The Deadly Zero Holding America Back

Physical currency is keeping people from finding work.

Photo by CHRIS RATCLIFFE/AFP/Getty Images

Paul Krugman has a great post on why economists used to think prolonged periods of mass unemployment and low output wouldn’t happen and the two deadly zeros that proved that assumption wrong. Basically they were always assuming that a sensible central banker would pull the economy back toward its potential. But it turns out that “the hard zero on interest rates and the soft zero on wage changes — can, all too easily, give central bankers a de facto license to let the economy stagnate, remaining far below potential for an indefinite length of time.”

The way this works is that the hard zero on interest rates means that to boost the economy you need to do something politically contentious like fiscal stimulus or quantitative easing. Meanwhile the soft zero that tends to prevent nominal wages cuts means that even a very depressed economy doesn’t fall into outright deflation once commodity markets stabilize.

It’s really worth focusing on exactly how maddening this hard zero on interest rates is. As Miles Kimball has been pointing out, this isn’t an iron law of economics it’s a practical response to the existence of paper money. A self-storage locker full of $100 bills has a very very very slightly negative interest rate (i.e. the rent on the locker is tiny compared to the amount of cash sitting inside) so interest rates can’t go much below zero before the banking system ends up in competition with physical storage of cash. But cash itself is marginal to the modern economy. I got the image of a storage locker full of cash from Breaking Bad. But Walter White stores his money that way because he’s a criminal. Most of us carry cash around every day and use it for this and that. But economically meaningful transactions—the payment of salaries, or rent, or mortgages, or utility bills, or the purchase of cars or homes or durable goods—are almost never conducted in cash.

If you got rid of the paper money entirely you’d never have to have these prolonged recessions. The old dream of monetary policy effectiveness would be real again.

I should note in a throat-clearing vein that over the past few years it’s become common for people urging political, social, or intellectual complacency about prolonged periods of depressed demand to sagely note that monetary policy doesn’t solve all problems. And I agree. For example, here are some problems:

  • Traffic jams.
  • Death in automobile accidents.
  • Scarcity of street parking.
  • Excessive supply of off-street parking.

None of those problems can be solved with monetary policy. And those problems are all related to the relatively narrow space of automobile transportation. The world is full of problems. But prolonged labor market downturns in which able-bodied people don’t have jobs are a particular kind of problem, and one we could solve with politically challenging methods today and hopefully in the future will be able to easily solve by eliminating the zero bound.