Paying interest on cash

Freigeld, or stamp scrip, is designed to pay negative interest, but it can be re-purposed to pay positive interest.

Remember when global interest rates were plunging to zero and all everyone wanted to talk about was how to set a negative interest rate on cash? Now that interest rates around the world are rising again, here's that same idea in reverse: what about finally paying positive interest rates on cash? I'm going to explore three ways of doing this. As for why we'd want to pay interest on cash, I'll leave that question till the end.

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The first way to pay interest on cash is to use stamping. Each Friday, the owner of a bill—say a $50 note—can bring it in to a bank to be officially stamped. The stamp represents an interest payment due to the owner. When the owner is ready to collect his interest, he deposits the note at the bank. For example, say that 52 weeks have passed and 52 stamps are present on the $50 note. If the interest rate on cash is 5%, then the banknote owner is due to receive $2.50 in interest.

Alternatively the note owner can collect the interest by spending the $50 note, say at a local grocery store. The checkout clerk will count the number of stamps, or interest due, and tack that on to the face value of the note. With 52 stamps, the owner of a $50 note should be able to buy $52.50 worth of groceries, not $50. After all, the store has the right to bring the $50 note to its bank and collect the $2.50 in interest for itself.

Stamped currency seems like a pretty big hassle to me. The clerk behind the counter must count out the stamps on the note by hand, and the owner of the note has to trek back and forth to the bank each week to get the stamp affixed. Instead, imagine that each banknote has a magnetic strip that records how long the bill had been in circulation. This would remove some of these hassles. Weekly trips to the bank for stamping would no longer be necessary, and a note reader installed at a bank or retailer would automatically record how much interest was due, precluding painstaking counting of stamps.

"They use this magnetic strip to track you." says Byers to Agent Scully, The X-Files

Apart from stoking conspiracy theories, there's still a major problem with a magnetic strip scheme. Because each note has entered circulation at a different time, each is entitled to a varying amounts of interest. And this means that banknotes are no longer fungible. Fungibility—the ability to cleanly interchange all members of a population—is one of the features of money that makes it so easy to use. Remove it and money becomes complicated, each piece requiring a unique and costly effort to ascertain its value.

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Our second way of paying interest on money doesn't destroy the fungibility of banknotes. The central bank needs to sever the traditional 1:1 peg between deposit money and cash, and then have cash slowly appreciate in value relative to deposits.

For instance, a central bank might start by setting an exchange rate of $1 note = $1 deposit on January 1, but on January 2 it adjusts this rate so $1 note is equal to $1.0001 deposits, and on January 3 adjust this rate to $1:$1.0002, etc. So the cash in your wallet is benefiting from capital gains. By December 31, the exchange rate will be around $1 note to $1.0365. Anyone who has held a banknote for the full year can deposit it and will have earned 3.65 cents in interest, or 3.65%. 

The major drawback with this scheme is the calculational burden imposed on the population by breaking the convenient 1:1 peg between cash and deposits. Assuming that retailers price their wares in terms of deposits, anyone who wants to pay in cash will have to make a currency conversion using that day's exchange rate. For instance, if the central bank's peg is currently being set at $1 note = $1.50 in deposits, then a popsicle that is priced at $1 will require—hmmm... let me check my calculator—$0.667 in cash. Phones will make this exchange rate calculation easy, but it is still likely to be a bit of a nuisance.

There are other hassles too. Would a capital gains tax have to be paid on the appreciation of one's cash? How would existing long-term contracts deal with the divergence? For instance, if my employer is paying me $50,000 per year, obviously I'd prefer this sum be denominated in steadily appreciating cash rather than constant deposits, and she will prefer the latter. What becomes the standard unit of account?

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The last way to pay interest (at least as far as I know) is to run lotteries based on banknote serial numbers, an idea independently proposed by Hu McCulloch and Charles Goodhart back in 1986.

