4
$\begingroup$

Recently, I read an IMF blog on how the negative interest rate policy can be implemented feasibly here. I don't really understand what they are saying in this paragraph:

When cash is available, however, cutting rates significantly into negative territory becomes impossible. Cash has the same purchasing power as bank deposits, but at zero nominal interest. Moreover, it can be obtained in unlimited quantities in exchange for bank money. Therefore, instead of paying negative interest, one can simply hold cash at zero interest. Cash is a free option on zero interest, and acts as an interest rate floor.

What I guess they are trying to say is that when cash is available, people need not take up loans and hence, the availability of cash diminishes the effectiveness of the policy. Could someone please help to enlighten me on this?

$\endgroup$
  • $\begingroup$ What a complicated suggestion - you wonder why they can't just increase inflation. $\endgroup$ – user253751 Dec 27 '19 at 12:55
  • $\begingroup$ (as it stands, the proposal is to make cash inflate, but not deposits) $\endgroup$ – user253751 Dec 27 '19 at 13:09
  • 2
    $\begingroup$ I guess their traditional way to cause inflation is not working, and that is why there are discussions about "helicopter money." $\endgroup$ – user253751 Dec 27 '19 at 13:12
11
$\begingroup$

Actually they're saying that, when cash is available, people need not to deposit their money into the bank, and hence is "guaranteed" (not taking into account risks associated with holding on to cash, like fire or getting stolen) a 0% interest rate.

Having cash, therefore, means that if the deposit rate goes into the negative territory (you're charged to deposit your money), then people could simply stock cash at home. As a result, the interest rate could not go much into the negative territory.

$\endgroup$
  • $\begingroup$ Oh that was easy enough to understand. Thanks! $\endgroup$ – Tan Yong Boon Dec 27 '19 at 2:57

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.