Dan Kervick: The Astonishing Case of the Impenetrable Zero Bound

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Yves here. I rather like the storytelling format of this post.

By Dan Kervick, who does research in decision theory and analytic metaphysics. Cross posted from New Economic Perspectives

In a small, peaceful town there once lived three people: Abbie, Baker and Carlie.

Abbie was a very wealthy aristocrat, and also a philanthropist. Her fortune and position in the town were the fruit of the hard work of her ancestors, but her life was dedicated now only to managing that fortune. She lived to make the common people of the town happy, especially Carlie, who was her personal favorite.

Baker was much more selfish, and looked out for his own interests. He wasn’t terrible and mean, just obstinately self-interested. It seems he was born that way; it was in his DNA.

Abbie frequently lent money to Baker, and Baker frequently lent money to Carlie. But in accordance with the ancient and venerable laws of the town, enacted to maintain a decorous distance between the aristocrats and common people, Abbie was forbidden from loaning money directly to Carlie. Nevertheless, Abbie was usually able to help out Carlie indirectly when necessary. She found that when she lent money to Baker, Baker was sometimes more willing than before to lend money to Carlie. And if Abbie loaned the money to Baker at lower rates of interest than previously, Baker would usually reduce the rate of interest he charged Carlie in turn.

Baker didn’t reduce these rates out of kindness. (He was selfish after all.) No, he reduced these rates because Carlie was sometimes willing to borrow money at the lower rate but unwilling to borrow the money at a higher rate. So he was glad when Abbie loaned money to him at low rates of interest, because then he could loan money to Carlie at a rate of interest that was higher than the rate Abbie charged him, but not so high that Carlie was unwilling to borrow from him.

There were two other lenders in the town: Wells and Bancroft. They were just as selfish as Baker, but they also loaned money to Carlie and to the other common people of the town. Whenever Baker tried to charge Carlie too much, Wells and Bancroft would espy an opportunity. They would immediately borrow money from Abbie and then offer Carlie loans at a lower rate of interest than the one offered by Baker. Opportunities for loaning money to townsfolk like Carlie were limited, so none of the three could make very much money if they didn’t compete aggressively to offer the lowest possible interest.

Sometimes Carlie or one of the other commoners had a little bit more money than needed to meet immediate expenses. They would then ask Baker, Wells or Bancroft to hold the money for them. The main reason they did this, instead of holding onto the money themselves, is that Baker, Wells and Bancroft were willing to pay Carlie and the others for the privilege of holding onto their money. And the reason they were willing to pay for that privilege is because they could then lend that money to other people. Suppose Carlie had a thousand dollars she was willing to give to Baker for one month, and suppose Baker knew someone who was willing to borrow those thousand dollars from him for three weeks at 5% interest. Then as long as Carlie was willing to accept less than 5% from Baker for allowing him to hold her money for a month, Baker could make money on the three-party transaction.

Abbie was enamored of this whole system. It was time-honored, and she thought it worked beautifully. When Carlie needed more money, Abbie could get it to her by reducing the rate of interest she charged Baker, Wells and Bancroft. And if Carlie was growing a little too exuberant and carefree, as she sometimes did when things were going well for her, Abbie would temporarily increase the rate of interest she charged Baker, Wells and Bancroft. This would make it harder for Carlie to borrow money. Abbie didn’t like to do this, but she knew it was sometimes for Carlie’s own good.

Then something very strange happened. Abbie heard that Carlie needed more money, and Abbie responded by reducing the rate of interest she charged Baker and the others. But Baker didn’t make any more loans to Carlie. So Abbie reduced the interest rate further. But Baker still did not make any more loans. Finally she reduced the interest rate lower than it had ever gone before: ¼ of one percent for a one month loan. But Baker still did not make any more loans.

Flustered and perplexed, Abbie invited Baker to her office to find out what was going on. Baker explained, “Well, for one thing, it costs me money just to run my loan business. So even though you charge me only ¼ of one percent, I still have to charge Carlie significantly more than that to stay in business.”

“But also,” Baker continued, “Carlie doesn’t seem to want to borrow money right now at even my lowest rate. She’s afraid she won’t be able to pay me back. And to tell you the truth, I’m also afraid she won’t be able to pay me back. She doesn’t have a job right now. So even on the days when she does want to borrow money from me, I don’t want to lend it to her. She will spend the money I lend her, I fear, but have no way off earning enough to pay back even the principle of the loan. Wells and Bancroft say the same thing.”

“Well, can’t she pledge something else to you,” asked Abbie. “Something she already owns? You and Carlie can agree that if she is unable to pay back the money, then you can take the things she has pledged.”

“She has already done that to some extent,” said Baker. “She has even pledged her house to Wells. But Carlie isn’t very well-off, to tell you the truth. She doesn’t have much of value left to pledge, and what she has is very valuable to her and so she does not want to risk losing it by pledging it.”

After Baker left the office, Abbie thought and thought and thought. “There must be some way around this problem,” she thought. Finally she hit on it: she would just have to give money to Baker. Then Baker would be willing to give money to Carlie. If Baker gave Carlie less money than Abbie gave Baker, then it stood to reason that Baker could still make money on the total transaction.

And money was no object for Abbie, because she had virtually unlimited stocks of money. Although not everyone realized it, Abbie owned the town’s money-printing machine, and could manufacture as much money as she needed at virtually no cost. The only reason that she did not print unlimited quantities of money for the town was that experience had convinced her that increasing the amount of money available in the town at a faster pace than the town’s economy was growing would generally just raise the prices of everything without helping anybody. So limiting the amount of money printed during any period of time was the best way to make sure the prices of things remained relatively stable. This made it easier for people to make deals with one another in which one party to the deal would deliver some good or service right away in exchange for some promised quantity of money to be delivered later by the other party. If people didn’t know how much the town’s money would be worth in the future, it would be harder for them to make those deals. So Abbie considered the stabilization of prices and the prudent control of the supply of money to be part of her role as the town’s chief philanthropic benefactor.

But things were very bad right now, so Abbie had decided that she would just have to give Baker some money. Abbie also decided that, for the sake of propriety, she wouldn’t say she was giving the money to Baker. Instead she would say she was charging him negative interest. She would charge Baker -5% interest for a one month loan. If Baker borrowed $10,000, then a month later he would have to pay back $9,500. He would thus make $500 on the transaction. He could then give free money to Carlie. Maybe he would loan her the $10,000 of borrowed money for one month at -4% interest. Carlie would then pay him back $9,600 one month later. Baker could then pay Abbie the $9,500 he owed her and still make $100.

Abbie called Baker to inform him of the new arrangements.

“Excellent!” he said.

“So, how much money would you like to borrow?” Abbie asked.

Baker replied, “Oh, for a start, let’s say


He actually had to write this number down, because it contained so many zeros that neither he nor Abbie knew the English word for the number. Abbie realized she would have to revise her plan and asked Baker to come back the next day. After pondering the matter a bit, she hit on a solution. The next day, when Baker returned to the office, Abbie offered the new terms:

“You may borrow for one month at -5% interest,” she said, “but there is a $10,000 limit on the amount you can borrow each month. How much would you like to borrow today?’

“I would like to borrow $10,000,” said Baker.

“Fine,” answered Abbie.

A month passed, during which time Abbie congratulated herself on the ingenious beneficence of her plan. The town was surely blessed to be guided by enlightened aristocrats like her, with advanced ideas about the proper role of money in society. One month later, Baker returned to her office, and repaid the $9,500 he owed. “Outstanding,” Abbie said, “and how much did you lend to Carlie?”

“Nothing,” Baker replied. “Why should I have loaned any money to Carlie?”

“That was the whole point,” Abbie said, with a touch of aristocratic pique in her voice. “You could have loaned Carlie money at negative interest, just like I did for you, and still have made a profit. If you had loaned at -4%, you still would have made $100.”

“True enough,” answered Baker. “But I profited even more by not lending her money at a negative interest rate. I made $500 instead of $100. No matter what rate I charged Carlie, so long as it was negative I would have made less than $500. And Carlie won’t borrow money at a positive rate of interest.”

“But my dear Baker,” continued Abbie, “Wells and Bancroft did loan money to some of the common people. I have spoken to them about it, and they behaved exactly as I expected, loaning money to the townsfolk at -4% interest, and thus making a 1% profit on the total transaction.”