It's surprisingly easy to get banknotes to pay interest. Run a lottery based on note serial numbers. Hu McCulloch dreamt this scheme up in 1986, but no central bank has ever tried it. Source: https://t.co/pUUf1liuhH pic.twitter.com/5mil9B62FN

— JP Koning (@jp_koning) January 14, 2018

Central banks would periodically hold draws entitling the winning serial numbers to large cash prizes. For example, if there was $100 billion in banknotes in circulation, the central bank could set the interest rate on cash at 5% by offering prizes over the course of the year amounting to 5% of $100 billion, or $5 billion.

This technique of paying interest on cash solves the fungibility problem that plagues the earlier stamping technique. Every note has the same chance of winning the lottery, and non-fungible winners are immediately withdrawn. And unlike the crawling peg idea, banknotes and deposits remain equal to each other so burdensome exchange rate calculations don't need to me made.

However, it introduces the threat of bank runs. The day before the big lottery is set to occur, everyone will withdraw deposits for cash so that they can compete in the draw. To prevent a bank run, it may be necessary to randomize the date of the big lottery so that no one knows when to withdraw notes, an idea proposed by Tyler Cowen. Another way to preclude bank runs is to have a regular stream of small weekly lotteries rather than one or two big ones each year.

Another drawback to note lotteries is the cost that is imposed on society by having everyone constantly checking serial numbers. As Brian Romanchuk points out, employees who are working behind their employer's tills may be tempted to switch out winning notes with losers. Employers may protect themselves by setting up scanning hardware to read in serial numbers as banknotes enter the tills, maintaining their own internal database of cash inventories so that winners can quickly be isolated and returned. But all of that is costly. Would it be worth it?

Interestingly, there is some precedent for these sorts of lotteries. In Taiwan, receipts are eligible for a receipt lottery, a neat way to incentivize people to avoid under-the-table transactions (ht Gwern). Lotteries can also be useful in attracting depositors, as outlined in this Freakonomics podcast (ht Ryan). George Selgin and William Lastrapes have gone into the idea of lottery-linked money in some detail:

Though the suggestion may appear far fetched, in many countries lotteries are presently being used with considerable success to market bank deposits. According to Mauro Guillen and Adrian Tschoegl (2002), “lottery-linked” deposit accounts have been especially popular with poorer persons, including many who might otherwise remain “outside the banking system.” ... In two popular Argentine schemes, for instance, depositors receive one ticket or chance of winning for every $200 or $250 on deposit (ibid., p. 221). Lottery-linked banknotes, in contrast, would themselves serve as tickets, allowing persons to play for as little as the value of the lowest note denomination, and with no apparent cost to themselves save that of occasionally inspecting their note holdings.

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Some readers may recognize these three techniques for paying interest on cash as the inverse of the three go-to ways of applying negative interest rates to cash being discussed a few years ago. For instance, one of the most well-known ways of imposing negative interest rates on owners of cash is to apply a Silvio Gesell style stamp scheme (see picture at top), whereby a currency owner must buy a stamp and affix it to the note in order to renew the validity of their currency each month. (I once discussed Alberta's experiment with Gesell's "shrinking money" here). Without the appropriate number of stamps, the note is illegitimate. In my first example above, Gesell's stamp tax has been re-engineered into a stamp subsidy. As for the magnetic strip modification, this is Marvin Goodfriend's 1999 update of Gesell, flipped around to award interest rather than docking it.

Miles Kimball has written extensively on escaping the zero lower bound to interest rates by setting a crawling peg on currency. But just as Kimball's crawling peg can impose a negative interest rate on banknotes, it can be used to pay interest, as I described above. Indeed, Miles (along with Ruchir Agarwal) frequently mention this possibility in his blog posts and papers (see this pdf).

