(photo credit: Courtesy)
In the shadow of an unprecedented series of interest-rate reductions that have already lowered interest rates to within half a percentage point of the floor of zero, a research report from the Bank of Israel considers a seemingly revolutionary proposal: negative interest. That's right, the money you deposit in the bank will lose value instead of gaining it.
The theory seems to be: If you can't get below the floor, then lower the floor. (This reminds me of what happened when the water level in the Kinneret reached the red line, under which no pumping is allowed by law; they just lowered the red line.)
It's important to note that this is only a discussion in a research report and not a concrete proposal. Still, it's worthy of discussion due to its novelty and the combination of economic and ethical issues it raises.
The underlying rationale for such a step is simple. The central bank strives to regulate the level of activity in a country via its control over the interest rate paid by banks. Usually this is very easy: If the central bank wants to stimulate the economy, it lowers the interest rate, in turn stimulating banks to make more loans, which are used to expand economic activity in the country.
If the bank wants to subdue the economy, due to its perception that unsustainable expansion will lead to a bust, then it does the opposite, raising interest rates to discourage lending or, in extreme cases, even calling back existing loans.
There are two ways this system can break down, and world economies are experiencing both to a limited extent. One is that lowering interest rates won't encourage lending if businesses don't want to borrow because they are pessimistic about their ability to make a profit, or if banks don't want to lend because they are pessimistic about the ability of borrowers to pay back.
As macro-economists say: "You can lead a horse to water" by lowering the interest rates and making money available, "but you can't make him drink"; i.e. you can't force businesses to borrow or banks to lend.
The other reason is that interest rates have a natural floor, which is zero. If interest rates are at or near zero you can't encourage lending by lowering it below zero... or so we thought.
But in fact, as the Bank of Israel economists point out, if a tax is placed on cash, then money has a negative return. This will make people want to get rid of it, either by spending it or by investing it in interest-bearing transactions that have slightly positive rates of return.
The truth is that this seemingly revolutionary proposal has a distinguished pedigree. As the central bank's report indicates, it was discussed at length by John Maynard Keynes in his landmark 1936 work, The General Theory of Employment, Interest and Money, where Keynes traces the idea a generation further back to the writings of Silvio Gesell.
One practical obstacle to this proposal is that the tax can be placed only on bank accounts and not on cash; thus, people will be able to evade it entirely by putting money in the mattress. The Bank of Israel report only examines this problem from the narrow point of view of monetary policy. It concludes that if the tax is small and temporary, the effect will be small.
In my opinion, this is far too narrow a point of view to discuss such a far-reaching proposal. Placing a tax on people's hard-earned money - above and beyond the income tax, value-added tax and other taxes they are already paying - could be widely perceived as unfair and even confiscatory.
It is also a mistake, in my opinion, to view the move to cash as something innocuous beyond its effect on money supply. This policy will basically give an official government stamp of approval to using the cash economy as a way of avoiding taxes, which could have a persisting corrosive moral impact not easily reversible. Having more money in currency also makes the work of the central bank much harder, since it is hard to keep tabs on it.
A more practical reason to shun this policy is that there is a much easier way to tax money-holding, one that has a pedigree of not a hundred years but of thousands of years. It's called inflation. Whenever there is inflation, your money is always losing a little bit of its value, even if it is in the mattress. This gives you a good reason to want to go out and spend it or to invest it in some tangible asset whose underlying value is unrelated to the price level.
Unlike a tax on bank accounts, inflation also generates meaningful revenue for the government. For this reason, some economists consider a low level of inflation quite innocuous and perhaps even beneficial.
It is also true that inflation creates inflationary expectations that have a negative impact on future growth. But I think the downside of a little bit of inflation is dwarfed by the potential damage from the moral cost of making it official government policy that taxes can be avoided by moving money to the cash economy.
Asher Meir is research director at the Business Ethics Center of Jerusalem (www.besr.org), an independent institute in the Jerusalem Institute of Technology.