“Yes, I spoke to them about it,” smirked Baker. “They said, ‘You fool Baker, we undersold you again! We were able to get people to take loans at the extremely low rate of -4% thanks to these -5% loans we’re getting from Abbie. We made a profit of 1% on each loan!’ “

“But I explained to them that they were idiots, and that I made much more money – by borrowing from you at negative 5% and not making negative interest loans – than they had made by borrowing from you at negative 5% and making negative interest loans. They grasped my point immediately, so I don’t think they will be lending out any of the money you give them again, not unless they can they can get a positive rate of interest from the borrower.”

Abbie realized that she would have to rework the plan again. The problem seemed to be that, with a negative interest loan from her, Baker could make money simply by holding onto the money she had lent him. So she considered charging Baker a holding fee for the money, so that he couldn’t profit on her loan to him. She would charge him a percentage of the quantity loaned for each day he held onto it.

But she quickly realized that made no sense. The holding charge was nothing but an adjustment to the interest rate. If she loaned him the money at -5% per month, but then charged him back 4% per month for the money as he held onto it, that was no different than a -1 % interest rate with no holding fee. If she charged him 6% for holding the money, that would be no different than a 1% interest rate. The holding charge did nothing to get around the fundamental problem. Somehow she needed to give Baker a negative overall interest rate, so that he could give a negative overall interest rate to Carlie and still make money.

She realized what she wanted to do was charge him for holding the money himself, but also let him avoid the holding charge if he lent it to Carlie. “Aha,” she thought. “I will loan Baker the money at -5% and put the money in a special metered box. I will then charge him 5% per month for keeping the money in the box. However, the interest rate is reduced by the amount of time the money is absent from the box. If the money is in the box for only 1/5 of the time during the month, for example, the total holding charge would be only 1%.”

Abbie tried this, but the problem was immediately apparent. Baker took the money out of the box and put it in his desk drawer. He avoided the holding charge in this way, but still did not lend any money to Carlie. Then he paid the amount he owed to Abbie at the end of the month, and earned the entire $500 profit for himself.

Growing somewhat less rational as her frustration increased, and more determined than ever to exercise control over what was happening, Abbie first thought that she must somehow force Baker to keep the money in the box instead of putting it in his desk drawer to avoid the holding charge. But she quickly realized that approach only returned the situation to the previous one: the holding charge was just an adjustment to the interest rate. Also, if Abbie forced Baker to hold the money in the metered box, what was he supposed to lend to Carlie? She was reasoning in circles.

Abbie thought extremely hard about this problem. She consulted the works of great economists, philosophers and financial geniuses throughout history who had studied the problems of money, interest and exchange. She also reflected on the advice of her father, who had once told her, “If you are failing in your job as an aristocrat, try an approach that makes things more complicated. If you succeed, that will be wonderful, but if you continue to fail then people will have to spend so much time just figuring out what is going on that at least your failure will not be so apparent.”

At last she devised a plan. The plan was comprehensive in scope, and would require the involvement of all three lenders, Baker, Wells, and Bancroft. She summoned them to her office.

“I will assign a box to each one of you,” Abbie began, “and post an executive assistant to watch over the boxes. The owner of any one of the boxes may only remove money from that box to transfer it to another box. My assistant will supervise the transfers. You may make whatever deals you like among yourselves to bring about these transfers. “

Abbie continued, “The boxes will be metered, and the owner of each box will be charged for holding money in a box, at a rate of 5% per month. The primary way any one of you can avoid these charges is to succeed in getting money in your box moved to another box.”

“And what, then, are we supposed to lend to the common people such as Carlie?” asked Baker.

“I am giving you these signed credit vouchers,” replied Abbie. “Each one is good for a certain quantity of dollars, and also specifies which box the dollars are held in – Baker’s box, Wells’s box, or Bancroft’s box. You may give these to the townspeople in exchange either for actual dollars, or for their promise to give you some other number of vouchers in the future. Although none of you is permitted to remove money from any of the boxes, my assistant will be authorized to remove money and transfer it from one box to another if you present him with the appropriate voucher. ”

“For example,” continued Abbie, as her listeners strained to listen and follow, “If Carlie has a voucher that represents $100 held in Baker’s box, and gives that voucher to her friend Carl in exchange for something else, Carl might then take that voucher to Wells. Wells might be willing to give one of his own vouchers to Carl in exchange for the Baker voucher, but instead of giving Carl a Wells-voucher with the same face value as the Baker-voucher, Wells will probably give Carl a little bit extra, just as he now pays Carl for the privilege of holding onto his regular dollars. Wells can then take the Baker-voucher to my assistant, who will transfer the number of dollars indicated on the voucher from Baker’s box to Wells’s box.”

“But since the common people have no vouchers right now, and are rather poor and short on dollars, how will they acquire enough vouchers or dollars to pay us back for loans of vouchers we make to them?”

“Well,” said Abbie, with a self-satisfied smile spreading across her face, “You can lend them the vouchers at negative rates of interest! Since I am lending you dollars at negative interest, you can still make a profit that way.”

Baker, Wells and Bancroft looked at one another, with blank and searching expressions. They squinted. Then they grinned and shook their heads just slightly, rolled their eyes and left the meeting room to begin working with this complicated new system.

Abbie soon realized that despite the nearly byzantine complexity of the system, and its innovative audacity, nothing fundamental at all had changed.

First, suppose she charged a -5% rate of interest on the loans and a 4% holding fee for holding money in one of the boxes. She realized that because the money could only move around among the boxes but was always in some box or other, then the situation was no different than if she were working with only one lender and one box. If the money was loaned out for a month, then the whole system of Baker, Wells and Bancroft had effectively borrowed it at -1% per month. And that system, as a whole, made money by holding the money in the boxes collectively, rather than lending it out via the new voucher system. And if the holding fee was such that the effective borrowing rate was positive, then they were right back at the starting point. The system of lenders as a whole wouldn’t want to borrow from Abbie, since the townspeople were unwilling to borrow from the lenders at a rate that would make positive interest loans from Abbie profitable.

The vouchers were really just ownership claims on the money in the boxes. Whether the three lenders loaned money to Carlie by giving her actual dollars, as they had in the old system, or by giving her claims on their store of dollars held in the boxes, as in the new system, the underlying logic of the situation was the same: lending money at negative interest is the same as giving money away. And there was no circumstance under which the three lenders benefited, either individually or as a group, by giving money (or claims on their money) away for free. It didn’t matter whether Abbie was giving them money for free as well. Since Baker, Wells and Bancroft were selfish, then no matter how much free money Abbie gave them they would only end up with less than that amount if they also gave some portion of that money away for free to Carlie and her fellow townsfolk.

It was at this point that Abbie had a sort of revelation. She hoped it wouldn’t turn out to be just as delusional a revelation as some of the previous revelations. The revelation was this: the fundamental problem here was that her transactions with Baker were too independent of Baker’s transactions with Carlie. Baker was a profit-seeker, and all the choices were in Baker’s hands. Baker could choose to borrow or not to borrow from Abbie on whatever terms Abbie was offering. As far as those transactions were concerned, Baker could take them or leave them. Similarly, Baker would them decide whether to offer Carlie a loan at whatever rate he wished, and Carlie could then take or leave those offers. But because these decisions were independent, and because Baker’s ability to take the loan from Abbie, or not take the loan, had nothing to do with whether or not he made a loan to Carlie, then there was never a circumstance in which making the negative interest loan to Carlie made sense for Baker.

Suppose X were the loan transaction between Abbie and Baker and Y were some negative interest loan transaction between Baker and Carlie. Then clearly Y alone, considered only in itself, loses money for Baker. So what about X and Y together? Would the combined transaction X+Y be profitable for Baker? It might be, but that would depend on the terms offered by Abbie to Baker and the amount of negative interest offered by Baker to Carlie. But one thing was obvious: Since Baker lost money on Y alone, considered only in itself, then if Baker made money on the transaction X, he would make less money from X+Y. And if Baker lost money from X alone, then he would lose even more money from X+Y. No matter what happened between Abbie and Baker, there is no way Baker came out ahead by making the negative interest loan to Carlie.

The only solution would be for Abbie to offer Baker profitable terms on her loan to him, but make his ability to obtain these terms contingent on whether or not he offered terms to Carlie that were acceptable to Abbie.

So Abbie’s next innovation was this: Baker, Wells and Bancroft would still operate with the system of vouchers and boxes set up previously, but they would now also be given a collection of official loan affidavit forms on which they could inscribe the terms of any loans they made to any of the townsfolk. The affidavits needed to be signed by both the lender and the borrower, with the amount of the loan, the interest rate on the loan, and the length of the loan clearly indicated. The lender could then take one of these signed affidavits to Abbie, and then – only then – would Abbie make a negative interest loan to the lender. Abbie would offer a rate 1% lower than whatever rate the lender had given to Carlie or one of the other townsfolk. If Baker made a 30 day loan to Carlie at -4%, then when Baker presented the loan affidavit Abbie would give Baker a 31-day loan for -5%. After Carlie had paid back Baker, Baker would then pay back Abbie, but still make a 1% profit. But Baker had to make a loan to Carlie first in order to get the loan from Abbie, so he no longer had the option of making an independent transaction with Abbie and then foregoing a transaction with Carlie.

