In December 2003, Willem Buiter demonstrated that creating new fiat money does not create a liability for the issuer: see ‘Helicopter Money: Irredeemable Fiat Money and the Liquidity Trap’, NBER Working Paper 10163. Buiter has recently taken his analysis further (see: ‘What more can central banks do to stimulate the economy’, Citi, Economics, 9 May 2012).
Buiter argues, in essence and amongst other things, that in cooperation with the fiscal authorities, the central bank can finance a boost to public spending through an increase in the money base. He suggests that this may be the most effective form of stimulus currently.
Buiter’s proposal warrants serious and careful consideration by policy-makers. His proposal has potential implications for periphery countries, where demand and output are already falling and public debt is high and rising. The latest IMF forecasts indicate on-going budget deficits for many years yet. This means, all else equal, that public debt, already around default levels in some countries, will remain elevated, or go on rising.
The renewed economic downturn in periphery countries demonstrates that continued fiscal ‘austerity’ policies cannot be relied upon to create economic growth. Monetary policy has limited capacity to stimulate investment, as policy interest rates are already very low, and aggregate demand is falling. Changing the shape of the yield curve has not delivered tangible results where it has been attempted. Microeconomic and structural reform policies cannot be expected to generate substantial supply-side growth when demand is falling, or turn aggregate demand around in a short time frame.
A new policy paradigm ― to provide economic stimulus without increasing public debt ― is urgently required to counter falling aggregate demand.
When the downturn occurred in 2008 the IMF called for widespread fiscal stimulus. However, by way of comparison, this time around public debt is already very much elevated, dangerously so in some countries, mainly as a consequence of governments following that earlier IMF advice. It follows that, this time, if a general stimulus is again called for at some point, the IMF message will need to be carefully thought through, and take into account consequences for future debt levels. There is now little, or no, scope to propose new fiscal stimulus measures that are financed by the sale of government bonds to the private sector, as that would take public debt higher again. That scenario would quickly prove disastrous for countries already heavily laden with debt, and would precipitate defaults and a general financial crisis.
Could Buiter’s proposal deliver the required fiscal stimulus without raising public debt as measured and viewed by credit rating agencies (that is, by general government gross and net debt)?
Clearly, on the basis of his analysis, Buiter’s proposal could provide stimulus without generating a liability for the issuer of the new money used to finance the budget deficit.
Viewing the Treasury and central bank together ― call it the consolidated public sector ― there would be no overall net debt arising if the central bank created the new money and provided it to the Treasury to finance the deficit. However, in some jurisdictions, private banks participate in the ownership or control of central banks. This is a grey area, but warrants caution when discussing the limits of the government sector, and the combined Treasury/central bank model. As well, credit rating agencies ‘see through’, and recognise that government bonds sold to the central bank by the government in exchange for new central bank created money may be on-sold to the public at any time, thereby increasing the debt held by the public: another grey area.
In developing any plan to resuscitate ailing economies, there may possibly be a need, therefore, to be cautious and to address these grey area issues, or at least take them into account. For instance, if the issuer of the new money was the Treasury, and not the Central Bank, then there would be no need for the Treasury to issue new government bonds to the Central Bank in order for it to be able to transfer new Central Bank money to the Treasury (to finance the budget deficit). On this basis (or if the Central Bank and the Treasury swapped new currency tranches, and later swapped them back) there could be no actual or perceived increase in public debt.
From a macroeconomic policy perspective, with monetary policy aimed at lowering interest rates now largely ineffectual, it is difficult to identify alternative general policy solutions that deliver economic stimulus without increasing public debt.
Orthodoxy has failed. Defensive monetary policies ― firewalls, bail-outs, and purchases of periphery bonds on secondary markets to contain rising bond interest rates ― do not address the underlying source mechanism driving public debt upwards (the new bond financing of deficits). Economic stimulus is required, but policy makers would be acting recklessly indeed if they took any action now that exacerbates current debt difficulties.
A new macroeconomic policy paradigm is needed, whether countries stay inside the Eurozone or leave it. Greater coordination between monetary and fiscal policy is essential. Fiscal consolidation is required, but may need to go on hold until aggregate demand and activity are better stabilised. Active incomes and prices policies may assist in the more speedy restoration of competitiveness in periphery countries.
The problems of banking systems need urgent, separate, solutions. A central authority, presumably the ECB, needs to assume certain responsibilities for the on-going functionality, supervision and viability of the Eurozone banking system as a whole (not necessarily individual banks). In the meantime, capital flight, where it occurs, may need to be contained by exchange controls, if that could be feasible and effective.
Sovereign governments need to assume responsibility for macroeconomic policy coordination, and for taking all necessary action to stimulate their economies to avoid depression.
Further details can be found in EconoMonitor articles ‘Turning Periphery Economies Around: Moving from Austerity to Economic Growth’, May 22, and ‘A Call for Greater Coordination Between Monetary and Fiscal Policy’, April 19th.