. Ha, you're getting the idea. You could also increase width and length as denominations increase in value, like Brazil, Europe, or New Zealand:

  4. Kimball's crawling peg plus a per capita refund added to the income tax refunds should take care of most of the equity based objections.

  5. Has anyone suggested relying less on monetary policy and more on fiscal stimulus?

    Fiscal policy is the best counter-stabilisation tool available to any government

    "The reality is that policy makers have very little idea of the speed and magnitude of monetary policy impacts (interest rate changes) on aggregate demand. There are complex timing lags given how indirect the policy instrument is in relation to its capacity to influence final spending.

    Further there are unclear distributional effects – creditors gain when rates rise, debtors lose. What will be the net effect? Central bankers do not know the answer to that question.

    Monetary policy is also a blunt policy instrument that has no capacity to target specific segments of the spending population or regions.

    Fiscal policy expansion is always indicated when there is a spending gap. It is a direct policy tool ($s enter the economy immediately) and can be calibrated and targetted with more certain time lags. Liquidity trap or not, fiscal policy is the best counter-stabilisation tool available to any government."


    Modern Monetary Theory in Canada

  6. Highly negative (real) interest rates have not been an infrequent phenomenon in the developing world. Obviously, they have been the result of very high inflation (relative to the bank rate, which was positive), but supposedly the effect is similar when inflation is low and the bank rate is pushed down to a very low level. For these developing countries, the most frequent outcome has been a de-facto dollarization of the domestic economy. I suspect that the same will happen under a highly negative nominal rate regime. There are plenty of currencies to choose from- the Canadian dollar, the NZ dollar, the Australian dollar, etc.