G20 Ministers and Central Bank Governors meeting in Argentina - Photo by IMF

JAKARTA (TheInsiderStories) – Many central banks reduced interest rates to around zero percent during the global financial crisis to boost the economy, said International Monetary Fund (IMF) through its a recent study last week.

The study also showed the Banks could set up a system that would make deeply negative interest rates as a feasible option. It said that the interest rate cut to zero or even below zero would transmit to bank deposits, loans, and bonds.

Without cash, depositors would have to pay the negative interest rate to keep their money with the bank, making consumption and investment more attractive. This would jolt lending, boost demand, and stimulate the economy, said the report.

The Euro area, Switzerland, Denmark, Sweden, and other economies have allowed interest rates to go slightly below zero, which has been possible because taking out cash in large quantities is inconvenient and costly, for an example storage and insurance fees. These policies have helped boost demand, but they cannot fully make up for lost policy space when interest rates are very low.

However, this implementing of the zero interest rate has to face challenge because cash continues to play a significant role in payments in many countries. To get around this problem, the IMF examines a proposal for central banks to make cash as costly as bank deposits with negative interest rates, thereby making deeply negative interest rates feasible while preserving the role of cash.

The proposal is for a central bank to divide the monetary base into two separate local currencies , cash and electronic money (e-money). E-money would be issued only electronically and would pay the policy rate of interest, and cash would have an exchange rate—the conversion rate against e-money.

IMF said, this conversion rate is key to the proposal. When setting a negative interest rate on e-money, the central bank would let the conversion rate of cash in terms of e-money depreciate at the same rate as the negative interest rate on e-money. The value of cash would thereby fall in terms of e-money.

While a dual currency system challenges the preconceptions about money, countries could implement the idea with relatively small changes to central bank operating frameworks. In comparison to alternative proposals, it would have the advantage of completely freeing monetary policy from the zero lower bound.

Its introduction would reconfirm the central bank’s commitment to the inflation target, rather than raise doubts about it. The pros and cons of the system are country specific and should be carefully compared to other proposals, such as higher inflation targets, for increasing monetary policy space in a low-interest environment, IMF stated.

Written by Staff Editor, Email: theinsiderstories@gmail.com