In practice, this is how it worked: Baker didn’t need to obtain a money loan from Abbie first, before making a loan to Carlie, because he had the vouchers to give out. So he would lend Carlie $10,000, for 30 days at -4% interest, by giving her 100 vouchers with a face value of $100 each. Carlie and Baker then filled out the affidavit and signed it, indicating these terms. Baker would take the affidavit to Abbie’s assistant, would would verify it, and move $10,000 from Abbie’s money box to Baker’s money box. The terms of this loan were -5% for 31 days. Carlie would spend $400 of the vouchers she had been given, and save the remaining $9,600 worth of vouchers. At the end of 30 days, she would give Baker those $9,600 worth of remaining vouchers, completely discharging her debt to Baker. Baker would then go to Abbie’s assistant the next day and authorize a transfer of $9,500 from his box back to Abbie’s box.

Baker might end up initially with $500 more in his box than he had before. But the $400 dollars Carlie wasn’t required to pay back would have been spent around town among the townsfolk. As before, that would result in money being transferred from Baker’s box to some other box. Even if it weren’t transferred, he always knew it might be at any time, so did not count those sums as part of his own profits. His profit was the $100 extra that would remain in his box no matter what. He could then spend that money on things for himself, if he liked, by paying for the things he wanted with his vouchers.

It worked! Baker, Wells and Bancroft began loaning money to the townsfolk at negative interest, and then applied for loans from Abbie at a rate of interest 1% lower than they had given. And so long as Abbie limited the total monthly size of the loans she gave out, she could make sure that this lending activity did not overly expand the money supply and lead to instability and unpredictability in prices.

But something had clearly changed in the town. According to the ancient and venerable laws of the town, Abbie was not supposed to lend or give money directly to Carlie. But it was clear to both Baker and Abbie that Baker now effectively worked for Abbie, and was delivering money to Carlie as a sort of agent or emissary from Abbie. Baker was now not much different than Abbie’s assistant. Baker could charge higher or lower rates of interest to Carlie, but he would always make the same amount of money. Abbie effectively set Baker’s profit margin, so Baker’s profit was really just a sort of salary that was determined entirely by Abbie.

And Abbie decided that even if the town returned to prosperity, it was probably best that the same system stay in place. Baker might then loan money to Carlie at 4% interest, and then apply for a loan from Abbie at 3% interest, making his 1% as always. Abbie could exert direct control on the interest rate Baker charged Carlie by announcing to Baker in advance the bottom limit on the interest rate she would charge him. And she could modulate the amount Carlie borrowed by telling Baker what the monthly limit on his own borrowing would be. All in all, the new system seemed to be working, and seemed like it would continue to work in the future.

Then something else went wrong.

Even though Carlie and the other townsfolk appeared to be getting more money now, they were not spending more money. Their little shops and cafes were rather empty. The big factories had previously cut down on production because Carlie and her fellow townspeople weren’t buying things. Because the factories were producing less, they had laid off many workers. That meant that the townspeople had even less income than before, and there were even fewer people with money to spend in the small shops and cafes. And things weren’t getting any better. Abbie was dumbfounded.

Having already abandoned the hoary pretense of the ancient and venerable laws against consorting directly with Carlie and her fellow townsfolk, Abbie decided to invite Carlie directly to her office. She was sure Carlie would be delighted with this opportunity to meet her great benefactor face-to-face, and would explain what was happening.

“Carlie, my dear friend,” started Abbie, “what is the matter? Why are you and your friends not spending the extra money I am providing you?”

“We are very happy for the extra money,” said Carlie. “But, I still have many old debts that are owed to Baker, Wells and Bancroft. My friends have these debts too. The interest on those debts is very high, and we can barely keep up with the interest payments. I have decided to use the extra money to pay down those debts. Also, I never want to go through this business of high, suffocating debt again. So even after I have paid the debts down, I don’t think I will ever spend as much as I did before. I am going to save most of the extra money.”

“Carlie, while I admire your values of prudence and thrift, the money was not intended to be saved. I wanted it to be spent to revive the businesses in my town.”

“Your town?”

“You know what I mean. Our town.”

“Well, there are other things you could do. My new job is very hard, and I am not paid much. My friends are also not paid very much and their incomes have been going down for years. Perhaps you could use your influence with the employers in the town to get them to pay us more. My brother’s job was also very hard, until he got laid off. He would desperately like to work. Why don’t you hire him?”

Abbie’s face clouded. Giving away free money in an emergency as a charitable endeavor was one thing. That is what philanthropic aristocrats like Abbie did. For the common people of the town these handouts were acts of grace and mercy from above, for which they should be thankful. But what Carlie was now suggesting was a more systematic change to the fundamental social order of the town. Abbie began to harbor suspicions that Carlie was a dangerous radical.

“I really don’t think that is an advisable course of action,” Abbie replied primly.

“Well then,” answered Carlie, “perhaps you could have Baker forgive some of the debts. He works for you now, does he not?”

Abbie gasped. The effrontery of this young woman knew no bounds! Didn’t Carlie realize that the system of borrower and lender, debtor and creditor, bondholder and bondsman, was part of the foundation of the entire social order of the town? A person who owned a debt owned a claim on the person who had taken on the debt. That debt was the creditor’s property, and Carlie was therefore suggesting tampering with the iron laws and relations of property itself! The laws and historically established allotments of property kept each person within his own proper social sphere, performing his assigned social function. If Abbie disturbed these laws even once, where would it all lead? Not just to a change in status for a few selfish money-lenders, she feared. No, the changes could ripple upward to threaten enlightened aristocrats as well!

Abbie curtly dismissed Carlie, and then thought hard about what she must do. She had to regain control of the situation! She must revive spending and economic prosperity in the town, but also restore firm social discipline and respect for the social order.

Abbie moved swiftly and took some very bold steps. She assumed even more complete control of the lending and payment system. Baker, Wells and Bancroft would now just work for her as odd-job assistants and not make loans at all. She then set up a system of boxes and vouchers for the townspeople that was very similar to the one she had originally set up for Baker and his colleagues. Each citizen of the town and each business in the town would now have a box.

She then eliminated the old money of the town altogether. She adjusted the settings on the money-printing machine to produce money that looked very different from the old money, and in conjunction with the mayor – whose salary she paid – announced a date at which the old money would cease to be valid. The townspeople were permitted to bring in their old money and trade it in for the new money. But they had to agree to keep their new money in their assigned boxes.

Each citizen and business was then issued an electronic voucher, and all of the people and businesses in town were supplied with small devices for processing these electronic vouchers. If someone wanted to buy even so much as a cup of coffee, they would present and swipe their electronic voucher through the payment device owned by the coffee shop. This would send a signal to Abbie’s assistants to transfer the appropriate amount of money from the purchaser’s box to the seller’s box. If a business wanted to pay an employee, they had to use the same method. Even a grandmother who wanted to give 50 cents to her grandson, or a passerby wanted to give a donation to a street musician, had to use this electronic system.

Then Abbie did something else, something that shocked everyone.

She announced that she would begin to charge a fee for holding the money in the boxes. No one was permitted to hold any money outside the boxes at all, but any quantity of money one held inside the boxes was diminished in quantity by a pre-determined monthly rate. If the holding rate was 5%, then at the end of each month, Abbie’s assistants would go to each box, and remove 5% of whatever quantity of money was in the box at that time. Abbie also decided to stop issuing the negative interest loans. Her expectation was that as people realized their money was diminishing in quantity each day, and that they had no control over this process, they would adopt a “use it or lose it” mindset and begin to spend money faster. This would revive the economy of the town.

That’s what seemed to happen at first, and there was a slight pickup in business around town. But then something else happened. People understood that since Abbie was the sole source of the money they used, and was enforcing the extractive holding fee rule, then the total quantity of money in the town was shrinking every day. At the current rate of reduction in the supply of money, one year hence there would be just a little more than half of the amount of money that was circulating initially. And there was a practical limit on the speed at which any existing quantity of money could circulate though the town, so the decline in the quantity of money couldn’t be offset by an increase in the pace at which the money circulated. As a result, the prices of everything began to fall to accommodate the drop in the quantity of money. And the more prices dropped, the less eager people were to spend the money they had. They realized that if they held onto their money, the prices of the things they wanted to buy might be lower the next day, and so they could buy more of those things.

