Sunday, January 3, 2016

Fischer: Fed’s Tools ‘Proved Effective’ in Raising Short-Term Interest Rates; Cashless Society Might Become Practical Question

Federal Reserve Vice Chairman Stanley Fischer has taken a bow here in San Francisco for the success the Fed had in raising the target Fed funds rate for the first time in more than 7 years.

“One possible concern about our unconventional policies has eased recently, as the Fed’s normalization tools proved effective in raising the federal-funds rate following our meeting two and a half weeks ago,”  Fischer said today at the American Economic Association’s annual conference. “Of course, these are early days yet with regard to normalization of interest rates, and issues may yet arise that would require adjustments to our tools, and we stand ready to do that.”

The Fed in mid-December raised the target Fed Funds range to 0.25% to 0.50%, and more significantly in open market operations trading raised the effective Fed Funds rate from 0.15% to 0.35%.

During his speech, Fischer seemed to throw cold water on the idea that the Fed would implement a negative interest policy during some future financial crisis (Never mind the idea suggested by some Austrian school economists that the Fed might soon implement a negative interest rate policy.):
Could negative interest rates be a policy response that the Federal Reserve could choose to employ in a future crisis? One possible concern with a strategy of this sort in the United States is the potential for destabilizing effects in money markets. For example, various observers have noted that negative rates could lead to scenarios in which money funds "break the buck" or simply shut down, either of which could generate strains in money markets. Another concern is whether the complex and interconnected infrastructure supporting securities transactions in the U.S. financial system could readily adapt to a world of negative interest rates. For example, similar to the types of issues addressed ahead of the year 2000, there could well be automated systems that simply are not coded properly at present to process transactions based on instruments with negative rates. All of these are, of course, transitional problems, but they might be sufficient to make a move to negative rates difficult to implement on short notice.

More concerning was the point Fischer made that the theoretical discussion about the end of physical currency "could possibly have practical implications as well," though, thankfully, he admitted such a move to a cashless economy was "far off":
While the European experience suggests that interest rates can be pushed somewhat below zero, the existence of physical currency likely still limits how deeply interest rates can be pushed into negative territory. That observation has led some to ask whether it would it be possible for the financial system to operate effectively without physical currency provided by the central bank. This is a theoretical question that has fascinated economists for decades and, with advances in technology, could possibly have practical implications as well. Indeed, the Scandinavian countries have embraced the development of new payments technologies that seem to be reducing the need for physical currency for transactions in those countries. Nonetheless, a transition to a cashless economy in the United States seems very far off; indeed, U.S. currency outstanding has been increasing relative to nominal gross domestic product over recent decades, driven importantly by foreign demands for U.S. bank notes. Moreover, to eliminate the ZLB associated with physical currency by going cashless, countries would need to transition to an economy that did not require widespread use of physical currency, and central banks in those countries would need to cease issuing physical currency on demand (for example, in response to demands spurred by negative rates on so-called inside money).14 For all of these reasons, as a practical matter at least for the United States, it seems highly unlikely that the constraints associated with the ZLB could be meaningfully addressed by steps to encourage a transition to a cashless economy.
Fischer's full speech is here.


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