By Marino Valensise
Whilst at university, I argued with my classmates on the merits of different economic policies. Some declared their full faith in Keynes as strong advocates of counter-cyclical fiscal policies, while others (including me) were more interested in the monetarist school of thought. Thirty years later, the debate continues amidst a series of unprecedented economic and market issues.
Over recent decades, fiscal policies have contributed to a substantial increase in public sector indebtedness. As the debt-to-GDP ratio grows, the effectiveness of a fiscal policy financed by borrowing gets called into question, as public sector borrowing crowds out financial resources that could have been deployed more efficiently in private projects.
Since the global financial crisis of 2008, monetary policy has taken over the baton. In many countries, the monetary approach has been pushed to the limit. This has greatly benefitted borrowers (governments, corporates and households) by lowering the cost of servicing debts. No doubt, the benefits of aggressive monetary relaxation have been significant. However, now that today’s extremes have been reached, substantial collateral damage has become evident.
Problems of such policies include technical issues, a hit to pensioners and savers, an increase in inequality, a negative impact on the business model of banks and insurance companies, and the perpetuation of excess supply due to zombie companies being kept alive for too long.
It seems that central banks have run out of options, but are struggling to accept it. Now that the limits of aggressive monetary policies are clear, we should ask whether there is life after quantitative easing (QE), and negative interest rate policies (NIRP).
Helicopter money
One possible way forward is the use of Helicopter Money (HM). As Arnold Schwarzenegger said let’s “Get to the Choppa!” (Predator – 1987).
The definition of HM, courtesy of Milton Friedman, is a peculiar combination of monetary and fiscal policies. In simple terms, HM is “monetary financing of fiscal spending”, a central bank which prints money for its government to spend; a practice definitely not included in the Bundesbank’s instruction manual. However, we should keep an open mind – Mario Draghi sees it as a “very interesting concept” and Loretta Mester from the Federal Reserve Bank of Cleveland considers it a possible “next step if … we wanted to be more accommodative”.
In most jurisdictions, rules exist and limit the actions of a central bank although, loopholes and safe harbour clauses are easy to identify as most central banks are allowed to do ‘whatever it takes’ to fulfil their mandate.
In practice, the central bank would deliver money to the treasury by receiving a meaningless asset (i.e. a zero coupon perpetual bond) in exchange, or – preferably – without any quid pro quo agreement. In either case, there would be no planned reimbursement for the sums extended. It is important that – at least for some time – this money creation is seen as permanent and irreversible, to avoid creating fears of challenging times ahead, and the associated desire to save, not spend or invest.
How to spend it?
There are three issues today that should be tackled. These are anaemic aggregate demand, persistence of excess supply and a growing social inequality. Any HM initiative must be dedicated to projects that aim to cure these.
It should help the majority of households by increasing their welfare and enhancing their disposable income, fostering confidence and promoting consumer spending, in order to benefit the majority of the population rather than enrich asset-holders by inflating financial asset prices.
We need a fiscal plan that aims to generate real prosperity without incurring public indebtedness, or offsetting its benefits with fears of a gloomier future in which debts must be repaid. It should also attempt to create inflation expectations, and trigger higher interest rates. While higher borrowing costs would mean weaker businesses would not survive, the profitability of the banking sector would be enhanced and insurance companies would receive crucial support. Ultimately, inflation is the only solution to today’s global debt problem. Some inflation would reduce the real value of the accumulated debt.
All this considered, the question is how much money should be created and spent? The calibration of an HM policy would be much easier than that of QE. While QE relies on an uncertain transmission mechanism, whether banks will lend more or hoard the additional cash, the multiplier effect of HM is easier to forecast.
Historical experience of HM shows good and bad outcomes. In the early 1930s with Taka Korekiyo in Japan, during wartime in the developed world, for more than 30 years in Canada, and also in more questionable situations like in Venezuela and Zimbabwe.
Conclusion
I believe that HM is superior to QE, and much better suited to our current challenges. It represents a pragmatic and superior alternative to any other policy, although it cannot be a panacea for structural issues such as poor demographics.
We must consider it now, or be forced to implement it in a hurry when the next economic recession hits.
Marino Valensise is head of the Multi Asset Group at Baring Asset Management