Also, since no one had ever lived in a world with the topsy-turvy rules that Abbie had imposed, they didn’t know how to function in that world. The confusion and strangeness of the new system, which required calculations very different from the kinds of calculations people were accustomed to making, added to uncertainty and fear, which wasn’t at all good for the economy of the town.

And then people found that they were having increasing trouble paying their debts. As prices fell, employers received less money for the products they sold, and in turn they pressured their employees to take lower monetary wages. That wasn’t a huge problem in itself, so long as the wages and prices adjusted at more or less the same rates. But since the debts people owed were fixed by the contracts they had made in taking on those debts, and since those contracts specified particular amounts of money that never changed, then as the townspeople’s money wages went down, the difficulty of paying their debts went up. This quickly led to panic and fear of mass bankruptcy.

Abbie also began to learn something about the limits of control from the top. If Abbie would not supply a stable monetary vehicle for people to use to save their earnings and store the value they had built up, people would create vehicles of their own. She learned that the townspeople were beginning to barter goods, so that they could avoid trading in Abbie’s bizarre shrinking money. A $5 jar of jam preserved its value longer than $5 of Abbie’s money. And when bartering was impractical, people issued IOU’s for various goods. Soon the IOU’s had taken on a life of their own, and were traded against one another at relatively stable rates according to circulating price lists.

Abbie tried having the mayor declare these IOUs illegal, and sent Baker, Wells and Bancroft – now reduced to the role of mere henchmen – out to find and destroy the IOU’s wherever they located them. But this solution was impractical. The three henchmen could never locate more than a fraction of the IOU’s. And in any case the popular resistance to this draconian step was fierce. The fact is that people always desire to save some portion of whatever they possess or have earned that is of value, and to convert saved value into a stable medium that they can hold until they are ready to exchange that medium for something else. And if their saving desires cannot be met in conventional ways, they will find some other ways to meet them.

As people moved away from Abbie’s dollars by fits and starts, and as confusion reigned, the value of these dollars vacillated wildly. Abbie could see that the deflationary pressure caused by the fact that the quantity of dollars was rapidly shrinking was doing battle everyday with the inflationary pressure caused by the fact that people were moving to IOUs and exhibiting less demand for the dollars themselves. The monetary situation was now highly volatile, unpredictable and unstable, and economic activity was suffering tremendously as a result.

Abbie was alarmed by the chaos, and realized she was losing control of the situation utterly. She initially concluded that she would have to restore the negative interest loans so that she could inject money into the town’s economy to offset the money that was being drained away by the holding fees. But as soon as she reached that conclusion she realized that she had put herself back in a situation that was eerily similar to the situation she had been in when she was charging Baker, Wells and Bancroft both a negative interest rate and a holding fee at the same time. Either the overall effect of the two rates amounted to charging negative interest for money or the overall effect amounted to charging positive interest for money. If she offset the bad effects of the holding fee entirely, she would be back in a situation in which she was giving money to the townspeople rather than taking it away. And when that was going on, the townspeople had responded by not spending rapidly, but by paying off their debts.

The only solution appeared to be to do something about those debts, as Carlie had suggested. But that solution was very radical, and Abbie was determined not to do anything that would set a dangerous and disruptive precedent by interfering with the iron laws of property and contracts. Like all of those in the town who possessed a great deal of property, Abbie had been raised to regard property rights and institutions as sacred boundaries in an inviolable natural order. She dared not interfere with these boundaries.

Abbie decided that a better approach would be to do something about the debts indirectly. She would turn her policies around in precisely the opposite direction. She would flood the town with money by offering the negative interest loans once again, and cancel the holding fees. As the supply of money increased, she surmised, so should prices. As prices went up, the town’s workers would press for higher monetary wages. And as their wages went up, it would become very easy for the townsfolk to pay off their debts.

Abbie also realized that to stabilize the currency, she needed to rely on the ancient practice of using the tax code to support the value of the currency. She had the mayor push through a town income tax that could only be paid with the official town dollars that Abbie issued. Since the townspeople could not pay their taxes with the unofficial IOUs or with real goods and services, the imposition of the tax caused an immediate surge in the demand for dollars, and people quickly began to move savings out of the IOU’s and back into dollars. If Abbie had still been inflicting the draconian holding fee on dollars, then the imposition of the tax would have been the last straw for the town. But now that she was augmenting monetary income once again with negative interest loans, rather than extracting monetary income via the holding fee, the tax was acceptable. People were even relived because they understood the stabilizing role the tax would play in re-establishing a single uniform currency.

So this is what Abbie tried, and it was definitely a step in the right direction. But she had failed to account for something. Many of the people in town were still unemployed. There were many fewer jobs available in the town’s businesses than there were people in town who wanted to work. So as prices on goods and services went up, wages did not go up as expected. Because so many people were unemployed, the town’s workers had no bargaining power. Businesses were happy to take the higher prices for the goods they sold while keeping their employees’ wages right where they were. If the workers complained too much, they could always be replaced with some of the unemployed who would be only too happy to take the same job at almost any wage.

So prices went up and wages stayed where they were. As a result, many people’s standards of living went down. They couldn’t afford to buy as many things as they could before, and business sales suffered. Businesses fired even more people as a result in a self-destructive cycle. Even though the proprietors of these businesses realized what was happening to them, they were trapped. All of the business people realized that they would all be better off somehow if they all hired more people and produced more things. Then many more workers would be employed and have more income, and could buy the additional goods that were produced. Since they would all then be selling more things, the increased sales would justify the costs the businesses had to incur to hire the workers in the first place. But the problem was that no single business found that it was in their interest to hire more people so long as they couldn’t be sure that all of the other businesses were doing the same thing. But in their system of private enterprise, no business had any control over what all the others would do, so they couldn’t afford to take that risk. They were mutually imprisoned by this mutual dilemma.

Needless to say, by this point the town had lost all confidence in Abbie’s management of the economy and her hidebound and paralyzing aristocratic traditions. While Abbie might have meant well initially and was willing to attempt various philanthropic maneuvers to alleviate the town’s economic problems, she was unwilling to do anything that would challenge the established social order. She was a defender of the social status quo at bottom, and it was turning out that the social status quo was bad for the town. And the worse things got, the more determined Abbie grew to control and manage everything. Nobody but Abbie was permitted to decide what the town’s economic policies would be. Increasingly, the townspeople couldn’t tolerate the situation.

What was especially frustrating to the town was Abbie’s insistence that only certain ways of attempting to influence the economic life of the town for the better were morally and socially permissible. Abbie was only willing to adjust interest rates and holding rates up and down as she deployed her money machine, but she was unwilling to use her monetary power to participate in the economy in other more direct ways to fix what was broken. Abbie struck them as something like a fussy and obsessive mechanic who, when faced with an obviously broken and damaged automobile, is only willing to drain oil or add oil to get it to run properly again, but is unwilling to put his hands into the actual machinery, get her hands dirty, and change the damaged parts.

Because they were not so bound to the incapacitating conservative traditions that Abbie venerated, the townspeople could see the fundamental problem with their town much more clearly than Abbie could. They saw that what the common people lacked was not something that could be repaired by the adjustment of borrowing rates or holding rates, or by changing the form of money first from paper to vouchers and then from vouchers to electrons. What they lacked was sufficient initial income they could spend to restart the engines of their town’s economy; and they lacked the opportunity to work and produce to build their town’s wealth and generate even more income. They began to realize that Carlie had been right when she had suggested that in order to address the problems of unemployment, Abbie should simply hire people.

One day, the townspeople en masse visited Abbie in her office. Carlie was there, along with her friends and her brother. The shopkeepers and cafe owners were there. All of the town’s unemployed were there too. Even Baker, Wells and Bancroft were there. What happened next the expunged town records do not reveal. Some say Abbie moved to another town and was never seen again; but others say Abbie changed her name and now runs one of the small cafes in town.

But what is known is that Carlie and the others took control of the town’s money machine for themselves, and from that point forward the townspeople voted together on the best ways to use the money machine. They made some mistakes, but all-in-all they did a good job with their new responsibilities. One of the things they did was to create a contingency employment plan for dealing with hard times when business was slow, incomes were down, and people were being laid off. The plan involved using the town’s money-creating power to hire the unemployed directly and invest in the town’s people and public services. They hired people to work on the parks and the roads, and to improve the schools and other town buildings. Some of the people the town hired were paid to teach others in the town the things they had learned how to do in their previous jobs; and some were even paid to learn these skills from others so they could move into new lines of work that were more in demand by local businesses.