Finally, remember Greg Mankiw's controversial 2009 article on imposing negative interest rates by serial number? He wrote:

Imagine that the Fed were to announce that, a year from today, it would pick a digit from zero to 9 out of a hat. All currency with a serial number ending in that digit would no longer be legal tender. Suddenly, the expected return to holding currency would become negative 10 percent.

Mankiw's idea is just the reverse of Goodhart and McCulloch's earlier lottery idea, the lottery replaced by with a demonetization.

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So why pay interest on currency? I can think of two reasons. One is based on fairness, the other on efficiency.

The decision to avoid paying the market rate of interest on currency amounts to a tax on currency users. Who pays this tax? Cash is often the only means for the poor, new immigrants, and unbanked to participate in the economy. So the tax falls on those who can least afford it. This hardly seems fair. By conducting note lotteries or stamping notes, those consigned to the cash economy can get at least the same return on banknotes as the well-off banked receive on deposits.

Now hold up JP, some you will be saying at this point. What about criminals? Yep, the other group of people who suffer from the lack of interest on banknotes are criminals and tax evaders. Rewarding them with interest hardly seems appropriate. One would hope that if central banks did adopt a mechanism for rewarding currency with interest, it would be capable of screening out bad actors. For instance, criminals may be leery of collecting their interest or lottery prize if making a claim at a bank means potentially being unmasked. Another way to set up the screen would be to pay interest or prizes on small denominations like $1-$10 notes, and not on $20s and above. Since criminal organizations prefer high denomination notes due to their compactness, they wouldn't benefit from interest.

As for the efficiency argument, this is nothing but the famous Friedman rule that I described in my previous post. All taxes impose a deadweight loss on society. When a good or service is taxed, people produce and consume less of it than the would otherwise choose, tax revenues not quite compensating for this loss. From a policy maker's perspective, the goal is to reduce deadweight loss as much as possible by selecting the best taxes.

In the case of cash, the deadweight loss comes from people holding less of it than they would otherwise prefer, incurring so-called shoe leather costs as they walk to the bank and back to avoid holding too much of the stuff. If a 0% return on cash is an inefficient form of taxation relative to other alternatives types of taxes, then it would be better for the government to just pay interest on the stuff and recoup the lost revenues elsewhere, say through consumption taxes or income taxes.

To what extent can Trump trash the dollar?

Donald Trump doesn't like the strong dollar, but is there anything he can do about it?

Last month Donald Trump told the Wall Street Journal that American companies can’t compete "because our currency is too strong. And it’s killing us...” Trump's dislike of the strong dollar doesn't surprise me. I've known a few mercantilists over the years, and all of them have always been keen on trashing their home currency, the idea being that with a weaker currency domestic manufacturers will enjoy a shot to the arm. This in turn stems from the antiquated (and very wrong) idea that manufacturing is somehow the most important activity an economy can be engaged in.

Tweeting about one's desire for a weak dollar is one thing, but are there any actual levers Trump can pull on to affect the exchange rate?

U.S. exchange rate interventions are rare these days, with only two occurring in the last twenty years. In September 2000 U.S. monetary authorities intervened with other central banks to support the euro, and in March 2011 they bought yen after the earthquake that rocked Japan on March 11. The main concern of modern central bankers is their inflation target. To hit this target, interest rates have become the preferred tool. Unlike the gold standard or Bretton Woods era, the exchange rate has little role to play in this story, either as a target of monetary policy or as a tool.

Past efforts to fiddle with the dollar's exchange rate have typically been joint affairs taken on by the Federal Reserve and the Treasury. It makes sense to have the central bank as a partner because a central banker has the ability to create as much money as necessary in order to drive the exchange rate down. If Trump were to try to go it alone, he'd first have to go through the hoops of raising taxes or issuing bonds in order to get the requisite dollars to sell, this being a much weaker lever compared to the Fed's infinitely-powerful printing presses.

