October 6th, 2014
in Op Ed
by Biagio Bossone, Thomas Fazi, Richard Wood, Voxeu.org
This article appeared originally at Voxeu.org 01 October 2014.
High debt and deflation have afflicted Japan, the Eurozone, and the US. However, the monetary and fiscal policies implemented so far have been disappointing. This column discusses the importance of helicopter money in the form of overt monetary financing in addressing these problems. Overt money financing is the policy with the highest impact in raising demand and output without increasing public debt and interest rates.
The G20 leaders may well endorse a higher 'growth target' at their November meeting in Australia, but they will be incapable of agreeing to the monetary/fiscal policy combination that is required to substantially lift aggregate consumer demand and economic growth.
Fiscal and monetary policy coordination is required for economic recovery
The IMF is reportedly examining 900 structural/infrastructure policies, and more will be needed to reach growth targets. However, the required locomotive power to substantially lift consumer demand is far and away beyond that which can be harnessed from supply-side policies. However, a mere handful of well-chosen, coordinated macroeconomic policies could ensure success.
Current policies are not working
Germany is now running both a budget surplus and a large current account surplus, thus providing none of the powerful locomotive potential it could provide to revive the Eurozone block.
There are also growing concerns ─ including at the Bank of International Settlements and the Financial Stability Board ─ that the ultra-low interest rate policies adopted by Japan and the US are creating large risks in the form of the mispricing of risk, asset overvaluation, downward price dynamics, and a new financial crisis. Quantitative easing (QE) has raised asset prices, but the new money has failed to stimulate spending and inflationary expectations to the extent that was originally anticipated.
Helicopter money and overt money financing
As provocatively discussed by Friedman (1969), helicopter money is a policy whereby new money is created by the central bank and provided directly to households and private businesses. Grenville (2013) notices that central banks have no mandate to give money away (they can only exchange one asset for another), and that such decisions need to be backed by the budget-approval process. In most countries, therefore, central banks cannot conduct helicopter money operations on their own - helicopter money must involve fiscal policymaking.1
Buiter (2014) focuses on the application of helicopter drops through overt monetary financing, whereby the central bank creates new money to finance a fiscal stimulus. He identifies the conditions under which such a helicopter drop increases aggregate demand. One of these conditions is the irreversibility of the new money base stock creation, which constitutes a permanent addition to the total net wealth of the economy, which is made possible by the ('fiat') money base being an asset for the holder but not a liability for the issuer (Buiter 2004).
Such irreversibility can be attained if overt monetary financing operations are executed by one of two routes.
- The first is by having the government issue interest bearing debt, which the central bank would buy and hold in perpetuity, rolling over into new government debt when the existing debt on its balance sheet reaches maturity.
In this case, the government would face a debt interest servicing cost, but the central bank would make an exactly matching profit from the difference between the interest rate it receives on its debt and the zero cost of its money liabilities, and would return this profit to the government.
- A second route is having the central bank buy government securities which are explicitly non-interest bearing and never redeemable.
In terms of the fundamentals of money creation and government finance, the choice between these two routes would make no difference (Turner 2013).
Note that the irreversibility condition has nothing to do with the fact that, at any future date, the central bank might decide to withdraw part or all of the liquidity injected in the system by selling its own bonds. In this case, the holders of liquidity would exchange it for the bonds sold by the central bank, but the total net worth of the economy would not change, only its composition would (shifting from more to less liquid assets). The addition to the economy's net worth originally operated through the overt monetary financing would not be undone by any new open market operation.
Note that where overt money financing operations are run by the Treasury, without involving the central bank (see below), neither of the two routes above is necessary, since the Treasury directly finances the budget by issuing money or a money-like instrument.
Overt money financing
In relation to overt money financing, we claim the following:
- First, it is the combination of monetary and fiscal policy that has the greatest impact in raising demand and output (McCully and Pozsar 2013, Turner 2013).
- Second, overt money financing is most likely to turn deflation into inflation in the shortest time. Unlike QE, it flows to households with a relatively high marginal propensity to consume ordinary goods and services. Hence, demand and consumer goods prices both rise relatively early under overt money financing.
- Third, overt money financing does not trigger Ricardian Equivalence effects (in contrast with conventional bond financing) since the intertemporal budget constraint of the state is permanently relaxed by the corresponding new money stock.
- Fourth, it creates no rise in interest rates and hence there is no crowding-out.
- Fifth, it always increases demand (Buiter 2014).
- Finally, and most importantly, overt money financing involves no increase in public debt, whereas conventional bond financing does.