Prices sometimes rose a bit due to the money printing, but not that much because the spending was generating new goods and services to purchase. And because everyone was employed, business didn’t fall off much in response to the layoffs. The workers also had more bargaining power, so wages stayed high and strong while the more greedy and rapacious business owners were forced to pay themselves less. As the demand for products returned businesses would hire back people who were employed by the town; and the town was then able to decrease the number of people they employed. In the meantime, the town had accomplished a large amount of needed public work that could be attended to best during the downturns. The later downturns in the town’s economy were also much milder, and didn’t last as long.

Perhaps the most important change was in the morale of the townspeople. Things didn’t always go well for them, but the people took heart from the fact that they were now governing their own community, rather than being governed by others in a system characterized by secrecy, hierarchy and unaccountability. When they disagreed, they fought it out in public debate and made a decision, which they then knew was their decision, not the decision of an aloof ruler whose goals and values were not their goals and values.

The town got back to work, and put the chaotic years of deep economic downturns and aristocratic misrule behind them. And if they didn’t exactly live happily ever after, they did live happily most of the time.


[The ideas for this story came from a long discussion at Steve Randy Waldman’s blog Interfludity of negative interest rate proposals. The proposals had been discussed earlier by Matt Yglesias and Ryan Avent. Special thanks are due to the commenters known as “K” and “JW Mason” for a long and stimulating discussion. The subject of negative interest rates has also been discussed here by Scott Fullwiler in two July, 2009 posts at New Economic Perspectives, but with a somewhat different focus. In those posts the topic was the money multiplier and proposals to boost lending by charging a penalty rate on excess reserves. Fullwiler thoroughly critiques these proposals and the classical money multiplier from an MMT perspective.]

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  1. craazyman

    Jesus Christ this must be a bedtime story because it puts you right to sleep. Dan, dude, you’re a Class A philosopher in my book but really. I can’t read Kant either, so no worries.

    This thing is a sledgehammer. Holy Cow! This is like a speech by Hugo Chavez. This is like reading the terms and conditions on your software license that you “Accept”. This is like an insurance policy statement of benefits.

    What if the low-life bankers lent money to Carlie, even at a negative spread, and she used it make apple pies they ate once a week? And then she expanded to peach danishes and coffee. Soon they were at her factory lending her more money. And she wasn’t on the street prostituting herself.

    None of these dudes knows what money is and neither does Abbie the Bimbo. She probly studied art history at Wellesly for God’s sake.

    If Carlie goes bankrupt, everybody goes bankrupt, in the end. If a clod be washed away by the sea, Europe is the less. If you screw your neighbor you’ll see a turd on your porch the next morning, or worse. Much worse. It’s all either up or down. And money is only the wake of the wind from it’s moving.

    1. Literary Critic

      I don’t know about you, craazy, but I always thought it immensely funny that economists were deathly afraid of negative numbers. That’s cause in engineering we worked with the entire range of real numbers all the time. (I’ll not mention imaginary numbers)

      So I always thought of a negative growth number as nature’s way of breathing.

      Now that I hear negative interest rates are even under discussion, I am scared to death of negative numbers.

      A few years ago, they even figured out a way around the zero bound using all positive numbers. They all contemplated their empirically derived Taylor Rules and concluded that you could get to the negative interest rate part of the graph which had the extrapolated line showing that the output gap (and by association – unemployment) closed. They simulated it with large amounts QE.

      Now I’m of scared of positive numbers.

      Next up is inflation targeting or nominal GDP targeting. Apparently they decided that the price of money doesn’t work, so volume of money is the way to go. (haven’t I heard that the other way around, in the distant past?)

      Now I’m scared of infinity.

      I’m seriously considering getting a student loan and going back to college for an art major or something so I can get this number stuff out of my head.

      1. Dan Pennell


        Yes, it was long but it was worth it. Great read.

        Making my middle schooler read it.

        Well done.

      2. Bill the Psychologist

        “(I’ll not mention imaginary numbers)”

        I’ve always been partial to the Transcendentals myself…..

    2. Dan Kervick

      Yeah, sorry about the length. I don’t know what came over me. I’ll try for shorter next time – really!

      Maybe print it out and save it for a train commute? Beats spreadsheets at least!

      1. YankeeFrank

        Screw that. This is an incredible piece. It shows in a way almost anyone could understand how screwed up our system is, and why, and what we should be doing to fix it. Thank you Dan.

      2. darms

        Seemed like a good idea at the time but you lost me at about halfway through – I’m a fast reader, too…
        Could you give us a summary?

        1. Dan Kervick

          Sure darms. I think this captures it:

          The zero bound is real.

          The Fed can’t engineer negative interest rates on either loans or deposits in the commercial banking system without, in effect, taking over the system completely and forcing banks to institute negative rates.

          Even if the Fed could engineer negative commercial interest rates on deposit balances, the effects would be unpredictable and best, and more likely harmful – as well as politically intolerable.

          The best way to get more spending in our stagnant economy is not to use monetary tricks to get struggling people to spend more and save less of their inadequate income. The best approach is to get people more income.

        2. Literary Critic

          Summarizing misses the point. It an exhaustive description of how exactly “bank intermediation” won’t work the way anyone besides banks would want it to work if banks don’t want to do it that way.

          Ergo, since the Fed works thru banks, nothing the Fed does will work.

          Which is why the Fed should have their full employment mandate taken away and just let them worry about stable money. Then Congress would have to respond to pressure – rather than bag off on the Fed all the time.

          I would go farther than that too. Make QE illegal – only allow the Fed to do FOMC ops with short term T-Bills – which is the way the used to do monetary policy. Require full disclosure on the emergency loan programs to banks would be another. Then, being a retired saver too young for SS, I think a legal minimum Fed funds rate of 2% is a good idea – one way to get the banks to spread the wealth around instead of getting the entire country’s savings for free.

          Then there should be some way we can make the Fed worry more about regulating TBTFs and maybe a little less about deflation and unemployment. If they did more of the former we would have less of the latter.

          1. nonclassical

            well said, LC…

            but, isn’t the result of such, that the FED actually raises interest rates, making
            U.S. debt unsustainable, and south america-1980’s like IMF intervention=”austerity” inevitable?…need to read “Confessions Of An Economic Hit Man” if anyone thinks IMF intervention is a good idea…

          2. Literary Critic

            All short term, low risk paper moves with the Fed fund rate – savings, checking accounts, money markets and of course t-bills.

            Whether longer term treasuries go up depends on other factors too, and could go up even if the Fed tries to peg short rates at zero.

            I’m just making a plug for savers here. We have been the goto people to solve the world’s problems since at least the year 2000. Without looking up the data, I’m pretty sure there have only been about 3 years since 2000 that real, short rates have been slightly in positive territory. The Fed has committed to ZIRP thru end of 2014 minimum. That is 14 years with only 3 in positive territory!!! Too many lumps for savers to bear. Someone else’s turn, methinks.

            Not to mention that ZIRP-QE distorts all “asset” values to the high side (commodities are assets too) so risk investors can loose their shirt eventually too.

            Course after blowing up parts of the world with rapid and large interest rates increases back in 1994, Greenspan concluded raising rates is best done slowly.

  2. Kukulkan

    A month passed, during which time Abbie congratulated herself on the ingenious beneficence of her plan. The town was surely blessed to be guided by enlightened aristocrats like her, with advanced ideas about the proper role of money in society. One month later, Baker returned to her office, and repaid the $9,500 he owed. “Outstanding,” Abbie said, “and how much did you lend to Carlie?”

    “Nothing,” Baker replied. “Why should I have loaned any money to Carlie?”

    “That was the whole point,” Abbie said, with a touch of aristocratic pique in her voice. “You could have loaned Carlie money at negative interest, just like I did for you, and still have made a profit. If you had loaned at -4%, you still would have made $100.”

    May I suggest that what Abby should have done at this point is, when Baker, Wells and Bancroft showed up to borrow their $10,000 for the next month, is invite the three of them into her office, explained to them that the loans were for the specific purpose of enabling them to make loans to Carlie and the the other townspeople. Then she should have given $10,000 to Wells and Bancroft and nothing to Baker, explaining that since he wasn’t making any loans, he obviously didn’t need it. Then sent the three of them on their way.

    If Baker wanted to get back in getting-money-from-Abbie business, he’d have to start making loans to Carlie and others. If he asked where he was supposed to get the money to loan, well, he had the $500 from the first month of negative interest.

