Unconventional monetary policies: From quantitative easing to debt monetisation
The first column in this two-part series (Bossone 2013) reviewed the unconventional monetary measures adopted by a number of central banks following the financial crisis of 2007, and the major policy proposals that were submitted as the crisis evolved into a deep economic recession or depression. The policies were: quantitative easing (QE); forward guidance; negative interest rates; overt monetary financing of fiscal deficits, including in extreme neo-chartalist forms; and debt monetisation. Although debt monetisation is primarily intended to avert default by highly indebted countries, once implemented it would increase public and private spending – thus helping to stabilise output and employment.
Table 1 offers a snapshot of what I consider to be the main features of each policy type. In the table, policies are reported from left to right in ascending order of the directness of their impact on spending – from those that rely on changes in prices and expectations to those that affect spending by adding money balances to the economy.
Table 1. Unconventional monetary policies: A synopsis
The policies that have greater direct impact on spending (overt monetary financing, neo-chartalism) are those that combine expansionary fiscal impulses with permanent monetary financing (‘helicopter money’). This combination requires a degree of cooperation between the government and the central bank, with implications for central-bank independence (see below). Government (and political) involvement, as well as the necessary coordination with the central bank, entail longer policy gestation periods than for policies involving the central bank exclusively (forward guidance, negative interest rates, and QE). On the other hand, the transmission from the fiscal-plus-monetary policy impulse to the spending response – which is inherent in helicopter money options – is more direct, quicker and stronger.
The features of the different unconventional monetary policies discussed in Part I suggest a number of interrelated considerations:
- Monetary effectiveness. In a highly-leveraged economy in a deep recession under deflationary expectations – with policy rates already at the zero lower bound – economic activity is constrained by aggregate demand rather than by the cost of money. Liquidity preference is high, lenders don’t lend, borrowers don’t borrow, and investors’ response to interest rates is weak. Under such conditions, the money issued by the central bank – typically against purchases of assets or through lending to banks – fails to yield enough economic stimulus. Interest rates lose their power to affect spending unless the large premium on liquidity is offset by a negative interest rate. Instead, money should be given out or granted for it to be effective, as occurs under helicopter money policies. Giving out money belongs to the realm of fiscal policy, not monetary policy.1 However, fiscal policy alone cannot implement helicopter money options, unless the government and the (independent) central bank cooperate (overt monetary financing) or if the government takes on full monetary sovereignty and finances deficits with money issuance (neo-chartalism).
- Central bank–government cooperation. Monetising fiscal deficits (or indeed fiscal debts, as under debt monetisation) constitutes a joint monetary and fiscal policy decision. With the exception of neo-chartalist operations (where money is issued by the government, or by the central bank as a government department), cooperation between the government and the central bank is necessary to engineer helicopter money policies, and such policies require a specific framework for assigning duties and responsibilities to the two institutions.2 Obviously, this impairs or calls into question central-bank independence, but in times of crisis this kind of cooperation may be necessary for the collective good.3 It is critical in such times to have an appropriate framework in place for emergency policy action. This framework should specify which institutions do what under which circumstances, and under which accountability rules. It should also be clear who is responsible for activating the emergency framework. In other words, just as in wars or national emergencies ordinary rules may be suspended and decisions delegated to a chief commanding body, so might economic policy decisions be delegated during particularly severe systemic crises.
- Money in central-bank models. In the macroeconomic models typically adopted by the central banks, there is no role for helicopter money. In these models, monetary policy operates through an interest-rate feedback rule – in which the interest rate is set in response to deviations from an inflation target and some measure of economic activity – and fiscal policy is usually restricted to a Ricardian setting (Tovar, 2008). There is no role in these models for money to be added directly into the public’s hands, or for the channels through which this money is spent. As a result, these models are not capable of gauging the real effects of such monetary-fiscal policies. At least for critical economic circumstances, there should be a way of introducing this type of money into the models in a meaningful way. This issued is discussed next.
Microfoundations of helicopter money
As argued by Buiter (2004), fiat money is not a liability of its issuer (the monetary authority), but it is an asset for its holder (the private sector). It is thus an integral part of the system’s net wealth. More generally, if the state is able to finance its own liabilities with permanent fiat-money issuances, the latter – for given current prices – add to the system’s net wealth.
In a dynamic stochastic general equilibrium model – with rational agents maximising utility over an infinite time horizon subject to inter-temporal budget constraints – an increase in net wealth through helicopter money issuance would lead agents to increase their current and future consumption – a ‘monetary wealth effect’. This means they plan to consume more than the income they earn by selling their labour for production. However, due to rational expectations, they realise that if they all behave this way then either:
- Output in each period grows by enough to satisfy planned consumption (which is possible only if there are unemployed resources), or
- The price level or the real interest rate rise so as to bring planned consumption back into equilibrium with output.
It follows that the Euler equation (which determines the solution to the agents’ optimal consumption programmes) reflects the monetary wealth effect, consistent with the current and expected resource-employment conditions. The same real effect would surely obtain in a model with an agent (the monetary sovereign state) that can spend and finance its own spending with helicopter money. This result vindicates the proposed measures to expand the money supply via overt monetary financing or neo-chartalism, which aim to inject new money independently of central banks' interest-rate policies – especially if these are limited by the zero lower bound.
Bernanke, B (2003), “Some thoughts on monetary policy in Japan”, Remarks by before the Japan Society of Monetary Economics, Tokyo, 31 May.
Bossone, B (2013a) “Time for the Eurozone to shift gear: Issuing euros to finance new spending”, VoxEU.org, 8 April.
Bossone, B (2013b), "Unconventional monetary policies revisited (Part I)", VoxEU.org, 4 October.
Bossone, B and A Sarr (2002), “A new financial system for poverty reduction and growth", IMF Working Paper No. 02/178, October.
Bossone, B and A Sarr (2003), “Thinking the economy as a circuit, in S Rossi and L P Rochon (eds.), Modern Theories of Money: The Nature and Role of Money in Capitalist Economies, Edward Elgar.
Buiter, Willem H (2004), “Helicopter money: irredeemable fiat Money and the liquidity trap”, CEPR Discussion Paper 4202.
McCulley, P and Z Pozsar (2013), “Helicopter money: or how I stopped worrying and love fiscal-monetary cooperation”, Global Society of Fellows, 7 January.
Tovar, C E (2008), “DSGE models and central banks, BIS Working Paper No. 258, September.
1 Grenville (2013). For an economy based on ‘noncredit’ money, see Bossone (2002) and Bossone and Sarr (2003).
2 Bossone (2013) identifies some essential elements of an operational cooperative framework.
3 Nothing makes the point more authoritatively than quoting the words spoken on this subject by Governor Bernanke (2003):
“[I]t is important to recognize that the role of an independent central bank is different in inflationary and deflationary environments. In the face of inflation, which is often associated with excessive monetization of government debt, the virtue of an independent central bank is its ability to say ‘no’ to the government. With protracted deflation, however, excessive money creation is unlikely to be the problem, and a more cooperative stance on the part of the central bank may be called for. Under [these] circumstances, greater cooperation for a time between [central banks] and fiscal authorities is in no way inconsistent with the independence of the central banks, any more than cooperation between two independent nations in pursuit of a common objective is inconsistent with the principle of national sovereignty.”