Central banks (CB) are now noting the limited effectiveness of their quantitative easing (QE) policies. The risks related to negative interest rates (destabilisation of the banking system, increase in household savings) are increasingly being taken into consideration. Not to mention that the resulting depreciation of the exchange rate is perceived as an act of hostility by trading partners (“currency war”). Therefore, it is no coincidence that all CBs have now relegated the negative interest rate option to the back burner: (i) Mario Draghi indicated in March that rates had probably reached a floor in the eurozone; (ii) for the moment, the BoJ has renounced the idea of continuing in this direction before assessing the impact of negative deposit rates on banks; and lastly (iii) Janet Yellen deliberately did not mention the negative rate option in her last monetary policy speech, considering that there were still two “unconventional” options if necessary: (1) outright securities purchases via monetary financing (QE) or (2) an “Operation Twist” (substitution of long-term Treasury securities for short-term securities, with an unchanged CB balance sheet).
Does this mean that monetary policies have run their course? What will CBs be able to do during the next recession? Recently, a “new option” has attracted attention, so-called “helicopter money”. What does this refer to? How does this option differ from the quantitative easing policies already carried out? And how would it be potentially more effective? We will return to the issues, risks and benefits related to this “new approach” to economic policy.
Brief return to “unconventional” options and their effectiveness
In order to understand the terms of the debate, it is useful to outline again the CB policies already implemented and their limits. After lowering their nominal rates to “zero”, CBs implemented securities purchasing policies (QE), gradually broadening the range of securities purchased (mortgage-backed securities (MBS) in the US, equities in Japan, corporate bonds in the eurozone, see article 1 " Changes in Central Banks' Tools: Present Situation and Future " for an exhaustive description of the measures specifically implemented).
CBs also presented negative deposit rates as an alternative in order to cause real interest rates to decline and stimulate economic activity. The implicit idea being that by taxing liquidity, companies would be encouraged to release their cash in order to finance productive investment projects and banks would be encouraged to increase credit. The implementation of negative deposit rate systems in several European countries (Switzerland, Denmark, Sweden and then the eurozone) served as an example for the BoJ which followed suit in January 2016. As a result, in the US, Ben Bernanke declared in December 2015 that during the next recession, the Fed should also consider this option.
The long-term economic impact of unconventional policies (securities purchases and/or negative interest rates) is still largely unknown: CBs had
Initially, the policies carried out (securities purchases) clearly played a stabilising role; in particular by helping to bring the prices of heavily discounted risky assets back to their equilibrium level. The decline in market interest rates has also led to the easing of financial conditions and therefore fostered the recovery. However, once assets returned to their “equilibrium level”, risks of bubbles (in the bond and equity markets) and therefore financial instability began to give cause for concern. The extension of the ECB’s securities purchases to corporate bonds is a typical example of “excessively low” interest rates (having no relationship with companies’ fundamentals). Further lowering the borrowing rates of large companies (those with access to the bond market) offers them a very limited advantage. It is actually not interest rates which are hampering the recovery but the demand outlook which is insufficient. Over time, we therefore observe that QE policies have a marginal decreasing impact on economic activity.
The impact of negative deposit rates seems to have been far overestimated. Negative deposit rates (1) weaken the banking sector (which is ultimately counterproductive for the credit channel and transmission to the real economy) and (2) tend to boost household savings (due to the erosion of households’ financial income). Remember that, apart from considering the withdrawal of fiduciary currency, the impossibility of very negative nominal interest rates results from the fact that agents have the possibility of transforming their assets into bank notes and storing them in this form. In absolute terms, deposit rates cannot therefore exceed the storage cost of “paper money” (safe, security expenses,
In the final analysis, if the monetary policy options have been exhausted and fiscal policies are also limited by solvency constraints (excess debt), does this mean that the room for manoeuvre in terms of economic policy is non-existent? No, reply those who claim that a CB can always inject money into the economy without compensation!
“Helicopter money” versus QE: what are the differences?
The helicopter parable dates from Milton Friedman who, in a famous article published in 1969, made the analogy with a (unique) operation for the distribution of bank notes by helicopter1, to evoke the economic impact of the creation of money without counterpart. This option differs technically from QE, at least when the balance sheets of the government and CB are separated2. A tax cut financed through the creation of money is a form of “helicopter money”. the money created is supposed to directly benefit the real economy.
QE, in its narrowest sense and as it has been implemented by the major CBs since 2008, consists in issuing money in order to acquire government bonds
It is noteworthy that if the CB decides to restructure all or part of its government debt holdings accumulated during past securities purchase programmes (peripheral sovereign debt for example), this would be another form of transfer enabling the government to undertake further expenditure. Although the procedures are different, ultimately the impact on the CB’s balance sheet is the same: in this situation, there is a difference between its liabilities and the value of its assets. The CB therefore falls into negative equity (and theoretically it would be necessary for the Treasury to recapitalise it …).
The helicopter can also take the form of a transfer to private agents (households or companies). Given that it is forbidden (notably in the eurozone) to directly finance governments, the option of a direct transfer to companies and/or households is currently attracting the most attention, notably in the media. Probably because it is also the most emblematic of the image of a helicopter dropping bank notes.
