Currently, new money creation by the European Central Bank has been deployed, inter alia, to purchase periphery country government bonds on the secondary market as a purely defensive measure to keep bond interest rates from rising above 6 or 7 per cent.
The question must be asked whether this is the best way to deploy such precious new money.
Clearly, if new money creation is used, instead, to finance the on-going budget deficits of these periphery countries, public debt would not increase further, all else equal. The public debt problem could, thus, be substantially resolved at its source. Sovereign credit ratings would not be further downgraded on account of rising public debt burdens. Periodic financial crises deriving from excessive public debt and resurgent bond interest rates could be avoided.
Historical precedent and support for monetisation of budget deficits
1) Since the Middle Ages, money-issuing organisations used reserves (e.g. gold or other legal tender money) to purchase financial assets, creating money in favour of some borrower, either other banks or the government. ‘More often than not, this borrower was the government’. ‘Over the centuries money-issuing organisations have chiefly supplied credit directly to the state; and even when loans to the banking system have become predominant, central banks have often accorded them provided that the banking system would, in turn, redirect at least part of them to the government’. ‘Historical evidence suggests that neither changes in the organisational model of central banks nor government deficit monetisation should necessarily be seen as evil’. (See Stephano Ugolini, ‘What do we really know about the long-term evolution of central banking? Evidence from the past, insights for the present’, Norges Bank Working Paper, 2011/15).
Deficit monetisation had both successes and some much publicised failures (due, in part, no doubt, to the policy being taken to excess). ‘Sometimes it ended in catastrophe, but on many occasions it did not’. (See Stephano Ugolini “What future central banking? Insights from the past”, VOX, 11 December 2011).
2) In ‘Functional Finance and the Federal Debt’ 1943, Abba Lerner states:
“When taxing, spending borrowing or lending (or repaying loans) are governed by the principles of Functional Finance, any excess of money outlays over money revenues, if it cannot be met out of money hoards, must be met out of printing new money, and any excess of revenues over outlays can be destroyed or used to replenish hoards’.
3) Milton Friedman later proposed that the main function of the monetary authorities could be ‘the creation of money to meet government deficits or the retirement of money when the government has a surplus’. ‘Under the proposal, government expenditures would be financed entirely by either tax revenues or the creation of money, that is, the issue of non-interest bearing securities. Government would not issue interest bearing securities to the public…’. (See Milton Friedman, ‘A Monetary and Fiscal Framework for Economic Stability’, June, 1948).
4) Milton Friedman later proposed the ‘helicopter drop’. This is a temporary tax cut, increase in transfer payments or boost to exhaustive public spending (including infrastructure investment), financed through a permanent increase in the money base. (See Milton Friedman, Optimum Quantity of Money, Aldine Publishing Company, 1969).
5) Ben Bernanke proposed the ‘helicopter drop’ for Japan in 2002 and for economies at zero-bound interest rates. (See Ben Bernanke, 2002, Remarks before the National Economists Club).
6) Willem Buiter formalised the proposition that new fiat money is not a liability to the issuer. (See Willem Buiter, ‘Helicopter Money: Irredeemable Fiat Money and the Liquidity Trap’, NBER Working Paper, No. 10163, December 2003).
7) Richard Wood argued that if the Treasury (not the central bank) printed new money to finance the budget deficit, economic stimulus could be delivered without an increase in effective public debt. (See Richard Wood, ‘Delivering Economic Stimulus, Addressing Rising Public Debt and Avoiding Inflation’, Journal of Financial Economic Policy, April 2012).
8) Willem Buiter argued that the ‘helicopter drop’ (including for Europe) is ‘perhaps the most effective form of stimulus currently’. He also argues for greater coordination between monetary and fiscal authorities. (See Willem Buiter and Ebrahem Rahbari, Global Economics View, ‘What More can Central Banks do to Stimulate the Economy’, Citi, May 9, 2012.)
Based on the above, there is a strong basis for considering deficit monetisation as the likely macroeconomic policy paradigm needed to simultaneously address both falling demand and rising public debt. When policy interest rates approach their zero bound, deficit monetisation represents (perhaps) the only combination of monetary and fiscal policy that could deliver a stimulus ― economic growth ― without increasing public debt (the formula so urgently required for periphery countries).
Hence, while a series of eminent economists have recommended deficit monetisation in the past ― when high public debt was not such a problem ― that policy approach is even more relevant today in circumstances where public debt is high, and threatening global financial stability. Deficit monetisation is particularly relevant, most immediately, for European periphery countries. Policy mistakes ― excessive reliance upon new money ― could be avoided if a strict legislative limit is placed on the amount of new money that could be created for this purpose.
8 Responses to “A Strong Case for Monetisation of On-Going Budget Deficits in European Periphery Countries”
To Richard Wood,
Your supporting argument for printing money and using it to buy things is a multiple appeal to authority. Essentially, "They all suggested doing it at one time or another". I would prefer an analysis of the good and bad effects.
Printing money is a stealth tax on anyone holding that currency and anyone lending in that currency. Eventually, they find that their money buys less; there is inflation.
