16.6 Zero lower bound solved
Direct capital taxation enabled by recycling expansionary financial system also solves the well known zero lower bound economic problem.
When economy is overheating and there are inflationary pressures, central bank increases interest rates which leads( among other things) to higher mortgage installments which cause aggregate demand to go down. Companies access to money is also restricted and all this produces more savings and less spending, thereby stabilizing the economy and subduing the inflation.
This part of monetary policy is tried and tested over time and works well. If consumers are still on their spending spree, central bank can always increase interest rates a bit more.
But what if situation is reversed and the problem lies in too much saving and not enough spending ? Obviously, the answer is the reversed policy, which means CB lowers the interest rates which encourage the demand and resulting higher spending leads to higher GDP, employment...
The possibilities to go down with interest rates in conventional financial system are rather limited. Central bank at present can go maximum to 0% interest rate. If that rate is not enough to rise spending and saving is still higher than spending, this leads to savings glut, which is withdrawing money from economy and causes unemployment. Without fully digital financial system, CB cannot go below zero, that is to introduce negative retail interest rates. If they tried, it would cause bank runs as people would try to avoid such „taxation“ by withdrawing their money from the banks.
This significantly reduces the flexibility of CB as this rather important arrow in policies quiver is simply missing. Without possibility to introduce negative interest rates there is no easy way how to overcome this zero lower bound problem and bring economy back to full potential and employment.
The only weak remedy CB can try is quantitative easing in an effort to start inflation, which will cause real devaluation of savings. This would equal to the same effect as negative interest rate as real buying power of savings would be decreasing in time with continuing inflation.
But inflation by itself is very crude method how to handle this problem.
Firstly, it affects indiscriminately everybody, regardless of amount of savings and age. Even people with reasonable amount of savings will be obliterated. People just before pension would be hit the hardest as value of their pension funds would evaporate during prolonged period of inflation. That would seriously diminish their future buying power as pensioners and could offset any gains such policy might bring about.
Inflexibility of inflation is its biggest weakness. Also, do we really want inflation per se ?
It can get out of hands and cause more damage than anybody can anticipate.
Secondly, the good old inflation is not so easily invoked as one might think.
Quantitative easing by buying assets is not directly increasing aggregate demand. The transmission mechanism CB hopes for is indeed very weak:
1. People who sell their government bonds will buy some consumer goods and so increase demand.
Well, they bought bonds because they had no use of their money anymore, so expectation that they will spend the cash now might not materialize.
2.Investors who sell bonds will invest in real economy, thus providing jobs and additional demand.
The problem is, that people who invest in low yielding government papers are not exactly entrepreneurial types. If they did not invest in real economy in good times, they are highly unlikely to do so now, during recession.
3. Speculators will change bonds for stocks, thus driving their prices higher and creating wealth effect which will support spending.
This is indeed happening, but the effects are rather muted. Not everybody is in stocks and low yields are hurting different type of investors. Also, this policy cannot go forever. As QE stops, the bubble will burst and damage could be even worse than gains.
Quantitative easing is simply not a permanent solution. By today´s highly concentrated ownership the result can by just extra billions for top 1%, without any significant increase of spending and demand. The money from QE can just impotently fall through the cogs of economic machine without producing any traction, landing at the same accounts that were already oversized. The main goal to decrease saving and increase spending might not be achieved.
Therefore, the ability to overcome zero lower bound is really crucial. By going digital, introduction of direct capital tax ( negative interest rate) we can solve this problem for good.
If somebody thinks that the term „zero lower bound“ sounds too technical, it can be easily translated to ordinary GREED. Now you understand. Some people simply hoard too much money and so are bringing the economy to a standstill. They cannot spend them any more and they are not willing ( or able) to invest them as well. But they keep hoarding. And as there is no such thing as money tree, from which ordinary people and investors willing to spend and invest could take replacements for these withdrawn money, the economy is slowing down. Only recycling of such dead financial resources through negative interest rate can get the economy moving again.