In one important respect, what we call "New Keynesian" macroeconomic models are in fact New Gesellian macroeconomic models. That's only in one respect, but it is important.
Silvio Gesell proposed a tax on currency. The higher the tax rate, the faster people would spend that currency. A tax is a negative subsidy. The higher the subsidy rate, the slower people would spend that currency.
Another name for a subsidy on currency is paying interest on currency. If that interest rate is 5%, for every $100 currency you hold, the bank that issued that currency pays you $5 currency per year.
If I hold a $20 banknote, issued by the Bank of Canada, it is as if I have a chequing account at the Bank of Canada with $20 in it. If I buy something from you, and give you that $20 banknote, it is as if I wrote you a cheque for $20, instructing the Bank of Canada to transfer $20 from my account at the Bank of Canada to your account at the Bank of Canada. It is as if we keep our $20 banknotes in little boxes at the Bank of Canada instead of in our pockets, and when I buy something from you the Bank of Canada switches one $20 banknote from my box to your box. These are just different ways of keeping a record of payments.
Imagine a world where every individual has a chequing account at the central bank. There are no other banks, and no other forms of money. People use cheques drawn on their accounts at the central bank to buy everything. The balance in any individual's chequing account can be either positive or negative. But the central bank puts a limit on how big your overdraft can be, to ensure the no-Ponzi condition is satisfied. You can't have an overdraft bigger than your total human and non-human wealth.
The central bank in that world can choose to pay whatever rate of interest it wants on positive balances, and charge whatever rate of interest it wants on negative balances. It's a purely administrative decision.
Suppose the central bank chooses to pay the same rate of interest on positive balances as it charges on negative balances. Nobody would choose to borrow at a higher rate of interest than that set by the central bank. Nobody would choose to lend at a lower rate of interest than that set by the central bank. So there will be no private borrowing or lending between individuals.
Suppose the positive and negative balances in those chequing accounts across all individuals sum to zero. The central bank itself has no assets except the negative balances, and no liabilities except the positive balances, and the two exactly cancel out. If one individual buys something for $20, his account goes down by $20 and the seller's account goes up by $20, so the net balances stay at zero. The central bank earns zero net revenue, because the interest it pays on positive balances exactly matches the interest it charges on negative balances. And suppose the central bank has zero administrative costs. The central bank therefore earns zero profits.
I have just described the monetary system of a New Keynesian macroeconomic model.
Monetary policy in that model is Gesellian, except the tax on central bank money is normally negative. It's a subsidy on positive balances, and a tax on negative balances. The central bank calls that negative tax rate "the rate of interest". If the central bank wants to speed up spending it reduces that rate of interest; if it wants to slow down spending it increases that rate of interest.
New Keynesians say their models are models of a "cashless" economy. We should ignore them. Forget what they say, and watch what they do with the equations. If there is no "cash", how can the central bank set the nominal rate of interest? If there is no "cash", how can the central bank influence people's spending decisions? What is it that people are spending when they buy goods? If it's a "cashless" economy, how come underemployed workers, who want to trade their labour for each others' consumption goods, don't just do a barter deal to get back to full employment?
It all makes perfect sense when you realise that there is money in the New Keynesian model, and people need to use that money to trade, and people spend that money when they buy things, and it is central bank money, and the central bank sets the rate of interest it pays on holdings of central bank money.
The only thing that doesn't make sense is the zero lower bound on nominal interest rates. The zero lower bound is an ad hoc constraint on the central bank's monetary policy that is stuck on afterwards.
And the real world does look very different. Very little borrowing and lending is done on the books of the Bank of Canada. Only commercial banks and the government have chequing accounts at the Bank of Canada that pay interest. Bank of Canada currency pays 0% nominal interest. Does it matter? It probably does, sometimes.
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Jon, in the model without money, the central bank can’t actually influence the interest rate by trading the bonds, since there’s no money, and the bank doesn’t have apples or any other real goods. So it would appear this has to be set by law.
Would this have an impact on real interest rates? In the model with money, the assumption is that when the central bank changes the nominal rate, in the short run inflation expectations don’t change, and the change in the nominal rate flows through into a change in the real rate, right? Is this still a plausible model in the absence of a medium of exchange?
“In the model, the central bank simply sets the nominal interest rate (not the real rate). You can imagine this is done by law. In reality, this is normally done through open market operations, i.e. the Fed buys or sells government bonds so that their interest rate equals its target.”
I don’t totally agree with that. The fed can set the fed funds nominal rate thru an “announcement affect”. They just say what it will be, and it goes there. Let’s say the fed wants to lower the fed funds rate from 5% to 2%. They announce it. The “market” does not cooperate. They buy a bond and sell central bank reserves. There are excess central bank reserves in the banking system. The fed funds rate falls towards interest on central bank reserves, including zero. When the fed funds rate gets to where the fed wants it (say above the interest on central bank reserves), it sells the exact same amount of bonds and buys the exact same amount of central bank reserves.
The result of both an “announcement affect” and the second scenario is that the amount of currency can stay the same and the amount of central bank reserves can stay the same (the monetary base is unchanged) while changing the fed funds rate and probably other interest rates too. The scenario does not have to be more money/monetary base raises the price(s) of bonds meaning lower interest rates (monetarist thinking).
The commercial banks learn from this and pay attention to the “announcement affect”.
TMF: While I agree that the “announcement effect” is important, I think this always involves the Fed actually trading in quantities. The announcement alone is not enough.
Consider the secondary market for treasuries, that trade at a certain interest rate. Then the Fed announces a higher interest rate target, and stands ready to buy or sell treasuries at that new interest rate. Will it actually have to make any trades?
I would say yes. The old interest rate is what cleared the market for treasuries. Now at the higher interest rate (lower price), some people who were willing to sell treasuries at the old price are no longer willing to sell at the new rate, and more people will want to buy treasuries at the new higher rate. The only way the new announced target rate can clear the market is if this excess demand for treasuries at the higher rate is met by the Fed — i.e. some people are going to buy treasuries from the Fed at the higher rate, and there will be a net flow of bonds from the Fed to buyers, and a flow of reserves from buyers to the Fed.
I agree that this happens faster and with less total change of quantities than if the Fed hadn’t announced the new rate and had simply started selling treasuries at a lower price.
I’m starting to view the long-term economy as a system of trying to achieve an optimal basket of technologies. A certain level of dynamic activities but some WMDs out of easy reach. This would apply to the interest rate selection of major central banks as well as regional and sector specific actors. If they are part of the solution you’d want to encourage more economic growth. If part of the problem: less. Perhaps some of the politic checks on power might have economic parallels that don’t yet exist.