Central banks and public debt
Government bonds held by the central bank are usually counted as part of general government debt (public debt). Indeed, this might be considered an anachronism since the central bank, as well as the Treasury, are both organs of the state. Conceptually, in a consolidated public-sector balance sheet there would be no new debt creation if the government received new money from the central bank to finance the state budget.
However, this is not quite the case in reality, for a number of possible reasons. Where central banks are partly privately owned by commercial banks, there is a justifiable separation. Another justification may be that many central banks are 'independent' agencies, and separable from government influence. A third reason is that financial markets 'see through' the consolidated public-sector balance sheet and recognise that a central bank may sell government bonds to the private sector at any time.
Not all helicopter drops are created equal
Except for the case where the central bank creates money to finance the budget in exchange for new government bonds, helicopter drops do not cause the public debt to increase. This equally holds when:
- New helicopter money flows from the central bank directly into the private bank accounts of individuals and businesses (see, for instance, Kimball 2012).
- Overt money financing operations are implemented under the two routes above (Bossone and Wood 2013)
- The Treasury (not the central bank) issues new money and uses it to finance its own budget (Wood 2012).
- The Treasury (not the central bank) issues a pseudo-money instrument to finance tax cuts (Bossone et al. 2014).
The first two cases require a great deal of coordination between a (possibly) independent central bank and the Treasury, implying that they have to come to an agreement in order to engineer an overt money financing operation. On the other hand, the third and fourth cases do not involve the central bank, thus simplifying overt money financing execution; yet, the government needs to exert a great sense of fiscal discipline in order to avert the risk of abusing the money financing.
Why is all this important?
The issues discussed in this article are important for a number of reasons.
First, if the above taxonomy is not clearly understood, then the policy of overt money financing could be misinterpreted, and its significance not appreciated, including by key policymakers who have, to date, seemingly turned a blind eye to it.
Second, QE has failed to deliver what was promised and is likely to be disruptive as 'normal' interest rates are restored. A new approach to monetary policy needs to be developed to impact consumer demand much more rapidly.
Third, as the case of Japan - where the public debt level is very large - shows, successive rounds of QE and bond-financed budget deficits do not prove effective.
Fourth, the afflicted countries just survived the global financial crisis. However, with public debt already at danger levels, they are currently incapable of responding to any new crisis that may emerge by using large-scale conventional bond financed deficit spending.
Fifth, Eurozone countries are again sliding into depression and deflation. Current policies need to be radically altered to create the requirements for widespread and strong economic recovery.
Finally, there has been much conjecture about whether or not some advanced countries have entered an era of 'secular stagnation' (Teulings and Baldwin 2014). Overt money financing offers the most effective monetary and fiscal policy response to secular stagnation.
- Bossone B (2013), "Unconventional Monetary Policies Revisited (Part I)", VoxEU.org, 4 October.
- Bossone B (2013), "Unconventional Monetary Policies Revisited (Part II)", VoxEU.org, 5 October.
- Bossone B, M Cattaneo and G Zibordi (2014), "Which Options for Mr. Renzi to Revive Italy and Save the Euro?" Economonitor, 3 July.
- Bossone B and R Wood (2013), "Overt Money Financing: Navigating Article 223 of the Lisbon Treaty", EconoMonitor, 22 July.
- Buiter W H (2004) 'Helicopter Money: Irredeemable Fiat Money and the Liquidity Trap', NBER, Working Paper 10163.
- Buiter W H (2014), "The Simple Analytics of Helicopter Money: Why it Works - Always", Economics, Vol. 8, 2014-28.
- Friedman M (1969), "Optimum Quantity of Money", Aldine Publishing Company. 1969. p. 4.
- Grenville S (2013), "Helicopter Money", VoxEU.org, 24 February.
- Kimball M (2012), "Getting the Biggest Bang for the Buck in Fiscal Policy", Confessions of a Supply-Side Liberal, May 29, 2012.
- McCulley P and Z Pozsar (2013), "Helicopter Money: Or How I Stopped Worrying and Love Fiscal-Monetary Cooperation", Global Society of Fellows, 7 January.
- Teulings C and R Baldwin (eds.) (2014), Secular Stagnation: Facts, Causes, and Cures, A VoxEU.org eBook, 10 September, CEPR Press.
- Turner A (2013), "Debt, Money and Mephistopheles: How Do We Get Out of This Mess", Cass Business School Lecture, 6 February.
- Wood R (2012), "The Economic Crisis: How to Stimulate Economies Without Increasing Public Debt", CEPR Policy Insight No.62, August.