    That way, Abbie would have practiced a little divide and rule — which is how aristocrats retain power — rather than allowing Baker, Wells and Bancroft to effectively combine and collude against her. Even though Abbie seemed to remain in charge, they were the ones in control from that point on since she was bound by how they chose to interpret her various new rules.

    Alternately, she could have hired Carrie’s brother Dave to go around and have a bit of a “talk” with Baker, explaining to him that when Abbie suggests the money she gave him was so he could lend it to Carrie, it was a polite way of saying he better lend at least some of it to Carrie. A couple of broken kneecaps would clarify Baker’s understanding of the situation pretty quickly. That’s another way aristocrats retain power — they have a monopoly on the use of violence and aren’t afraid to exercise it. Given Abbie’s ingenuity in coming up with complex schemes, I’m sure she could have come up with some legal rationale for what happened to Baker, but I think Baker, Wells and Bancroft would all have gotten the real message. I’m sure that’s what Abbie’s ancestors would have done, otherwise Abbie wouldn’t be in the position she was.

    Baker, Wells and Bancroft are basically bagmen for Abbie and they obviously need to be reminded who they work for and what the conditions of their continued employment are. Abbie could be either nice or nasty about it, but she needed to remind them. She didn’t. Everything else flowed from that.

    Finally, Abbie could have just hired Carrie to count her money or tend her garden or to act as receptionist when Baker, Wells and Bancroft showed up to collect their money and bypassed Baker, Wells and Bancroft having to lend money entirely. Given that Abbie does just hire Baker, Wells and Bancroft later in the story, there’s apparently nothing in the town ordinances to prevent that.

    Of course, any of these responses would have avoided the complexities of the holding boxes and vouchers and other such things, which would have voided most of the story, but I really can’t see why that would be a bad thing.

    1. Dan Kervick

      Yep, there are all sorts of ways Abbie can loan at negative interest to Carlie if she basically takes charge of the banking system, and tells people what to do. But as long as she permits the lending to be intermediated by independent profit-seekers, it seems to me the zero bound is a real barrier.

      Of course once she does take over, that turns out to be no picnic for the town either.

      Nothing gets fixed until they take over their own financial system.

    1. Literary Critic

      You mean the part about our “Global Village” voting on how we use our printing machine?

      Well, sort of, but maybe not.

  3. Jim

    Well, Argentines started to barter with each other and states began to issue their own scrip to pay workers – all this as the hardliners in the Argentine insisted on the US dollar peg and disregarded the resulting deflation.

    Finally, the people overthrew the government (four presidents within one week) and put in place a center-left president.


    Argentina grew more over the last decade, in real terms, than any other country in Latin America.

    P.S. Well done. Long, but worth reading.

    1. Dan Kervick

      Some would no doubt choose the extra water-boarding if offered the option. But maybe there are a few philo-economists in the group.

  4. Joe Buck

    Krugman has made a similar point, though in a less entertaining way: “you can’t push a rope”. The traditional tricks the Fed has used to manage the money supply don’t work when the interest rate approaches zero, for the reasons described: a banker isn’t going to charge negative interest even if given money at negative interest rates.

    Seems we need to create some inflation.

    1. Jim

      Inflation would work with stronger unions. Private sector unions are too weak, so all inflation would accomplish is a SIGNIFICANT decline in real wages.

      We don’t need inflation. We need an expansionary fiscal policy featuring a PERMANENT increase in the Earned Income Tax Credit of 4K per person.

      1. Dan Kervick

        Agreed. Why don’t the economists just call for the public sector to pick up the ball the broken down private sector has so obviously and laughably dropped, instead of spending so much time thinking about complicated monetary bankshots to re-jigger a broken system?

        We have unused human and material resources galore. People want government to do something? Stop praying for a Ben Bernanke rain dance. Buy things, hire people, make stuff.

        1. nonclassical


          …because fundamentalists have so demonized public sector funding…

        2. Ian Ollmann

          And the Austerians are obsessed with public sector debt. As a point of fact, private sector employment growth is back to pre-crash rates. The problem right now is it is being offset by contraction in public sector employment.


          If the public sector saw fit to mirror private sector growth with its own growth, then the unemployment situation would be sorting itself out double-time.

          So, yes, the government should fix unemployment, in part, by making a point of hiring people.

  5. Crazy Horse

    I think this tale could benefit from Occam’s Razor.

    Given a finite population size— you know, that nasty food and energy problem:

    Given the capitalist system imperative of growth or death by competition:

    Given a financial system that reaps its rewards by lending money at interest thus creating a system that structurally requires exponential growth:

    Said financial system will INEVITABLY increase the amount of debt in the system until it reaches the point where borrowers can no longer pay the interest on their indebtedness.

    Somehow I don’t think the end game will be Ben Bernanke retiring to run a coffee shop and everybody living happily ever after.

  6. Paul Tioxon

    You know what the problem is, the numbers used in economics are outside of any thing known in the universe, much less the real, everyday economy. Feynman said this about economics, when discussing the federal deficit, and talking about billions of dollars, the term astronomic really is not appropriate. Why? Because the numbers in astrophysics, in contemplating the number of stars on the galaxay, he was only using 10 to the power expressing 100 billion stars. That was the known estimate of stars in the galaxy. And the federal deficit was using numbers that far exceeded the largest measurement of celestial bodies. Now, we have gone onto a 10s of $TRILLIONS of dollars in discussing the deficits, public and private. And of course, in discussion of the fictitious world of derivatives and credit default swaps, we are in la la land of upwards of 600 TRILLION. Feynman believes that in referring to something on a wholly new scale of gigantitude that we should no longer refer to it as astronomical but rather economic in size. I concur.

    1. nonclassical


      I’m even seeing the terminology, $1.2 quadrillion…how the hell much is that?

    2. Ian Ollmann

      The magnitude of the number is merely a reflection of the value of the base unit, which is arbitrary. We could revalue the dollar by 1,000,000 to 1 and your point would fall, but nothing much would have changed except that people would be looking for ways to pay in fractions of a penny.

  7. Bryan Willman

    And, in the real world, were only members of Public Employee Unions and Certified Somethings can work on town contracts, where only Certified Teachers can be allowed to teach anything, all of that “spending on the unemployed” is actually “spending on Abbie’s cronys”.

    Not to say that actual employment of the actual unemployed to do things in actual need of doing wouldn’t sometimes help. But Greece, Italy, etc. show where this actually leads in the real world. And hiring unemployed people to be thugs who hassle other people is an old and oft tried plan which doesn’t fix things either.

    The established order isn’t about Abbie, it’s about the 60% or so of the townsfolks who are NOT unemployed, poor, or bankers, and who have great interest in the status quo.

  8. Jack M.Hoff

    I doubt inflation is needed. What is needed is deflation with EVERYBODY being deflated by the same percentage. Debts included. Its the extraordinary income differential that screws everything up. Get all the numbers closer to zero and the economy would surely improve. Then implement a tax system that simply takes away anything over a certain predetermined income differential. No fucking exceptions.

    1. chitown2020

      Inflation is massive now. The FED is masking it. They are bankrupting us under the radar. CONgress is doing this from behind the scenes. They are traitors from within …CONgress tells the FED what to do.

      1. chitown2020

        …….and CONgress tells Obama what to do. Nothing gets to Obama without their approval. CONgress and The Senate have been infiltrated by our enemies for decades. The robbery of our wealth has emboldened them. They want our National Sovereignty and to microchip us to the quadrillion dollars in fraud created by their perps at the FED. In case you missed the last hearing with Congress and Bernanke….Bernanke told CONgress that if they don’t like FED policy they are who created the FED and they can draw up a mandate to abolish the FED. The hens and the foxes are trying to outsmart us. They are all a fraud. The healthcare plan and the gold backed dollar will be their final act of treason against us. That will usher in the microchip and end our freedom, independence and our National Sovereignty. Beware of the deceivers. If you don’t know who your enemy is you cant win the war.

  9. Derryl Hermanutz

    Crazy is right,
    “Said financial system will INEVITABLY increase the amount of debt in the system until it reaches the point where borrowers can no longer pay the interest on their indebtedness.”

    We have a problem of monetary arithmetic, and the only possible solution is being prevented by plutocrat morality. Our money system issues money to “the townsfolk” as loans at interest, so that the town always has to repay MORE money than the amount that was issued. Unless new borrowers continuallly borrow and spens new money into this equation, the town’s past borrowers will find there is simply not enough money in their economy for all of them to repay their loan principal (which is ALL the money that was issued into circulation) AND somehow conjure additional money to pay the interest. Even if the money was issued as zero interest loans, people save some of their income, which removes that money from the spensing-income stream, so borrowers have no chance to earn their spent loans back out of the economy. The only solution that can work, acknowledging the simple arithmetic of this money equation, is for SOMEBODY to add additional non-debt money into the town’s income stream. That additional money can be spent to replace money that is saved, and it can be used to pay interest. As it stands, savings and interest payments reduce the town’s circulating money supply and the only thing keeping the negative arithmetic system going is exponential new debt-money being spent into the system. But the town won’t take on more debt, so it’s either deflationary collapse or Abbie starts helicopter dropping money directly to the townsfolk, NOT to the town’s bankers.

