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Review of Kenneth S. Rogoff – The Curse of Cash Jayati Ghosh

Published by :Princeton University Press 2016     ISBN-10: 0691172137        ISBN-13: 978-0691172132

Kenneth Rogoff is among the more prolific and topical of US economists – and certainly no less controversial for all that. As former Chief Economist of the IMF, Rogoff was famously embroiled in a debate with Joseph Stiglitz, former Chief Economist of the World Bank, on the merits of and concerns about globalisation (of which he has been a fervent supporter). Subsequently, he has waded into many issues of current concern with a mix of theoretical and empirical analysis and strong policy conclusions. Perhaps unremarkably given the state of academic thinking globally and the current intellectual atmosphere in the US, the confidence with which he writes tends to be unaffected by serious logical and empirical critiques of his previous work.

For example, Rogoff and his colleague Carmen Reinhart produced a best-selling book describing the experience of eight centuries of financial crises (This Time is Different: Eight centuries of financial folly, 2009), which made strong claims on economic patterns before and after crises on the basis of statistical analysis of 66 countries through more than one hundred episodes of crisis in different countries. Among the many policy conclusions derived from this analysis, one stood out because it was so heavily used by fiscal hawks in the US and elsewhere to argue for government debt reduction and cutting public expenditure through austerity measures. Reinhart and Rogoff argued that too much public debt causes recession and may lead to financial crisis, and specified a government debt to GDP ratio of 90 per cent as the tipping point, after which the level of debt is not just excessive but likely to lead to significant economic slowdown and crisis. Since this supported some existing prejudices even if it flew in the face of much contrary evidence, this was seen as a major result.

But an analysis of this result alone (by the three Amherst economists Thomas Herndon, Michael Ash and Robert Pollin) using the database of Reinhart and Rogoff, found that this supposedly definitive result was actually the outcome of a very flawed analysis, including a set of simple spreadsheet errors! They pointed out that in Rogoff and Reinhart’s work, “coding errors, selective exclusion of available data, and unconventional weighting of summary statistics lead to serious errors that inaccurately represent the relationship between public debt and GDP growth among 20 advanced economies in the post-war period.” Even more significantly – and more damaging for the analysis – they found that the econometric analysis used to establish the results involved selective exclusion of relevant data and an inappropriate weighting scheme used to generate means and medians. These are errors that a graduate student would be hauled up for, possibly even with ethical implications. But instead of the expected mea culpa, Rogoff and Reinhart decried the “politically charged” atmosphere in which their work was being interpreted, and proceeded to trumpet their other empirical results with much fanfare.

Indeed, this reality check has not prevented Rogoff from wading into other political and economic minefields with arguments that are likely to stir up more debate. His latest book is no exception, since it propounds the desirability – and even necessity – of doing away with paper currency as a means of payment in advanced countries.

Indian readers are bound to be particularly interested in this book, since it comes in the immediate wake of the dramatic demonetisation of Rs 500 and Rs 1000 currency notes that still leaves most Indians reeling. But proponents of Modi’s shock demonetisation who would seek support for this move from Rogoff’s book will be disappointed. He argues for a much more gradual process of phasing out high value currencies, over a period of 15 to 20 years rather than the few hours that Modi allowed to the Indian nation. And he suggests this only for developed countries with already well-developed infrastructure and very different financial contexts. Indeed, he explicitly makes it clear that this proposal is not intended for developing countries and emerging markets.  He notes that most such countries are nowhere near the zero interest rate bound that makes his proposal interesting for advanced economies; but more to the point, “their overall financial infrastructures are much less developed, with a high proportion of people still being unbanked” (page 204). “The challenges in India, which is growing but still significantly lags China in economic development, are even greater. Perhaps most importantly, for emerging markets and developing economies, it is far from clear that measures to reduce the size of the informal economy by reducing the use of cash will be a net benefit.” (pages 204-5, emphasis added.)

So this move to reduce/eliminate the use of high value paper currency is not applicable to developing countries, according to Rogoff. Rather, it is what he proposes for developed countries – and particularly for the United States. His proposal is based on two separate arguments for why the use of paper cash of high denominations is undesirable.

First, he notes that large notes (that is, those of very high denomination) are more likely to be used for illegal activities than legal ones, and even play “a starring role in a broad range of criminal activities, including drug trafficking, racketeering, extortion, corruption of public officials, human trafficking, and of course money laundering”. (page 2) He suggests that the fact that the US and some other advanced economies have a gigantic currency supply, the bulk of which is in high denomination notes that are rarely used for most ordinary transactions, means that this is the way in which such illegal activities are lubricated. Doing away altogether with high value paper money (such as the 500 and 200 Euro notes in Europe or even the 100 dollar bill in the US) would obviously make it at least slightly more difficult for such criminal activities to continue undetected and unhindered.

This is a fairly standard argument, and one that is widely accepted in many circles, to the point that the European Central Bank has already announced plans to do away with the 500 Euro note in a phased manner. Rogoff agrees that this should be done gradually so as not to cause disruption to legitimate transactions. Indian readers should note, however, that this argument for delegitimising high value currency notes makes nonsense of the Indian government’s strategy of demonetising Rs 500 and Rs 1000 notes while simultaneously introducing an even higher-value note worth Rs 2000.