If Trump were to request that the Fed weaken the dollar, could Fed Chair Janet Yellen refuse to co-operate? The Fed could certainly dig in its heels. Anna Schwartz, channelling former Fed chairman Paul Volcker, notes that "the Treasury does not have authority to instruct the Federal Reserve to spend its own money on intervention and to take the attendant risks, and that the Treasury would be reluctant to intervene over strong objections of the Federal  Reserve." This Peterson Institute publication provides an actual example of heel-digging. In 1990, most of the members of the FOMC were against continued purchases of Deutschmark and yen by George Bush, with three members voting against raising warehousing limits (see below for a description of warehousing) from $10 billion to $15 billion. While their push back wasn't enough to carry the day (the warehousing ceiling was increased), presumably it indicates that the Fed has a means for resisting Treasury demands, if not always the guts. The Fed has at times been dragged along as an "unwillingly participating" in Treasury-initiated interventions because—as Michael Bordo, Anna Schwartz, and Owen Humpage put it—appearing not to cooperate would "raise market uncertainty and could sabotage the operation's chance for success."

Given these conflicting views about the hierarchy between Fed and Treasury, when push comes to shove I don't know who would win out in a conflict between the two institutions. What seems sure is that any effort by Trump to arm twist the Fed into weakening the dollar would be controversial. If the Fed were to get its way, expect to hear outrage about the trampling of democracy by an "inbred" technocracy of academic economists. On the other hand, if Trump were to get his way he would be denounced for threatening the Fed's ability to keep inflation in check. As Goodfriend and Broaddus put it in this paper, Fed participation in Treasury-led foreign exchange operations has the potential to confuse the public as to whether monetary policy is supposed to support short-term exchange rate objectives or longer-term anti-inflationary objectives. Which is why Goodfriend and Broaddus advocate legislation that enforces a complete separation of the Fed from the Treasury's forex operations.

Let's imagine a Yellen-led Fed successfully rebuffs Trump. Does the President have any other levers to influence the dollar?

Enter the Exchange Stabilization Fund, or ESF. When the Fed and Treasury partner to intervene in foreign exchange markets, it has always been the ESF that has been responsible for the Treasury's contribution to the intervention. This obscure account, managed by the Treasury Secretary, is entirely self-funding. This means that, unlike the Treasury's other expenditures, spending from the ESF is excluded from the congressional appropriation process. Only the President, not Congress, has the authority to review the Treasury’s decisions regarding ESF operations.

The ESF has an odd history. It was established in 1934 by the Gold Reserve Act with $2 billion worth of proceeds derived from the revaluation of the U.S. gold from $20.67 to $35 per ounce. It has been used not only as the Treasury's counterpart to the Fed in exchange interventions, but also as a tool to bailout foreign governments, including a Clinton-led rescue of Mexico in 1995. Courtesy of George Bush and Henry Paulson, the ESF was most recently tasked with guaranteeing U.S. money market mutual funds during the 2008 credit crisis.

As of December 2016, the ESF's assets clock in at a cool $90.4 billion. How much of this might Trump devote to riding down the dollar? Take a look at the ESF's balance sheet and you'll see that of that $90.4, the ESF has $22 billion in U.S. securities. So it could sell $22 billion right now in order to push down the dollar.

Scanning through the rest of the balance sheet, the ESF also owns $50.1 billion IMF special drawing rights, or SDRs. (I wrote about SDRs here). The Treasury has the power to monetize these SDRs by depositing them at the Fed in return for fresh dollars. For the curious, I've snipped the relevant section from the ESF's statements:

To date, $5.2 billion worth of SDRs have been monetized, so presumably that leaves another $45 billion left as firepower. Note that the Fed cannot legally refuse to accept SDRs that have been submitted for monetization.

