The central banks across the globe have faced a problem like never before, if they decrease interest rates to zero, they might encounter a cash problem.

Willem-Buiter_2849341b

The reduction of interest rates is the first instinct of a central bank, whenever the conditions in economy worsen. By doing this, the central banks are stimulating the growth of the economy.

Basically, the ELB problem is essentially cash money. Citigroup’s Willem Buiter thinks that the existence of the ELB is caused by the existence of cash, the bearer instrument paying nominal rates of zero. Why would anyone deposit money on a rate that is negative, and effectively reduces your wealth, when the option of holding cash has no such consequences? People can easily avoid negative nominal rates just by holding onto cash. The expert sees only three solutions to the problem – taxing the currency, abolishing the currency and removing the fixed exchange rate between the central bank reserves and the currency.

Buiter suggests that, in order to solve the problem of negative deposit rates we could opt to abolish cash money! But for the cash abolition to be necessary, the central banks would need to set the nominal rates to lower then -100bp. This doesn’t see too implausible, as the Federal Reserve has lowered the rates as much as -6% during the crisis.

Buiter is off course completely aware of the how controversial the cash abolition idea is, so he lists some of the disadvantages of the process. First and foremost, people usually react negatively to any life change, and tend to resist it. Buiter goes on and list some more disadvantages, concluding with the inevitable security issues of the exclusive electronic payment method.