Is the lower bound for interest rates really zero?

Suppose that tomorrow, the Fed cut the target federal funds rate to -0.25%. Conventional wisdom says this is not possible - investors could always hold cash yielding zero and so would never lend at a negative interest rate. This isn't really right though -- the nominal yield on cash is actually less than zero and the Fed has significant latitude to move below that.

Here's why: cash is risky. The risk is not that the cash will lose value, but that you will lose the cash. In order to hold your assets in actual, physical dollar bills, you have to store the dollar bills, and that costs money, particularly if you want to put them someplace safer than your mattress. If you don't hold the physical bills, "cash" is actually bank deposits -- the liabilities of a financial institution. This is hardly risk free for large investors, who take the credit risk of their bank. That's why Treasury yields have been able to drop below zero in recent months -- people are willing to pay for the safety of principal that Treasuries provide that can't be had elsewhere.

The same principle applies even for retail customers. While it might be difficult for banks to get away with actually posting negative interest rates on checking and savings accounts, in many cases banks already effectively pay negative interest by charging fees to small depositors that exceed the interest they pay. I probably already pay my bank about 0.3% per month for the privilege of keeping my money there, for example.

Of course, this kind of policy has limits. At some point it does become cheaper to store the cash, especially if investors expect the NIRP (negative interest rate policy) to continue for a while and devise more cost effective ways to store dollar bills. So very negative rates wouldn't work, but there's probably an ability to go significantly below zero.