Everyone agrees that the recovery from the 2008 crisis has been disappointingly lacklustre. A central concern in the current global debate is that policy-makers, having tried unconventional monetary policy, are running out of effective instruments. How real is this concern?
I have argued previously that, despite the daily dose of disaster scenarios from the financial press and market commentators, the current situation is much the same as it has been for the past four years, with global growth in the low ‘3s’. Nevertheless just about every country would like to be growing a bit faster. Some argue that the problem is structural and is either largely unavoidable (eg. aging demographics), or requires far-reaching reforms which politicians find hard to do (‘we know what to do; we just don’t know how to get re-elected after we have done it’).
Others, such as Paul Krugman, argue that the failing is not only on the structural side, but also lies with deficient demand. Most countries applied a coordinated fiscal stimulus in 2009 that boosted global growth in 2010, but then they started to worry about government debt levels. As a result, the crisis-affected economies applied strong fiscal contraction. Meanwhile, borrowers in the private sector shared the debt concerns: in the new mood of austerity they felt over-committed and reined in expenditure to repair their balance sheets. How could a strong recovery take place in these circumstances?
Monetary policy was left with the task of boosting the recovery. The conventional instrument — the short-term interest rate — was dropped to near-zero. With this unusual setting, monetary policy remains strongly stimulatory. It’s like putting the car accelerator to the floor; its effect continues even if it is not pushed any further.
This has not been enough. Hence the resort to ‘unconventional monetary policy’ (UMP). The first element of UMP was quantitative easing (QE). Most commentators judge that it had some effect, but wasn’t enough. The second element — negative interest rates — is being explored by five countries. The sky has not fallen in: depositors have not abandoned their bank accounts and fled into cash. So far, banks’ deposit rates have not gone below zero because policy-makers have not gone far into negative territory in setting the policy interest rate. Many policy-makers now feel constrained by the damage that bolder moves into negative territory might do to bank balance sheets and profits.
Thus there is now increasing talk of ‘helicopter money’; the most unconventional policy of all. Central banks would give money directly to households to spend. This was first proposed by Milton Friedman and subsequently explored in a 2002 speech by Ben Bernanke, when he was a Fed Board member but not yet Chairman. The image of a helicopter dropping banknotes is compelling, but it wouldn’t happen so dramatically, or so randomly. Many Australians will remember the ‘cash splash’ of 2009, where most families received a direct deposit from the government into their bank accounts. This is usually judged to have been successful in providing a boost to demand. This was similar to, but not the same as, a helicopter drop as envisaged by Friedman and Bernanke. The crucial characteristic of the 2009 cash splash was not the method of delivery, but the source of funding. It was funded from the budget, not directly from the balance sheet of the central bank. It was fiscal policy, not monetary policy.
Despite high-level endorsement by Financial Times chief economist Martin Wolf, and former head of the UK Financial Services Authority Lord Adair Turner, the helicopter drop policy proposal is misguided, both 'in principle' and for technical reasons.
There is a long history (most famously in the adventures of 18th century financier John Law) of governments using the funding capabilities of their central banks to finance profligate expenditure, such as foreign wars. Industrialised economies have not experienced central bank funding of a budget deficit since the Weimar Republic. Good governance requires a country's budget to be funded by a process whereby law-makers have the opportunity to peruse expenditure plans but, at the same time, they are disciplined by the need to fund this by selling government bonds to the public, rather than leaning on the central bank.
Central banks have been given a high degree of independence, but only within a well-specified policy framework (often inflation targeting), surrounded by accountability and transparency requirements. Even when central banks implemented QE, they were not 'printing money' and giving it away: they were buying government bonds in exchange for central-bank money (‘base money’). Nowhere have they been given a remit to override the budgetary process and give away cash. Central bankers may think that more fiscal stimulus would be appropriate but they have no mandate to make general expenditure, funded from their own balance sheet.
There are, as well, technical issues that create misunderstandings. Helicopter drops are proposed because the budget has run into some kind of debt constraint which prevents the funding of stimulatory expenditure by issuing more government debt. But helicopter drops create central bank money. Neither the public nor the commercial banks wants to hold this extra base money, so it ends up being deposited back as a liability on the balance sheet of the central bank. Taking the government and the central bank together, their combined debt (and debt servicing) will be much the same as if the expenditure had been made from the budget, funded by the issue of government debt.
It’s hard to see this idea as anything other than a sleight-of-hand trick to confuse the public and the credit-rating agencies into thinking that helicopter drops don’t raise official debt. It could even work: the public has other things to think about and the credit-rating agencies gave a clear demonstration of their self-serving incompetence in their readiness to hand out AAA ratings in the years leading up to the 2008 financial crisis.
But the superior policy, by far, is to make the case for extra fiscal expenditure, within the usual budget governance framework. Funding this expenditure with new debt issuance seems easy: when long-term bond rates are effectively zero, it can’t be hard to sell more bonds. Adair Turner argues that normal fiscal policy has become hamstrung by unwarranted debt concerns and helicopter money is a legitimate second-best way out. This advocacy allows expediency to over-ride principle.
Friedman might have originated the idea of helicopter drops, but it was not his enduring message. Instead, his mantra was that in economics 'there is no free lunch'. The 'free-lunch' promise of helicopter drops is a fantasy.
Photo by Christopher Futcher through Getty Images