Monetary systems that allow for negative interest rates are nothing new.
Over a century ago, Silvio Gesell, an economist Keynes admired, came up with the idea of money stamps – forced depreciation of money to discourage people from hoarding.
More recently, Miles Kimball of the University of Michigan has proposed a system of negative short-term rates that would spur spending.
So what makes One-Month Money different?
The answer is simple: under the system proposed in One-Month Money, interest rates would be set entirely by the free market.
In all other negative-rate proposals – whether it’s Gesell’s or Kimball’s or even the higher inflation targeting proposed by many renowned Keynesians – the control of interest rates would still remain in the hands of the central bank.
First, though, a caveat: in our current system, the fact that the central bank sets interest rates is actually a good thing. If interest rates were left to their own devices, it’s highly unlikely they would ever settle at a level consistent with full employment and steady inflation. Our economies would swing from extremes of inflation to extremes of unemployment.
Millions would suffer needlessly. So despite what opponents of quantitative easing claim, central bank intervention does a fairly good job at softening our business cycles.
But this system is by no means perfect. The first big problem is that central banking is really just a form of central planning, and we all know how well that worked for the Soviets.
No matter how brilliant our central bankers are, setting perfect interest rates is enormously difficult. In fact, it’s nearly impossible. How can central bankers possibly know what interest rate is required to drive spending to a level that achieves full employment and steady inflation?
Quite simply, they can’t. Instead they wait for economic data and make educated guesses. As a result, our economies are still subject to cycles. These cycles are smaller and less frequent than in a world without central banks – but they are cycles nonetheless.
The second problem is that the central bank’s attempt to manipulate interest rates can itself affect the rate necessary to achieve full employment and steady inflation.
For instance, if a prospective homebuyer suspects that the central bank might cut rates, she might delay applying for her mortgage. To compensate for this hoarding, the central bank would have to cut rates even further to boost spending.
So even if omniscient central bankers knew what rates should be tomorrow, the central bank’s very effort to target this rate may once again cause the rate to move. This is why central banking can be compared to pushing identical poles of two magnets together – the closer we get, the more elusive the goal.
For this reason, proposals like Gesell’s or Kimball’s are inherently flawed. With the central bank still controlling interest rates (whether positive or negative), business cycles would continue to exist.
Furthermore, there is the very real risk that cutting rates into negative territory would trigger a panic that would cause rates to behave erratically. What if people start hoarding out of fear? The central bank would have to cut rates even further, and then suddenly lift them once the hoarding is reversed.
It’s an imprecise, messy system, and the unintended consequences could be dire.
With the system proposed in One-Month Money, these problems simply won’t exist anymore. Because of money expiration, spending is always at the level that guarantees full employment and stable inflation. As a result, the central bank will no longer need to spur or reign in spending by manipulating interest rates. Rates will be set, not by a central authority, but by thousands of financial institutions whose job is to match savers and borrowers.
Business cycles, whether small or large, will be banished to history.
Oliver Davies blogs at All Things Secular Stagnation and is the author of One-Month Money: Why money ruins our economy – and how reinventing it could end unemployment and inflation forever. It is available now.