Central banks to the rescue? Is this the time for helicopter money?

Central banks are crucial to the resilience of the current system. But should they play the primary role in stabilizing the economy and initiating recovery after the battle against the pandemic has been won? Central banks have less tools available today than they did two decades ago. With interest rates near or below zero and large-scale asset purchasing programs proven to be inefficient, we asked the question if this is the time for helicopter money. Or should we leave the question about macroeconomic performance entirely up to the subsequent panel on fiscal policy?

Helicopter money is the idea that central banks create money to directly finance public spending or distribute the money directly to citizens. Yet, there has been some confusion about what helicopter money is, where the idea comes from and what its potential benefits and dangers are. In order to bring some light into the debate and to set the stage for the panelists, Marc Adam (Economic Analyst at Forum New Economy) presented a paper explaining the fundamental history and idea of the concept (here).

Eric Lonergan (M&G Investments) then started discussion by asking what the role of a central bank is and if central banks are fulfilling their mandate which we assigned to them. His answer was a devastating assessment of central banks’ performance since 2008. Lonergan argued that their main task is to stabilize nominal demand, as measured by the inflation rate. But that central banks have consistently failed to keep their mandate and are constantly missing their inflation targets. Lonergan therefore argued that central banks should make use of the tools they have, in particular helicopter money. For the Eurozone this would work if the ECB makes use of their dual rate system with tiered reserves. By setting the TLTRO rate, a lending rate subject to the condition that banks pass the loans on to the private sector, below the rate of interest on reserves, the ECB is effectively already engaging in helicopter money. Lonergan argued that the ECB should make more use of this instrument and expand the infrastructure.

Peter Bofinger (University of Würzburg), however, refrained from the idea of using the ECB as the actor to stabilize demand.

He argued, that the public sector should take over the debt caused by the crisis, which is an idea based on the Modern Monetary Theory (MMT).

Without defending MMT, Martin Hellwig said that inflation as the usual concern with public debt will not be an issue at all during the crisis. Hellwig was critical about the ECB engaging in helicopter money since fiscal policy is much better at targeting microeconomic problems and, moreover, is backed by a democratically elected government.

Hellwig then turned to a debate between Carl-Christian von Weizsäcker and Stefan Homburg which mirrors the debate between Larry Summers and Olivier Blanchard in the US. The debate around secular stagnation and the low level of interest rates was neatly summed by by Hellwig with: “Are there enough stores of value?”

The argument von Weizsäcker put forward in a recent book is that the stock of real assets is unable to catch up with the increase in savings of modern advanced economies. The critique against this argument of “dynamic inefficiency, put forward by Stefan Homburg and other economists in the Austrian tradition of economic thought, is that the presence of land, a non-produced durable asset whose value becomes arbitrarily large as interest rates go to zero, can accommodate any need for a store of value. Therefore, Homburg has argued that dynamic inefficiency cannot arise.

Martin Hellwig argued that including a paper asset into a standard growth model that serves as a store of value illustrates why the Homburg critique is misguided. A shock to the demand of the store of value can be accommodated by either a) changing the price of the bubble (Austrian position) or b) changing the size of the bubble (Weizsäcker position). The problem with changing the prize is that nominal prize stickiness can cause debt deflation effects (an idea developed by Irving Fisher in 1933). Because the real price of debt increases, this makes it harder for debtors to repay their debt, thereby creating a vicious cycle of default and deflation.

While Hayek and Mises have argued in their books that debtors must be protected by changes in the purchasing power of money, the policy prescriptions of the Austrians want the gold standard and argue that we should let deflation run its course.

Martin Hellwig then turned to monetary policy and stated that fiscal policy determines the size of the bubble and monetary policy determines the structure of the bubble. But if we want to change the size of the bubble then why should we not use fiscal policy directly?

Hellwig came out in favor of von Weizsäcker’s argument and argued that we need more government debt.  Hellwig however admited that we should talk about the monetization of debt, while pointing out that in the EU this is supposedly prohibited. He highlighted the upcoming German constitutional court decision on the quantitative easing program of the ECB.

But the prohibition to monetize government debt is not as such stated in the treaty. There is a prohibition on direct but not on secondary open market purchases. Hellwig argues that it is unclear if monetization of government debt is legal or not and that “it’s all a question of legal interpretation”. So far, the courts have decided to impose quantitative restrictions on the amount of government debts that can be bought (one third of GDP). In the fight against the pandemic, these constraints are now becoming binding and we are headed towards a conflict between the ECB and the courts because the ECB said it won’t abide to these restrictions.

Regarding Europe, the diverging paths of Northern/Central and Southern countries were identified as the major problem.

With the possibility of lending money relatively cheap, Germany is in that sense obliged to help its struggling European allies.

Gabor argued that fiscal and monetary policy have never been entirely separated and, indeed, are connected via the repo market. In a repo-based financial system with liquidity cycles, German Bunds are a safe asset for market-based finance. This gives Germany an exorbitant privilege and Germany has therefore a political incentive not to change the structure of that system.

Gabor therefore called for the ECB to target “helicopter spreads”. This should help to reverse the architectural privilege given to Germany under the current system until we have a common safe asset.