I will try to simplify some basic concepts regarding market monetarism and the velocity of money and negative interest rates and negative Interest on reserves (IOR). The basics are not complex and I have done my best to sort it out. But the conclusions are for the reader to determine. The nuts and bolts of determining the effects of payment on reserves by the Fed make for interesting reading, so I will give Cullen Roche’s opposing opinions regarding the debate over IOR at the end of the article.

As Scott Sumner has said regarding the MMers’ stand against negative interest rates:

In a monetarist model, lower market interest rates are contractionary for any given monetary base, because they reduce velocity.  It’s the Keynesians who are likely to claim that lower rates are expansionary.  Now of course Friedman was talking about market interest rates, not IOR. Lower IOR is theoretically expansionary, and so far markets have reacted to negative IOR announcements as if they are expansionary.

Will that be true in the future?  Nothing is certain, as monetary policy is very complex…

Sumner says low interest rates are a sign of deflationary pressures, if I read him right. And he is likely correct, since the New Keynesians have not built a robust economy through lower interest rates. they got us off the mat, or at least big business off the mat, but that is about all. And, by the way, negative interest rates, as we see elsewhere in the world, appear to be failing as well as Sweden has pushed negative rates for years with no increase in their inflation targeting. (Market monetarists oppose inflation targeting and prefer NGDP targeting.) 

Now, one can argue that velocity is forever reduced by such a large amount of excess reserves, as banks have reduced interbank lending. But the market monetarists say that is not true, that negative IOR, ie., the Fed charging the banks for excess reserves they hold at the Fed, is expansionary.  Remember IOR is not negative interest rates on bonds.

And Scott goes on to say that banks do not have to hold excess reserves, as negative IOR takes affect. Banks could buy assets or bonds. I think buying bonds would be a bad idea due to the demand for them. Buying assets may be a good idea, that could start out good and maybe go bad later.