Tyler Cowen says

If currency disappeared, how might negative nominal interest rates come about? The market won’t do it automatically.  Let’s say we start with zero price inflation and the real rate of return goes negative.  Competitive banks won’t impose negative nominal rates, rather the equilibrium is that they stop further real investments and pay zero on the balances.  One constraint is that some form of withdrawals may always be possible, the more important constraint is simply that “storing balances” costs almost nothing at the margin and so competition will bring a zero rather than negative nominal return, adjusting for costs of transacting of course.

Think of the action as moving through the bond market. Suppose currently the central bank wanted to keep buying Treasuries until the interest rate went negative. This would be difficult though not impossible.

Once the yield went even a bit negative banks would simply sell all of their bonds into reserves, which they could – and typically do – convert to cash. However, in our new world there is no cash.

A penalty rate on reserves means that the demand for Treasuries is no longer completely elastic at zero.  Thus the interest rate of Treasuries can go negative.

At this point banks lose money holding both reserves and Treasuries. The incentive is to go into some other asset which is yielding some non-negative nominal return even if it yields a risk adjusted negative return.

Right here this should break the ZLB. But, we can take the chain of events forward.

On the consumer side you get higher fees on checking accounts, perhaps even a penalty rate. This pushes consumers into savings accounts. An increase in the supply of savings would then push savings account rate negatives.

You might ask why this would prevail in the market; why the bank not just accept savings for free? Well, because the way the bank accepts savings is by first accepting reserves. Reserves come with a penalty that you now want to get rid off.

That is, you open a savings account at ABC bank. How do you deposit money into that account? By writing a check from XYZ bank. That check clears by XYZ transferring reserves to ABC.  Now ABC is paying the penalty. They don’t want to do this and need some incentive from the saver to make this happen.

With no cash outlet the monetary base can become fundamentally costly to hold, which means that you will “pay” people to take it off your hands. This means buying more inventory than you would at a given price or hiring more workers than you would or even purchasing more durables than you would.

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