The peasants might object to higher explicit taxation to meet government expenditures, but they are somewhat confused about the implicit taxation imposed by inflation. Yet, all of the bad effects of higher taxes are imposed in either policy.
Would you lend money knowing that the government might inflate the currency by say 5%, or 10%? How would that affect your desire to invest with a 3+ year time horizon? Does Europe benefit from policies which tell people to reduce their investment?
You write: "Deficit monetisation had both successes and some much publicised failures (due, in part, no doubt, to the policy being taken to excess)."
So, there have been bad effects from this policy "in excess". What is the econometric evaluation of what "excess" means? There might be a net bad effect from creating the next Euro, as there might be a bad effect from raising taxes to collect the next Euro. How do you know? What is the economic analysis? When and why did printing money make things better, and for whom?
I agree that a thorough analysis of the consequences of 'money printing' needs to be done. However, a distinction needs to be made between unilateral v. multilateral action regarding the effect on currency valuations. For example, if the issuers of all of the world's major currencies undertake such monetisation within the same time frame, surely the effects on currency valuations can be minimised, if not largely eliminated? These just so happen to be the countries where such action is most needed! Nonetheless, there is still the potential for an 'investor strike' down the track, but again multilateral action might tend to reduce this possibility.
I am sorry but according to Olivier Blanchard Macroeconomics book…..1930 Great Depression was solved by printing money.
Please consider that we are approaching zero interest rates in US and Germany: isn't that a low inflation scenario ?
Please consider that at the same time a real free x-rate floating regime should be applied to China currency and a review of bank regulation should be implemented (i.e.: back to Steagall Glass act).
It's good to hear out all proposals, even radical ones. If I understand Wood correctly, he wants central banks to issue money to governments and receive nothing in return. That's quite radical as it breaks the principal that central banks issue money in exchange for assets. It would be a different kind of fiat money, and I think not a stable kind. Wood should make this proposal more explicit and if he can provide a positive example from history. Gold and silver issuance in medieval times is not a parallel.
The developed world has though moved into a de facto practice of partly monetizing deficits. Central bank issuance in the US, UK, EZ and Japan indirectly funds governments. A leap from there to similar amounts of direct central bank purchases of primary government debt issue would break taboos but not make much practical difference. Public debts would still grow in line with deficits. We would I think still see the issuance kept on deposit and not re-lent, and so providing little demand stimulus and no investment stimulus.
In this discussion, naming Olivier Blanchard is another appeal to authority. I'm looking for an explanation, the policy, the measured results, and the confirmation that the policy led to those results, the cause and effect. Why is this compelling argument not online for reference?
Otherwise, the argument for spending is merely "in the 1930's government spent a lot more, and the Depression eventually ended".
How does the following fact fit into the conventional wisdom for borrow and spend:
Henry Morgenthau Jr. was FDR's Treasury Secretary in 1939:
We have tried spending money. We are spending more than we have ever spent before and it does not work. I say, after eight years of this administration, we have just as much unemployment as when we started, and an enormous debt to boot!
About zero interest rates. The federal reserve is buying US bonds to establish that zero rate. The theory is that businesses will boom when they can borrow at 0% rather than stagnate at 3%. That has not been the historic association. Booming economies usually have higher interest rates because there is competition for capital. That 3% difference doesn't much affect business decisions in this uncertain climate of national economic manipulation.
The US and Germany are in a perfect storm financially because of the "lifeboat effect". US bonds are seen to be much safer than European bonds because of Europe's financial crises. Big banks are authorized to buy US bonds without concern, because they have always been safe. German bonds are the safest euro demoninated bonds and sell for a premium at lower interest return, or even a negative return.
Everyone is sinking, but the US and Germany are sinking more slowly. People are rushing to the lifeboat, even though it is not really stable. This is supporting high Treasury bond prices and low interest rates, along with meddling by the Federal Reserve to create very low rates.
I'm glad you are continuing to publicize this policy option. It seems eminently workable to me. The proposal would enable the federal government to finance countercyclica fiscal actions without incurring any costs to the taxpayers. And, as you make clear, the proposal provides safeguards against inflationary after-effects.'So kudos to you and to economonitor for publicizing your thoughts.
As you continue your crusade to make this part of the mainstream policy discussion, why don't you devote an occasional blog to the case of the USA? Were you to do that be sure to cover:
1. The institutional fact that the Federal Reserve is required to pay interest back to the Treasury. So the Fed could buy the Treasury bonds and the interest payments would be a sim" ple two part bookkeeping entry. The Treasury would incur zero interest cost.
2. The Fed's option to hold the Treasury notes in perpetuity in which case future tax receipts would not be needed to pay back the loan. Alternatively, of course the Treasury could pay off the principal of the old loan by taking out a new loan from the Fed.
Thank you for your comments. I appreciate it.
In a long article appearing in the April edition of the Journal of Financial Economic Policy, I refer to perpetual debt. However, as I understand it now, the perpetual bonds would be included in gross and net general government debt, which is what credit rating agencies use to make their decisions. If my understanding is wrong please let me know. There is clearly accounting treatment friction/impediments in this area, and I cannot see that changing any time soon.