Nominal interests rates have a zero bound, because it is preferable to hold money rather than lend it if rates go negative. But Mankiw and his clever grad student have a solution: let the Fed randomly pick an integer from 0 to 9 once a year and invalidate all currency whose serial number ends with it. Then people would gladly accept negative interest rates to unload their disintegrating cash.
Um, no. I don’t know what they teach at Harvard, but where I work we don’t postpone past grad school the following rather elementary observation: most money is not currency. The most recent Fed data put the monetary base at just under $1.6T, of which about half is in the form of reserves held by member banks at the Fed. M2, which includes the deposit accounts you and I have at our banks and represents a more relevant measure of the money supply, is a bit over 8.3T (not seasonally adjusted). In other words, about 90% of the money supply under a reasonably conservative definition is not cash and bears no serial numbers.
And even if we could force everyone to trade in the coin of the realm and abjure those newfangled bank accounts, there would still be the international dimension to consider. About half of our dollars circulate abroad; whole countries are even dollarized. Now here’s something for Mankiw to consider: Panama, to take one example, pegs its currency to the dollar but prints the stuff itself to put a local face on legal tender. Can you foresee a spike in demand if they decide to not play the self-destructing digit game?
All of this is bonkers, of course. The more serious proposal in Mankiw’s column is for the Fed to target a particular rate of inflation, but effectively, by publicly opposing deflation, they are already doing that. Money growth has been ample so far (for instance, a 9.4% growth in M2 over the past year); there has been no repetition of the monetary contraction that accompanied the early stages of the Great Depression, just like Bernanke promised. The Fed’s toxic asset buying spree has been a form of open market operations, and monetary expansion has been one of the main sources of its bailout finance. There is general agreement, however, that this particular spigot cannot be opened much further. Enough money creation can always crank out high rates of inflation, but this would set off a run on the dollar, and the willingness of portfolios to accept ungodly amounts of dollars, and dollar-denominated T-bills, is the underpinning for the entire bailout strategy. Surely Mankiw must know this too.
So what’s the point?