Europe is stuck in a rut and it’s getting dangerous. Monetary policy is looser than it’s ever been and there’s little chance it will tighten any time soon. Is helicopter money the way out?
If growth slows suddenly due to, for example, the coronavirus – or if the Brexit transition and a re-elected Donald Trump cause a bigger dip in trade – there will be calls for more monetary easing.
The Federal Reserve has a bit more space, but if the European Central Bank (ECB) cuts its deposit rate, now at minus 0.5%, it could be contractionary.
As I have heard time and again from economists, as well as bankers, further attempts to use the deposit rate to stave off deflation could end up hastening it by making life even less bearable for the banks.
The obvious response is that ECB president Christine Lagarde’s strategic review this year needs to herald a new approach and allow more radical measures.
Yes, governments should spend more, but will they, and what if they don’t? Is the central bank simply to give up? Just accepting lower inflation would damage the central bank’s credibility and make long-term negative rates more likely.
From a northern European perspective, in any case, inflation may already be too high. In Germany, it’s roughly at the ECB’s target of just under 2%. It’s higher still in the Netherlands.
If, as some propose, you add more housing costs to the inflation basket then, eurozone-wide, inflation could be roughly at the ECB’s target of below but close to 2%, says Moritz Sterzinger, director at risk consultancy Chatham Financial.
But the ECB would be right to look for ways to drive inflation and growth higher. The spectre of deflation has not gone. German growth has fallen further than Italy’s in recent months, risking recession. Inflation is around zero in Italy and austerity-tired borrowers in southern Europe will not withstand higher rates.
Some politicians argue that more highly indebted nations – in the absence of an ability to devalue their currency – should instead suffer looser welfare and labour protections than northern Europeans enjoy.
That’s not a one-way bet, though, as the economic benefits of loosening labour laws may not outweigh the political costs of greater perceived precarity, which is already the biggest contributor to the rise of populism, across the continent.
The idea that only Germany should spend more on its infrastructure is similarly fallacious.
Inflation and growth have been lower than Germany’s in southern Europe and the infrastructure is generally worse, but if Germany itself won’t spend enough, there’s even less chance of a German-led European Union allowing southern Europe sufficient space.
Furthermore, the moral hazards of quantitative easing (QE) would be even more obvious if the ECB bought only higher-yielding government bonds.
So, what to do?
It is now fundamentally harder to keep inflation up, as the ageing population raises pension needs. The internet wastes just as much of our time as it saves – unlike previous technological advances, such as trains and planes – so it’s not improving productivity.
Yet central banks, including the ECB, also hold some responsibility for the financial crisis of 2008 and the devastating recession that followed. Interest rates and financial regulation were too lax before the crisis and too tight in the aftermath.
Could the ECB target nominal GDP, based on an estimated potential – or average inflation, which allows temporary over- or under-shoots – to ensure similar mistakes are less likely in future?
The difficulty is that if you accept that growth and inflation are too low and too hard to budge, changing the target will not get around the impasse. Experiments such as QE and negative rates have merely alleviated the situation. Things like QE targeting green finance will not be a game-changer either.
The same applies to those arguing for a higher inflation target: it’s justifiable in the longer term, but today it would either involve much deeper negative rates, or more damage to the central bank’s credibility.
Could helicopter money – where the central bank makes a one-off deposit into your bank account – prove more politically palatable?
As central banks’ core problem has become low not high inflation, helicopter money is moving ever further from the realm of theory. Prominent figures from the world of economics and central banking, such as Stanley Fischer and Adair Turner, have recently set out how it could be part of the practical tools available to central bankers, if properly limited and defined.
There are questions to resolve – who gets paid, how, how much and how many times – even before you get to the issue of how to ensure national governments play ball. But these problems can and should be tackled. Just because something seems radical, that doesn’t mean it is unworkable. Doing nothing is riskier.
Helicopter money cannot be a tool for normal times, but in an extraordinary scenario it could serve to reset inflation expectations and jolt the economy out of deflation. It could avoid the most salient criticism of ultra-low rates and QE, which is that they merely inflate asset bubbles.
A helicopter drop could be in the form of consumption vouchers with an expiry date, for example.
You’ll end up paying for it, as prices rise, but being forced to spend, say €1,000, will surely make everyone cheerier, particularly as it would happen at the gloomiest economic moment.