The ESF also has euros and yen to the tune of ~$19 billion. While it can't sell these currencies in order to weaken the dollar, it can exploit a long tradition with the Fed called "warehousing." If the Treasury Secretary wants the ESF to sell dollars but it lacks the resources to do so, the Fed has typically offered to buy the ESF's forex assets up to a certain warehoused amount in return for dollars, the ESF agreeing to take on the exchange rate risk. Think of this as a repo, securitized loan, or swap. According to the Treasury, this Fed-determined limit is currently $5 billion, although during the 1995 bailout of Mexico the warehouse was temporarily increased to $20 billion. So of the ~$19 billion in yen and euros on the ESF's balance sheet, at least $5 billion could be automatically converted into dollars and sold via the Fed's warehousing facility.

Where does that leave us? $22 + $45 + $5 billion = $72 billion. That's a lot of dollars that the ESF can potentially sell. But would it be enough to have a real impact the exchange rate? Foreign exchange markets are massive. According to the BIS, daily spot trading in U.S dollars averaged $1.4 trillion in April 2016! The ESF seems like a drop in the bucket to me, no? Furthermore, the Fed would become the ESF's biggest enemy in this game. If the ESF were to be successful in pushing down the dollar, this would constitute monetary loosening and would have to be offset by the Fed lest it miss its inflation target. Nor is Congress likely to top up the ESF's firepower, as Russell Green points out here, given the odds of success are low.[1]

Suffice it to say that Trump can certainly score an initial symbolic victory by tasking the ESF to weaken the dollar, but he needs to have the unlimited firepower of the Fed if he wants to do true damage. And that firepower might not be forthcoming, at least as long as Janet Yellen—and not a Trump flunky—is holding the reins.

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[1] One exception that Congress might agree to is the obscure $42.22 maneuver.

Does the Fed lack the technical means to dive into negative rate waters?

The Federal Reserve may be in a bit of a bind.

With the Bank of Japan reducing rates to -0.1%, many commentators are calling on the Fed to reverse its policy of rate normalization and follow Japan into negative territory.  The problem is this. Thanks to the rules laid out in the Federal Reserve Act, the Fed may lack the technical means to dive into negative rate waters. Let me restate this in different terms. If the Federal Reserve were to reduce the rate at which it pays interest on reserves (IOR) to -0.25% or so, the overnight rate may not follow very far. Monetary policy is useless, or at least less effective than it would otherwise be.

Not only would monetary policy lose some of its potency when IOR falls below 0%, but an unapproved fiscal transfer from the Fed to another set of government institutions could occur. This is because negative IOR has the potential to provide a large subsidy to a narrow range of governments sponsored-entities that are allowed to keep 0%-yielding deposits at the Fed. At deeply negative rates, this subsidy could get very large, turning the Fed's substantial profits into large losses. The result, a steady fall in its share capital, might undermine Fed independence and the credibility of monetary policy.**

Why these odd effects? As Nick Rowe says in this delightful post, in a world with negative interest rates everything old is new again, only it's a mirror image. And in a world of negative U.S. rates, the mirror image of the Fed's leaky floor is a sticky ceiling. And just like the leaky floor (more on this later) dragged the overnight rate down to 0% when IOR was positive, the sticky ceiling effectively pulls the overnight rates back up to 0% when IOR is negative. To see why this would happen, we need to take a quick tour of the legal and technical history behind IOR.

Until October 2008 the Fed was legally prohibited from paying interest to banks. Any bank manager who left reserves on deposit at the Fed earned 0%. This changed with the passage of the  Financial Services Regulatory Relief Act of 2006 which bolted Section 19(b)(12) onto the Federal Reserve Act allowing banks to "receive earnings to be paid by the Federal Reserve Bank." As a direct result of 19(b)(12), the Fed has been paying interest of 0.25% for a number of years, a rate that was recently increased to 0.5%.

Not only did Section 19(b)(12) provide the Fed with the ability to pay interest on reserves, it also gives it the technical means to pay negative rates on reserves. Now there is some controversy whether the wording in Section 19(b)(12) authorizes a negative rate; for instance, it mentions the paying of earnings to banks, not the payment of negative earnings:

World is cascading to - rates. Does Congress need to authorize Fed to "charge" IOR? ('06 law says "pay") @dandolfa @jp_koning @mileskimball

— Diego Espinosa (@dvespinosa) January 29, 2016

...and here is Stephen Williamson on the issue.

