The global economy is in the grip of deflationary grip in dollar terms for last few years. The industrial commodities, and the food prices peaked in early 2011, and crude oil peaked in mid 2014. The experience of individual countries would vary depending on the the currency movement and the structural flexibility of local economy.
In the developed world, in most of the countries, the CPI inflation is running below target for many quarters now. In response, the global central banks, Japan being the latest, have taken interest rates to negative territory. As a result, many sovereign bond market yields are at negative levels at varying parts of the yield curve. It was unthinkable just a few years ago to have negative 10-year bond yields, but now that is a reality for many markets.
However, at the same time, for last five years or so, every year the actual global GDP growth is lower than what was expected at the beginning of the year. This clearly indicates lack of aggregate demand as compared to original expectations.
Clearly, the unconventional monetary responses are not working as effectively as thought by the policy makers. We have been advocating, for last two months, adding unconventional fiscal measures to boost the effectiveness of current monetary policies at global scale. However, judging by the mood of the policymakers and Mr. Market, it seems unlikely that the world will go in the direction of unconventional fiscal policies, as suggested by us.
In order to arrest the current self fulfilling deflationary cycle, especially given that most parts of the world are still highly leveraged, even after current modest deleveraging in some parts of the world, it is important that policy makers act quickly and decisively sooner rather than later.
One policy option, which monetary authorities in Europe and Japan can explore is issue of Stamped Currency. A stamped currency is a currency which requires attaching new stamps, say of 1% of the face value, every month to remain a valid legal tender.
There has been one example of issue of such a currency during great depression in the Austrian city of Wörgl. An image of Wörgl scrip is shown below:
According to Bernard Lietaer, the mayor of Wörgl “had a long list of projects he wanted to accomplish (re-paving the streets, making the water distribution system available for the entire town, planting trees along the streets and other needed repairs.) Many people were willing and able to do all of those things, but he had only 40,000 Austrian schillings in the bank, a pittance compared to what needed to be done.
Instead of spending the 40,000 schillings on starting the first of his long list of projects, he decided to put the money on deposit with a local savings bank as a guarantee for issuing Wörgl’s own 40,000 schilling’s worth of stamp scrip. He then used the stamp scrip to pay for his first project. Because a stamp needed to be applied each month (at 1% of face value), everybody who was paid with the stamp scrip made sure he or she was spending it quickly, automatically providing work for others. When people had run out of ideas of what to spend their stamp scrip on, they even decided to pay their taxes, early.
Wörgl was the first town in Austria which effectively managed to redress the extreme levels of unemployment. They not only re-paved the streets and rebuilt the water system and all of the other projects on Mayor’s long list, they even built new houses, a ski jump and a bridge. Even the French Prime Minister, Édouard Dalladier, made a special visit to see first hand the “miracle of Wörgl.”1
This example shows that negative interest rates, when applied to paper currency directly, act as a very strong stimulant to the economy. Currently, since negative rates are applied only to electronic money held in bank, it has possibility of creating a run on banking system if the negative rates are passed on to the common depositors. Due to this reason, the negative rates are not passed fully to the depositors and they are not having desired impact on the economic activity.
It might be imperative that the along with negative rates on bank balances; the paper currency and the unused credit lines also need to attract negative rates to have effective transmission of this type of monetary policy. As shown in the above example, it is every bit possible the aggregate demand in Europe and Japan may increase rapidly if this stamp currency is introduced alongwith modest fiscal boost.
Policymakers have been trying unconventional measures since 2008, and now time has come to try even newer unconventional measures.