Insanity, we are told, is doing the same thing time and again and expecting a different solution. By that definition, and no surprise to anyone who has watched the slow motion train wreck that is the Eurozone, the ECB is insane. But, as I have written in 2014, there is a cure.
Its closing in on 4 years since Mario Draghi said that he would do “whatever it takes” to preserve the euro. Well, that has been done, for a given level of preserve. Part of the mandate, on any reasonable reading of the ECB is that it has to consider not just the mere existence of the euro but the stability of the system. And that has not been preserved. We are in a frozen stasis and the extent to which the Euro system can operate absent the propping up of the ECB is still very much open to question. The disfunction of the real economy impacts on the existence of the monetary, and it is beyond time that the ECB took steps.
QE, the process by which the ECB has poured money into the financial system, has been ineffective in restarting the stalled Eurozone. Yes, it aided in pulling the system back from the brink, but the reality is that the Eurozone GDP growth rates remain low by historical standards. Inflation is almost non-existent ; household consumption growth rates are mired in low single figures; industrial production struggles to grow and unemployment is sticky.
Faced with this the policy remains the same ; cut interest rates and purchase government and other high quality bonds to allow the system to reinflate. This is what is meant by quantitative easing. What has happened however is that while the banking system has reinflated the money has not gone in to the real but into the financial side of the economy. By contrast with the much more aggressive Fed the ECB has been sluggish and sometimes downright wrong. Asset bubbles have been inflated by money seeking any yield in an ultralow interest rate environment. Interest rates on government bonds have continued to fall into negative territory. As bond yields, interest rates, fall, the prices rise. Standard economic thinking struggles to deal with zero or negative interest rates. And the Eurozone staggers on.
There is a further shot in the locker, if Draghi is willing to contemplate it. That is to resort to what is called helicopter money. This is to give people, or more generally the real economy, money directly. If an aim is to reinflate the Eurozone to allow it to kickstart into a modestly self sustaining growth cycle not dependent on a never ending QE program, then surely everything must be on the talbe?
Heicopter money is not a new concept. The term was coined by Milton Friedman in the 1960s in a thought experiment. His argument was that if somehow helicopters were to appear and drop money, actual hard cash, then people would of course spend that. If we want to get households spending, and that is a good thing given the contribution it makes to euroarea growth, then we need to find a way to do this.
Economically, helicopter money can be modelled as a tax cut. It is in effect a fiscal stimulus, and one that acts like any other. we have significant evidence that tax cuts do get spent and fiscal stimuli stimulate. So there is no question that a direct credit to persons would result in increased spending.
There is a debate on the way that helicopter money would affect central bank balance sheets with some arguing that in order for the central bank to not become insolvent (whatever that actually means for central banks) the marginal policy relevant interest rate would have to be held at zero for a very long time. In effect helicopter money can be thought of as a permanent QE, at least permanent until the economy and money demand “catches up.This is of course exactly where we are now. So that argument perhaps is moot.
A second argument is that this is in effect fiscal policy and that that is not what central banks should be doing. This relies on a historical and some might argue outdated and artificial distinction between fiscal and monetary policy.
Others still argue that this distinction is somehow valid and indeed perhaps moral. In effect this devolves to “the germans wont wear it”. I have yet to meet a german who, when asked, would say no to free money. It is like those who declare that fiat currency is not real – ask them for the contents of their wallet and they decline. The ECB cannot, directly, support government bond sales but must instead go via the market. They are not explicitly excluded from creative interpretations of their actions however.
So how might this work? The ECB balance sheet is €2,800b. This is actually the balance sheets of the member banks, so if the Bundesbank is worried about the moral fiber of the Germans they don’t have to participate. Final consumption expenditure of households in the Eurozone in Q4 2015 was €1,400b. A proposal exists which is legal and possible within the Eurozone system. In effect the ECB offers zero interest perpetual loans to banks BUT the banks must then pass these onto the customers on exactly the same terms. While this would leave out those who do not have a bank account there is nothing to stop governments providing such persons with an account at a state bank. The banks would have to agree to allowing all persons getting such loans to use them for consumption not for debt reduction, and there might be issues around timing. These loans would also not be counted in any personal indebtedness calculations. Yes, its a bit clunky, but its workable. Phasing this in and giving a loan to the equivalent of say 25% of GDP per capita over 5 phases would be a massive stimulus. That’s about €10,000 per capita in Ireland. While much of this would of course leak out in imports and perhaps down pub drains the point is that it would stimulate the economy. Indeed, it might even overstimuate some areas of the economy. But at a Eurozone level stimulus is what is needed.
Now, where’s me helicopter..