Rogoff’s second reason for suggesting the removal of paper currency is altogether more novel and also much more controversial. He believes that paper currency has become a major impediment to the smooth functioning of the global financial system, because it makes it difficult if not impossible for central banks in advanced economies to generate prolonged periods of negative interest rates.  Holding currency obviously involves no positive return, but the return on holding it would be negative only with inflation. In nominal terms, currency provides a zero rate of return. This in turn sets a “zero bound” for interest rates, since people would switch to cash if putting the money into banks involved earning a negative interest rate on deposits. Rogoff believes that this “zero bound” for monetary policy is a major constraint, to the extent that it “has essentially crippled monetary policy in the advanced world for the last 8 years since the financial crash of 2008. …A good case can be made that open-ended negative interest rate policy would have been extremely helpful in the depths of the financial crisis” (page 4).

This idea is based on the presumption that monetary expansion alone can push an economy out of recession or depression. While Rogoff does provide a cursory consideration of the role of fiscal policy, he appears to be convinced that it is a very poor cousin to the aggressive use of monetary policy. Indeed, he seems to think that fiscal policy on its own, without the benefit of loose monetary policy, cannot do very much. “One must distinguish between second-best opportunistic (or one might say hyperactive) fiscal policy, and fiscal policy that would be justified even in the presence of the fully functioning monetary policy stabilization that would be possible in a world with no constraints on negative interest rate policy” (page 154).

Given this excessive (one could even say blinkered) obsession with monetary policy as the only viable macroeconomic policy lever, Rogoff outlines his plan for the phasing out of paper currency altogether (with only coins used for small-denomination purchases). This involves first phasing out paper currency, beginning with the higher value bills. During this phase the government should also ensure universal financial inclusion by providing all individuals access to free basic function smartphone/debit card accounts, with costs of this subsidised by the government. Privacy requirements should be met through an appropriate regulatory framework that simultaneously discourages other means of making large-scale payments that can be completely hidden from the government (a tall order). It is also important to ensure real-time clearing, an apparently technical issue but one that can create serious difficulties in the absence of efficient infrastructure.

Rogoff notes that such a phasing out of paper currency could take several decades. He also accepts that such a move would require global co-ordination (particularly in view of the US dollar’s status as global reserve currency). But he believes that all associated costs are more than worth the eventual benefit in terms of reduced liquidity for criminal activities and the greater freedom for central banks to push interests down into significantly negative territory for reasonably long periods.

This is certainly thinking outside the box –  but it is simultaneously combined with an extraordinary failure of the imagination at another level. In fact, Rogoff’s book encapsulates much of the failure of mainstream macroeconomic thinking in the ways that were highlighted in the now-famous blog by Paul Romer. Let us leave aside for the moment the perfectly acceptable argument that high-value notes are more easily used for transactions that circumvent legal and tax processes, and should be discontinued for that reason. Consider instead his more original argument: that negative interest rates are, in effect, the only way left to save global capitalism from itself.

The necessity for negative interest rates arises because Rogoff seems to see these as the only viable route out of the current limping recovery/proto-stagnation afflicting advanced economies. Yet the much-discussed secular stagnation of the world economy is very much a reflection of low and stagnant demand – and years of progressively lower interest rates have done little to change that. Some of that is because the monetary policies themselves (through liquidity expansion in the form of Quantitative Easing or through lower interest rates) have been misdirected, largely benefiting banks that used them to improve their own balance sheets rather than to ensure continued credit to those who would actually increase spending as a result. But a more important reason is that this loose monetary policy has in general been combined with fiscal austerity, or at the very least constraints on fiscal expansion, that have prevented effective demand from increasing. The distributional effects of this combination of policies have further worsened the problem, by increasing inequality and keeping aggregate consumption levels stagnant at best.

The inability to see these obvious facts leads to Rogoff’s extraordinary dependence on further use of monetary policy even when it is clear that it is no longer effective. It is not just Rogoff’s continued reliance on the notion of inflation targeting – which should surely have been blown to smithereens by the experience of the last eight years. It is also that the argument lacks conviction even in logical terms: if reductions in interest rates down to zero (and even less than zero in some countries) have not really worked so far in pulling advanced economies out of this mess, why should further reductions do the trick? And how far down in negative terrain do they have to go to deliver the goods?

In addition, Rogoff fails to see some crucial implications of negative interest rates that could affect his sanguine approach to their extensive use. First, it is evident that low or negative rates, even if they are associated with low or falling prices of goods and services, could fuel asset price inflation, with attendant speculative bubbles emerging. Second, it is not at all clear what prolonged negative rates will do to the viability of the banking system. The combination of speculative bubbles and problems in banks could in turn generate future financial crises.

Because of his focus on negative interest rates, Rogoff also fails to note or see the potential of other possibly more effective forms of monetary policy that have been put forward. For example, there is a proposal to tax excess bank reserves, to force banks to lend the money they receive. Or there is “People’s Quantitative Easing” as advanced by Jeremy Corbyn and others, whereby the central bank could directly purchase (say) infrastructure bonds on the primary market, so that debt monetisation would be tied to public investment that would raise economic activity and add to public welfare.

There are other more conceptual concerns that arise from Rogoff’s treatment, such as the flawed perception of the nature of money or liquidity in a market economy, and the inadequate recognition of the role played by the interest rate in capitalism as a distributive marker and the basis for the profit rate. But the more immediate answer to Rogoff may well come not from reasoned arguments but from the results of changed policy conditions in the US and other advanced economies consequent upon recent political changes.

The US President-Elect Donald Trump has already signalled his intent to encourage higher interest rates and a more expansionary fiscal stance driven by lower tax rates and higher military and infrastructure spending – in other words exactly the opposite of what Rogoff seems to be recommending. This may well generate even more inequality, but it could also lead to a situation in which the rest of the world once again funds US economic expansion. The negative interest rates of Rogoff’s dreams may well appear then as one more quaint preoccupation of macroeconomists out of sync with reality.

(This article was originally published in The Wire)