Ex-Fed official Narayana Kocherlakota points out that various members of the Fed Board of Governors, including William Dudley and Stanley Fischer, have already hinted at negative rates as a potential tool, the implication being that the Fed has high confidence in a certain interpretation of the Act that would legally justify the move, otherwise they would not have spoken. Don't forget that Fed general counsel Scott Alvarez will have to sign off on the question of legality. Alvarez is the one who allowed a truck to be driven through Section 13.3 during the credit crisis, legalizing the bailout of Bear Stearns and AIG via Maiden Lane.

Let's assume that there is no legal controversy and the Fed sets negative IOR of -0.25% tomorrow. That's where the Fed's real problems start. Because as I said at the outset, the overnight rate won't follow IOR down in lock-step, it may even stick to the 0% ceiling. On top of this is the aforementioned subsidy provided to those institutions that have access to interest-free deposits at the Fed, namely the government-sponsored entities Freddie Mac, Fannie Mae, and the Federal Home Loan Banks (I'll describe this subsidy later).

As I said at the outset, the sticky ceiling problem is the opposite of the well known leaky floor problem. Over the last few years the various U.S. overnight rates have traded below IOR. These leaks are odd since IOR is supposed to set a lower bound to the overnight rate. After all, why invest your funds at 0.05% overnight when you can get 0.25% at the Fed? We can blame the leakage on our three government-sponsored entities (GSEs): Freddie, Fannie, and the Federal Home Loan Banks. These GSEs are allowed to keep accounts at the Fed but are prohibited from collecting interest. Rather than earn nothing, the GSEs have been lending their reserves overnight to banks who have access to IOR. These banks have been engaging in arbitrage whereby they borrow GSE funds at 0.05%- 0.15% and invest them at 0.25%, a nice gig if you can get it.

From whence this prohibition on interest? 19(b)(12), the same bit of legalese that authorizes IOR, emphasizes that only "depository institutions" can receive interest, and since Freddie, Fannie, and the Federal Home Loan Banks are not depositories, they do not qualify (this article speculates why).

Which means that if the Fed is going to stretch Section 19 authority for payment of interest  to allow for the payment of negative interest rates, then the GSE prohibition on receiving positive interest means that they will likewise be exempt from paying negative interest.

The ultimate effect of all this is that if and when the Fed decides to brings IOR to -0.25%%, the overnight rate is going to do a flip—rather than trading below IOR it will start to trade above it. Why the inversion? In positive rate land the IOR exemption meant that it really sucked to be the GSEs. But in negative rate land it's great to be a GSE. When all other banks must endure a -0.25% penalty, an exemption from IOR becomes an asset, not a liability. Banks, sensing a way to improve their returns, will compete to purchase 0% shelter from the GSEs. Say they offer to lend funds to the GSEs in the overnight market at  -0.17%, an 8 basis point improvement to IOR of -0.25%. GSEs would be hard-pressed to not accept this gift. After all, they'd be borrowing at -0.17% in order to lend to the Fed at 0%, which means 17 basis points in risk free profit. Taken to the extreme, a profit-maximizing Fannie, Freddie, and the Federal Home Loan Banks will compete to borrow the entire $3.3 trillion in reserves held at the Fed, driving overnight rates back up towards 0%. No matter how deep the Fed brings IOR into negative territory, the overnight rate stays stuck at a shallow level thanks to the GSEs.

You may recognize that the sticky ceiling problem is just another (perhaps weaker) version of the good old zero-lower bound problem, but in the role of 0% cash as antagonist, 0% deposits held at Fannie, Freddie, and the Federal Home Loan Banks have been substituted.