In practice, this transfer can take the form of a cheque from the CB to households, or even to companies. Technically, banks are credited by the central bank with the total amount of cheques issued. Provided that economic agents do not anticipate a corresponding rise in inflation, the sums injected help bolster global demand, at least in the short term. The economic impact is similar to a tax cut… except that the “CB cheques” are neutral for the public finances (apart from considering that the Treasury must recapitalise the CB!).
As with the transfer to the government the CB’s balance sheet is unbalanced, with a negative equity position. Even if a CB is not an economic agent like the others, clearly this option has its limits. If the amounts issued far exceed the CB’s assets, this can cause a general loss of confidence, as well as inflation anticipations that would lead to savings behaviour or a flight to real assets (gold, property etc.). The fact that the CB is not an economic agent like the others – in practice it is the only economic agent that can issue money to cover its losses – does not change the situation, quite the opposite. Remember that the recourse to “helicopter money” theoretically only works if it occurs once (or let’s say if it is “exceptional”).
Very uncertain consequences on financial stability
Such a development, giving an explicit role to the central bank in the direct financing of the economy and especially openly shattering the difference between fiscal and monetary policies4, is likely to lead to the complete reformulation of the framework for the analysis of economic policy. In the absence of a well-defined frontier between monetary and fiscal policies, it is the actual independence of CBs that would inevitably be called into question sooner or later. In addition, giving the illusion that it is always possible to create money ex nihilo and without counterpart amounts to opening a Pandora’s box of all kinds of demands (pension financing, tax cuts, wage increases etc.).
Not to mention that the creation of money without counterpart is likely to cause a collapse in the external value of the currency of the country concerned, especially if “use of the helicopter” only affects one, or a limited number of countries. And where it affects the majority of countries simultaneously (a very hypothetical case following, for example, a global crisis), the helicopter is likely to precipitate a crisis in the international monetary system, with potentially a general flight to real assets (property bubble, soaring gold prices).
Is use of the helicopter doomed?
No, not necessarily. However, it will probably be necessary to rethink the procedures for intervention and more importantly not foster the illusion of a “free lunch” among private agents. The “transfer to the government” option seems more well-founded than that of a transfer to private agents.
Indeed, money is a public asset. Resorting to the creation of money can therefore be justified in order to remedy market malfunctions in the financing of other public assets (maintaining the quality of the environment and infrastructure for example). The financing of energy transition, certain research or educational spending, or the renewal of aging infrastructure all share the opportunity to maintain or increase potential growth. If the CB finances projects of this nature by issuing money, it finances public assets which must in some way be included in its assets. The only difficulty, which is considerable, lies in valuing these public assets.
Over and above this accounting debate on the CB’s balance sheet and the value of public assets, it is necessary to define, upstream, the rules precisely governing the conditions for resorting to such measures (limitation in time, changes in demand and inflation, anchoring of inflation anticipations) in order to be able to fully benefit from the advantages (stimulation of final demand, improvement in growth potential) without suffering the drawbacks (crisis of confidence, increase in savings, currency’s loss of value).
In the final analysis, this is one of the promising areas of reflection on future economic policy in a regime of low growth, zero interest rates and high debt. In addition, history shows that some historical experiences have proved to be conclusive (Japan in the 1930s or Canada after World War II)5.
Nonetheless, it is important not to underestimate the obstacles: dissensus within CBs and legal constraints (e.g. the ECB is not authorised to finance governments) which prevent progress being made in this direction. A new crisis will probably be necessary in order for issues of “helicopter money” to be accepted. Until then, even though the impact of securities purchases on economic activity is far from certain, we believe it is more realistic to see CBs (the ECB in particular) buying equities.
1 “Let us suppose now that one day a helicopter flies over this community and drops an additional $1,000 in bills from the sky, which is, of course, hastily collected by members of the community. Let us suppose further that everyone is convinced that this is a unique event which will never be repeated.” Milton Friedman, “the optimum quantity of money” 1969.
2 We can debate the validity of separating the balance sheets of the Treasury and the CB on a theoretical level. If we reason on the basis of the intertemporal budget constraint of public agents, it is theoretically necessary to consider the consolidated balance sheet of the CB and Treasury. That said, the institutional reality (independence of central banks, public finance constraints and legal rules regarding the monetary financing of governments) militates in favour of continuing to clearly separate the balance sheets of the Treasury and the CB which, in practice, makes it possible to distinguish the QE option from the helicopter option.
3 In practice, this involves monetary financing of the government. The ECB can only directly acquire bonds in the secondary market. It is explicitly forbidden from purchasing in the primary market (since it is direct financing of the government). That said, via the substitution effects in the portfolios of private agents, there is clearly monetary financing of the government but it is indirect: governments can more easily obtain financing since there is a natural porosity between the primary and secondary markets.
4 Note that this frontier has already been shattered with the QE policies carried out since 2008. In the helicopter case, the confusion increases a notch.
5 Japan escaped depression in the 1930s by implementing a highly aggressive policymix combining public spending and new money creation. In Canada, the central bank regularly financed public spending until the 1970s, without this triggering inflation!
The long-term economic
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If the ECB restructures
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Transfers from CBs to