Monetary Policy for the Next Recession
By pre-crash standards, the big central banks have made and continue to make amazing efforts to support demand and keep their economies running. Quantitative easing would once have been seen as reckless. The official term of art -- unconventional monetary policy -- tacitly acknowledged that.
But QE isn't unconventional any longer. It mostly worked, the evidence suggests. The world avoided another Great Depression. Yet even in the U.S., this is a seriously sub-par recovery; growth in Europe and Japan has been worse still. Now imagine a big new financial shock. It's quite possible that all three economies would fall back into recession. What then?
According to your economics textbook, the obvious answer is fiscal policy. But bringing fiscal expansion to bear in a sustained and effective way proved difficult after 2008. Next time round, the politics might be harder still, because public debt has grown and concerns about government solvency (warranted or otherwise) will be greater. Sooner rather than later, attention therefore needs to turn to a new kind of unconventional monetary policy: helicopter money.
One thing's for sure: The idea needs a blander name. Milton Friedman, who argued that central banks could always defeat deflation by printing dollars and dropping them from helicopters, did nothing to make the idea acceptable. Put it that way and most people think the notion is crazy.
How about "QE for the people" instead? It has a nice populist ring to it -- suggesting a convergence of financial excess and the Communist Manifesto. The problem is, it isn't bland. It sounds even bolder than helicopter money. "Overt monetary financing" is closer to what's required, but something even duller would be better.
The logic is simple. If central banks need to expand demand -- and interest rates can't be cut any further -- let them send a check to every citizen. Much of this money would be spent, boosting demand just as Friedman said. Nobody, so far as I'm aware, is arguing that it wouldn't be effective. What, then, is the objection?
One concern is that if a central bank starts giving out money, it will create liabilities with no corresponding assets -- thus depleting its equity. Compare with QE: This also creates liabilities in the form of money, but the central bank gets assets (the securities it buys) in return.
Does it matter that the central bank's equity is reduced? No. Standard accounting terms lose their usual meanings when applied to central banks. Money isn't a liability in the ordinary sense. Nobody is owed and nothing ever has to be paid back. In the same way, a central bank needn't worry about losses, even though accounting "losses" might sometimes arise -- as they also could under QE, by the way. An entity that can create money can't ever go bust.
The only non-trivial economic objection to overt monetary financing is that the central bank, having increased the supply of money, might find it difficult to control interest rates later. When inflation starts rising and the time comes for the central bank to tighten monetary policy, will it be able to?
Again, this concern, if valid, applies to QE as well. Central banks have explained why QE doesn't cause them to lose control of interest rates. Similar reasoning applies to overt monetary financing. As Lonergan puts it, the central bank can do four things when it wants to tighten policy:
1) Raise the rate of interest on reserves;
2) Issue debt or sell bonds on its balance sheet (this amounts to the same thing);
3) Raise reserve requirements (the Bank of England does not use them currently, but easily could);
4) Make other regulatory changes that increase private sector demand for reserves or raise the spread of market interest rates over base rates, for example, by raising capital ratios.
QE for the people -- sorry, overt monetary financing -- doesn't render any of these methods ineffective.
The real objection is political not economic. Sending out checks is a hybrid of monetary and fiscal policy -- public spending financed by pure money creation. That's why it would work. Politically, this is awkward.
The big central banks have been granted independence to discharge a narrow mandate. Aiming for low inflation was seen as uncontroversial and hence non-political. Central banks could be left alone, without much compromising the democratic process. Meanwhile, politicians wouldn't be tempted to risk higher inflation for short-term political purposes.
This idea that monetary policy isn't political was never more than a useful fiction. Central banks can't avoid making choices with distributional, hence political, implications. The real case for central-bank independence isn't that monetary policy is non-political; it's that central banks are better than politicians at economic policy.
Today, persistently slow growth and the possibility of another recession call that view into question. Not because central banks have been incompetent or because politicians would do a better job by themselves -- plainly, neither is true -- but because the monetary-and-fiscal distinction no longer works. The useful fiction has become a harmful fiction.
What if ordinary monetary policy isn't enough? What if central banks can't discharge their inflation-target mandate without a hybrid fiscal-and-monetary instrument? QE has already posed that question -- it's a hybrid too -- but in a much more subtle way. When the discussion turns to the Fed sending out checks, the issue is impossible to ignore.
It needs to be addressed. Independence for central banks only makes sense if they have the means to do the job they've been given. At the moment, they're dangerously under-equipped.
This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.
To contact the author on this story:
Clive Crook at firstname.lastname@example.org
To contact the editor on this story:
James Gibney at email@example.com