Now it could be argued that GSE arbitrage will force the overnight rate within a hair of negative IOR. For instance, if  IOR is at -0.25%  the overnight rate might trade at -0.24%. If so, the problem is less about monetary policy impotence and more about the massive subsidy being granted to the GSEs. These institutions have a large incentive to hoover all the reserves held by non-GSEs in order to earn risk free returns. Rather than earning 0.25% on reserves held by banks, the Fed will get 0%. And since the Fed's profits--what economists call seigniorage--typically flows to the taxpayer via the Treasury, taxpayers would be subsidizing Fannie, Freddie, and the Federal Home Loan Banks to the tune of millions, a fiscal transfer lacking the appropriate Congressional approvals.*

If the GSEs take the free gift, this will have very real effects on the Fed's financial health.  With IOR at -0.25% the steady rolling-over the Fed's assets will result in a decline in their yields, maybe even negative returns. As the spread between the return on assets and cost of liabilities shrinks, the Fed's seigniorage will drop dramatically. In  normal times, a certain portion of this seigniorage goes to rebuilding any impairments to the Fed's capital base while the rest flows through the Treasury to the taxpayer, either in the form of reduced taxes or services. With a 0% loophole being offered to the GSEs, the Fed risks running permanent operating deficits which in turn will lead to a steady erosion in its capital base. If the equity writedowns gets too large this may reduce the Fed's credibility in the eyes of the market, thus reducing the effectiveness of monetary policy.**

The Fed will have to plug this hole if it doesn't want to find itself neutered and/or subsidizing the GSEs. Maybe Fed officials can cap the amount of reserves that the GSEs are allowed to borrow, or use moral suasion to get the GSEs to drop out of the market. Better yet, maybe Fed Chair Janet Yellen can ask Congress to change 19(b)(12) so that, like all other banks, GSEs get to receive IOR (and are forced to pay it). Alternatively, maybe the laws can be altered so that the GSEs are prevented from keeping deposits at the Fed to begin with.

The legal option is a good idea for two reasons. First, it means that negative IOR effectively sets the overnight rate, restoring the pass-through from negative rates into financial markets and the real economy. It also removes the subsidy to the GSEs and the potential for large hits to share capital. Secondly, it fixes the Fed's leaky floor problem at positive rates of IOR. The Fed has already set up an overnight reverse repo agreement (ON RRP) facility to borrow from those ineligible to receive IOR, the idea being to keep a sterner floor under overnight rates. But as Marvin Goodfriend writes, ON RRP

violates the minimal intervention principle of central banking by turning the Fed into a financial intermediary operating directly on a large scale beyond the banking system with the potential to distort short term credit allocation and enable disruptive flight-to-quality flows during periods of financial distress.

Far less obtrusive to fix the leak with a quick change to legislation than fully arming a new battle station.

In closing, if the Fed wants to go negative, it may have some technical details to worry about. Fed officials no doubt already know this. If they don't, the blame can be attributed to their all-out focus on so-called normalization. By throwing all their organizational capital into the creation of a mechanism for keeping rates on an upward trajectory (the ON RRP), the Fed has diverted resources and attention away from the design of a complementary mechanism necessary for a downward rate trajectory. In hindsight, perhaps the Fed should have been tasking half its lawyers, accountants, financial architects, and media personnel to the rate normalization project, and the other to the negative rate project. Time to play catch-up?

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Due to the difficulty of this subject matter, I've altered this post a few times since initially publishing it. The general idea has remained the same.

* In my original post, this paragraph didn't appear but was in the footnotes. I think it's important enough to bring up to the body of the text.
** Added on January 4.
*** Since originally posting this, I've softened my position on the sticky ceiling. I originally thought that the overnight rate would stay stuck at 0%, but I now feel it is likely to move closer to negative IOR. It would remain above IOR, however, so the idea of a sticky ceiling, while muted, is still relevant.