    1. Dan Kervick

      Just like in real life, my eyes kinda glazed over during the middle, confusing, complicated part, even though I understood the general principle it was demonstrating, i.e., no way this is gonna work :)

      Sounds like the typical State of the Union speech!

  10. JCC

    Great Fable, and the length only added to it all! Just like in real life, my eyes kinda glazed over during the middle, confusing, complicated part, even though I understood the general principle it was demonstrating, i.e., no way this is gonna work :)

    1. Dan Kervick

      Just like in real life, my eyes kinda glazed over during the middle, confusing, complicated part, even though I understood the general principle it was demonstrating, i.e., no way this is gonna work :)

      Sounds like the typical State of the Union speech!

  11. chitown2020

    All that we really need to know is that the FED has robbed us and transferred most of our wealth overseas. The Politicians are ALL TRAITORS who allowed this. The FED fully intends on bankrupting us and stealing all of our wealth, freedom, independence and our National Sovereignty and microchipping all of us to their unsustainable debt fraud for their owners at the World Bank. This is the plan of the psychopaths who have hijacked the world. They have for decades used secrets, lies and mass deception to defraud us out of everything. There is no logic here, just clinical psychosis.

  12. Miguel Jones

    Go public Banking. Jubilee! How do we do it? We cut out the middleman! Fiscal and monetary policy that actually makes sense for all of us instead of just those with extensive holdings? It could happen. I think the turning of the worm will eventually happen, probably after much human suffering, and exceedingly, excruciatingly slowly. Not a bad allegory Dan. Sooner or later we’ll have to shake off the orthodoxy of our monetary status quo. It’ll be a bit harder when moneyed interests control the election process, so I think that changing that paradigm will necessarily be a precurser to the reimagining of money and its creation/management that you describe. So the question is how can we best facilitate the gestation of these ideas? Just keep telling your story. Sooner or later it will either sink in, or we’ll get around to trying it after we’ve exhausted all other avenues of approach.

  13. Kevin de Bruxelles

    But Carlie’s town did not live in isolation. In fact there were several other towns, much poorer towns, in the vicinity. One of the reasons for Carlie’s economic problems is that Diego and Esperanza and their friends were moving into Carlie’s town and agreeing to work for much lower wages than the local’s would work for. Diego and Esperanza meant no harm; to them they were getting paid much more than back in their poor towns. The rich people of Carlie’s town pretended to not be happy about Diego and Esperanza but in truth they were very, very excited to have these new people work even harder than the locals for much less money. Soon many of the original people of Carlie’s town started to see certain jobs as beneath their dignity to perform.

    So when Carlie’s town decided to make a job for everyone, they were forced to decide who “everyone” consisted of. Would these jobs be open to Diego’s and Esperanza’s friends back in the neighbouring poor towns? And if not how would they stop them from coming? Some argued that if these jobs were open to all then they would serve as a magnet and a flood of cheap labor would wash over Carlie’s town. Others argued it was racist to even ask the question and tried to shut down the discussion. But was Carlie’s printing press really strong enough to support all these people. And wouldn’t this flood of poor people really mean that Carlie’s town would in a very short period of time be just as poor as all the neighbouring towns?

    1. Kevin de Bruxelles

      No Carlie’s town did not live in isolation. The other, even more important problem her town faced was that most of the town’s factory owners had stopped making their products in Carlie’s town. And this made many of Carlie’s friends unemployed. No, the factory owners preferred to build their products in Fong’s huge town, which many years ago used to be the richest town in the world but was now among the poorest – and largest. Now sure, the products may have cost a little less since Fong’s people were only paid a tiny pittance compared to what Carlie’s friends used to get paid. But after a while, when Carlie’s friends no longer had jobs, they couldn’t afford to buy these cheap trinkets in any case.

      So when Carlie and her friends got the idea to only gain sovereignty over the town’s printing press, others, especially Marine, asked if this was coherent given the other two problems (jobs going to other towns and other towns coming to take the existing jobs). While she certainly agreed with gaining sovereignty over the printing press, Marine also supported gaining sovereignty over the town’s borders and the town’s trading policy. Marine wanted to protect the town from unfair trade with poorer towns. Marine knew that if they ran the printing presses without stopping unfair trade and without securing their borders, then most of the newly printed money would just go to Fong’s friends who made the products and most of the jobs would go to Diego and Esperanza’s friends who worked cheaply. She saw Carlie’s emphasis on monetary sovereignty as a “nationalist” policy in a “globalist” context but wanted to go further in the nationalist direction.

      But Carlie was scared by the word “nationalist” and besides Marine’s father was a really bad man. Also, Carlie’s town was dominated by two High Priests named Paul and Randy. Now these two priests and their different groups of disciples didn’t agree on everything, but the two things they did agree on was that stopping unfair trade and securing their borders with poorer towns was not compatible with their sacred texts. So Carlie called Marine a heretic and continued to try to convince people that currency sovereignty is important but trade and immigration policy are not.

      1. Aquifer

        Well, methinks you have looked at half the problem – but the other half is that the reason there were much poorer towns in the vicinity is that Abbie had forced them into trade agreements that screwed their local economies, impoverishing them and making it impossible for their residents to make a decent living in their own towns – those residents had little choice but to migrate to Abbie’s town.

        If Abbie’s town had policies that helped the neighboring towns to themselves be self sufficient, folks wouldn’t feel compelled to move. “Protecting borders” is a losing proposition when the pressure for migration comes from basic instinct for survival …

        So protecting borders from cheap imports is one thing, “protecting” them from hungry people is quite another ….

        1. Kevin de Bruxelles

          Thanks for you reply. Remember we are discussing borders in the context of a Guaranteed Job proposal. So you seem to agree that indeed if Carlie grabbed control of the printing presses started handing out jobs to everyone then all the poor people from any other town would be able to get one of those jobs due to open borders and Abbie-guilt.

          Do you see this as anywhere near sustainable? The more money printed, the more poor people come in to take jobs, the further the native residents are from ever regaining their former standard of living. The only way this ends is when Carlie’s town is as poor as the neighbouring towns. Remember recently there has been an outflow of migrants from Abbie’s town. Where would these new people live, in the working class areas?

          Do you see how this Job Guarantee idea without sovereignty over both trade and borders is going to be a pretty hard sell to working class people? What working class people want an answer to is how first world countries can maintain their higher standard of living over second and third world countries.

    2. Jack Parsons

      Well, actually, no, Diego and Esperanza were out of work as well. Instead of sending money to the neighboring towns, suddenly the neighboring towns sent them money.

      Even worse, Diego and Esperanza were paying taxes under assumed names, along with the real people with those names. When D & E lost work, the tax income dropped even faster than anyone expected, because they didn’t count D&E.

    3. Peripheral Visionary

      And then Carlie just decided to ignore all those problems, and just print all the money anyway, because her friend Kraig told her to do so, and he had won an award once so she trusted him. So she printed the money, then the people of the town figured out that the money was worthless because she was just going to keep printing it.

      So, with worthless money and all the jobs going to people from the other towns who would work for less, the people of the town gave up on it and moved somewhere else.

      The End.

  14. Obey von Dag

    Nicely done Dan!

    What you’re suggesting at the end is in effect a kind of indirect tax on savings in order to boost aggregate demand.

    So why not just … have a DIRECT tax on savings?

    That way people would be incentivized to boost spending. Of course that wouldn’t involve the Fed so much. It would be basic fiscal policy. And the indirect tax you suggest would not be very progressive – the poor would pay the same ‘tax rate’ (at the same savings rate). So that counts against it. Much as does the sheer complexity and cost of such an Yglesias-ed electronic currency system.

    So my simple solution to the zero-bound issue:
    have automatic adjustments in the ratio of income tax to savings tax as interest rates rise and fall: raise the income tax (and cut the savings tax) when interest rates rise, and cut income tax (and raise the savings tax) when interest rates fall.

    And make the savings tax progressive – say, kicking in at savings of over 50’000 a year.

    What d’ya think, brainiac?

    1. Dan Kervick

      Actually, I thought I was arguing against the Yglesias-style tax on savings. Yglesias seems to think the problem is that people generally are saving too much out of their incomes, and devoting too much of their income to paying down debt. He wants to force them to spend more, and his ideas about negative interest rates (taxing savings) are part of that approach.

      I think the problem is that most people don’t have enough real income: their desire to save more and pay down debt out of savings is completely rational, but they can’t collectively sustain previous levels of consumption and employment in conjunction with those savings desires. Since debts are denominated in nominal terms – quantities of dollars – the role of government in this situation is to get people more nominal income by extending the deficit. We could also use more selective taxes that shift wealth from those with a high propensity to save and high positive stocks of savings to those with a higher propensity to consume and a deeper stock of debt.

  15. reslez

    The story seemed to say that banks lend out savings, meaning once they have people’s savings deposited with them they go out and make loans. This isn’t true, so I stopped reading there. In the real world, banks lend first and attract deposits later. Banks aren’t reserve constrained, they’re capital constrained.

    This is clearly a fairy story and therefore of dubious value.

    1. Dan Kervick

      No, I don’t think there was any suggestion that bank lending is constrained by savings. The MMT view is that bank lending is driven by the demand for borrowing at the prevailing interest rate. Banks do have to acquire additional reserves as their loans and deposit balances increase, but can always acquire those reserves after making the loans. Central bank policy only has an impact on lending to the extent it that it influences the price of reserves. It adjusts this price by setting and hitting a target Fed Funds rate.

      But attracting additional deposits is one way a bank can accumulate additional reserves, and they will prefer to acquire the reserves in that manner – rather than through interbank borrowing – if the price they pay for the deposited sums is less than the amount paid for Fed Funds.

  16. joebhed

    Nice try, Dan.
    Lots to think about.
    And we recognize the truthiness in there which is that under a debt-saturated national economy, and continued utilization of a debt-based money system, there is really no way out. That system itself is insolvent.

    For all those who would like for the Restovus to now get hold of OUR OWN MONEY SYSTEM (printing press), please have a gander at Dennis Kucinich’s proposal for exactly that solution.

    And tell us why that will not work.

    For the Money System Common.

  17. craazyman

    I need to try to read this when I’m sober. Last night was too crazy after half a bottle of wine and trying to kick the Xanax habit. I kept losing my place. and freaked out.

    Lots of good stuff in here if my mind is calm. This could be edited into a financial/philosphical dialogue but probably 3000 words for a blog post is pushing it and this was 8191. Even F. Scott Fitzergald savagely edited himself, but it’s hard to do, I understand.

    But I bet lots of banks already lend at negative rates just to get juicier profits from other services. so if Carlie can avoid prostitution and start a pastry and coffee restaurant chain and go public, then the story could have a happy ending even without money printing to the moon.

    Of course, who’d buy her pastries if everyone is broke and in debt? I see the problem and the solution proposed. Why not? If you’re broke and in debt it can’t get much worse and if you have loads of cash, then you don’t need to worry either.

  18. hermanas

    Seems to me, interest rates set the tempo to the musical chair game and everyone’s not playing to the same tune.

  19. pws

    It helps if you imagine Abbie in the above story being played by Imelda Staunton (in a manner similar to the way she played Dolores Umbridge in the Harry Potter movies).

    1. craazyman

      I didn’t see that one but I kept thinking of the Merchant Ivory films.

      The Abbie/Carrie relationship could be a good character study.

      Abbie starts out as a properly refined philanthropist and supporter of arts who fancies herself a humanitarian and liberal — but as her finances deteriorate she gets nasty and short-tempered, seeing Carrie less as an equal and more as a repulsive object to be monetized — eventually pimping her out to upper-class businessmen and feeling as if she’s doing Carrie a favor by providing her with business opportunities when so many are much less fortunate.

      I see Carrie as a — get ready for the trip into the past — a Judy Garland type. It would take an extraordinary actress to convey the pathos of being Carrie, although I’m sure being Abbie would be a slam dunk for most Hollywood starlets. haha

      1. Dan Kervick

        Old school: I thought maybe Katherine Hepburn as Abbie; Donna Reed as Carlie.

        1. craazyman

          LOL YeAH I could see Hepburn for sure. Too much fun for a workday . . .

          The Impenetrable Bound

          Scene 3
          Empty cafe in early afternoon.
          Abbie & Carlie alone at table near the back wall

          Abbie: “Carlie I have a gentleman for you. Tomorrow at 3 p.m. It’s Mr. Long from the lumberyard, I think you know him.”

          Carlie: “How much is this one? May I ask?”

          Abbie: “$300. One hour.”

          Carlie: “And you? How much for you?”

          Abbie: “That’s none of your business! Why do you have to ask such questions? Can’t you see I’m helping you? Where can someone like — someone in your position get this kind of money? Without me you’d be on the street begging.”

          Carlie: “Someone . . . like? Someone like me, you mean? And what I’m I like, exactly? Tell me.”

          Abbie: “Please darling, don’t be sentimental. Things have changed and you know damn well there’s no more money for handouts. It’s only an hour. There is no alternative. Don’t you understand! There is no alternative!”

          Carlie: “What do you know about alternatives? You’ve lived your whole life in a womb of money. Why don’t you go tomorrow, at 3 pm., and you see what it’s like. You see and then you tell me what I am and you’ll see you’re just the same, but you have more money. That’s all.”

          Abbie: “You little bitch! I used to look out for you like a daughter and shared what I had when I had it. Now I’m sharing the only way I can. And you. You have one chance. Right now. Yes or no. Tomorrow at 3?”

          Carlie: “Yes” (starts crying)

          Do you think Abbie will ever believe in MMT? :)

  20. Max424

    “Yglesias seems to think the problem is that people generally are saving too much out of their incomes, and devoting too much of their income to paying down debt. He wants to force them to spend more …”

    Not only are Ameri/Consumers suddenly saving too much, but they’re no longer adding on to their massive debt load at an electrifying rate.*

    Demand mad Matty Y thinks this is bad.

    No doubt Yggles will put up a another digital money/negative interest rate post over at Slate, in reply.

    Matt’s new idea is that digital money will eliminate most black market crimes –without cash, it’s hard to perform illegal drug transactions on a street corner. That type of thing.

    Of course, as always, Matty is focusing on paper billions, while someone else is stealing the digital trillions.

    *Except for students. Student loan debt is set to double over the next 4 years, reach $2 trillion in 2016. That is a good thing, in neo-liberal MattyLand.

    Two birds, one stone. Debt serfs get an education, allowing them to better compete in a hostile global environment, while banks finally get their Dream Bubble, a bubble that never pops.

    1. hermanas

      It’d be nice to have a legality chart of (aborgation of contracts), who wins and who looses.

  21. Aquifer

    Hmmmm, sounds a lot like the Green New Deal proposal, with the added benefit that the Town can help stop the floods/droughts that wipe out the local businesses and farmers crops ….


  22. Tim

    Root Cause:
    “But in accordance with the ancient and venerable laws of the town, enacted to maintain a decorous distance between the aristocrats and common people, Abbie was forbidden from loaning money directly to Carlie.”

    Because of that constraint Abbie started doing stupid things to fix Carlie’s deteriorating condition.

  23. Tim

    The zero bound on interest rates wasn’t presented completely true.

    You could influence borrowing all the way down until the end borrower was paying slightly more than zero percent to make it worth the banker’s while. So if I can get a 10 year loan at 3 percent today, when the fed rate is at zero, then if the fed rate went to -3 percent then the bank would be willing to lend to me as long as I paid .1 percent interest which may influence my decision to take on a loan that I would otherwise not take on.

  24. Tim

    Can anybody explain to me how a corrupted government overseeing 350 million people has a fighting chance to efficiently impement MMT?

    Seriously. In a town of 200 people it would be hard, and maybe you could see a monetary efficiency of 80% but for our government and scale? Our current state is 2.5 dollars of debt is preciding over 1 dollar of GDP growth and that could just be correlation, not causation.

    Again MMT is an okay kickstart, merely a better execution of what is already being done that is not working well if at all. A comprehensive solution must also include partial default and gradual implementation of austerity until receipts equal expenditures, then create an airtight balanced budget only to be overriden by war fought to defend from invaders.

    1. Ian Ollmann

      I see no justification or even the hint of requirement for austerity or balanced budgets in the article or the current situation. Where in the world did that come from?

  25. Tim

    Appreciate the narative though. Very good at walking through the macro dynamics, and not easy to do at all. Thanks!

    1. chitown2020

      Secrets, lies and deception is how they defraud us. They tell you lies as facts. Their only power is in what they can make us believe.

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