Paul De Grauwe and Yuemei Ji (“Quantitative easing in the Eurozone”, VOX, 2015) have argued that quantitative easing (QE) can occur in the Eurozone without fiscal transfers. This may be the case, but their analysis is fundamentally misplaced, as it is based on incorrect, incomplete or missing premises. We think it would be a mistake for the European Central Bank (ECB) to embark on QE, and we see no reason to believe it would effectively assist the crisis-hit countries of the Eurozone overcome economic stagnation and deflation.
The first proposition of doubtful value is that the ECB should adopt QE to counter the deflationary tendency in the Eurozone. There is little convincing evidence from Japan, the UK or the USA that QE has any significant effect on consumer price inflation. If you haven’t noticed, despite massive money injections, the deflation tendency is still present in all three countries. Rather, it is clear that QE (asset and longer-term bond purchases) directly raises asset and bond prices. That is the objective of QE. QE does not buy-up ordinary goods and services, and consequently QE does not create consumer price inflation.
The second implied proposition is that an increase in the money base is needed to increase inflation. This proposition, too, is of doubtful value. QE does increase the money base, but it does not necessarily increase the money supply. Successive rounds of QE in Japan and the USA have not increased the money supply even though it increased the money base enormously.
The third is a “missing” proposition. De Grauwe and Ji miss to recognize that QE has delivered positive effects only when it was implemented in conjunction with decisive fiscal stimulus, since it counteracted the interest rate rises that deficit and debt growth would have otherwise caused. In other words, QE must be complemented by fiscal expansion for aggregate demand to be affected. This does not seem to be possible in the Eurozone today. In Japan, QE has kept long-term interest rates low, but the already huge debt has grown further larger, raising the likelihood of future necessary fiscal corrections and increasing the uncertainty for private sector spending decisions.
Finally, De Grauwe and Ji seem to suggest that QE reduces the financial obligations associated with the debt purchased by the central bank. Yet, they fail to specify the conditions required for the related debt obligations to be “sterilized” indefinitely.
Monetary and Fiscal Policy Coordination
In the Eurozone there needs to be much closer cooperation between monetary authorities and fiscal authorities. The objective should be to raise aggregate demand with fiscal policy (fiscal expansion) and to avoid any further increase in public debt.
When QE is combined with a bond financed fiscal deficit there is an increase in the public debt. De Grauwe and Ji observe that, under QE, government bonds are replaced by a monetary liability without interest and that, at the moment of the purchase, the government bonds cease to exist. As they still observe, prior to the purchase the government has to make these payments on the outstanding debt, and has to tax citizens to make this possible. Therefore, they conclude, the purchase of the bonds by the central bank relieves taxpayers. Yet all this holds true only if the purchase is permanent, that is, if the central bank commits explicitly and publicly to holding the purchased debt permanently, thus eliminating all government obligations to repay the debt (capital plus interest) purchased and held by the central bank.
De Grauwe and Ji seem to be aware of this point, although they notice that the in the future the ECB might want to sell part of the governments bonds it has acquired in the secondary market.” They miss to specify the condition whereby, for Governments and taxpayers to be effectively relieved of debt and tax obligations, QE purchases must be accompanied by a “permanent debt holding” commitment clause, which would “sterilize” such obligations indefinitely. In the absence of such condition, Governments will continue to bear the obligations associated with the outstanding debt, and taxpayers will face the related future tax obligations.
It follows that a policy plan is required that provides economic stimulus through a budget deficit without increasing public debt. This can be achieved by adopting an appropriate form of Overt Money Financing (OMF). OMF – which is a form of helicopter money – is the most effective instrument to affect aggregate demand in economies under heavy recession and totally limited fiscal space.
Under this approach, a Government of the Eurozone would submits to its Parliament and the Eurogroup a pre-defined fast-track public-spending package or tax-reduction plan to be financed in deficit under the Emergency Liquidity Assistance (ELA) facility of the European System of Central Banks (ESCB). The corresponding deficit is set with a view to delivering a pre-determined domestic nominal-demand target. After consideration of the approved Government programme, the ECSB would endorse use of the ELA for deficit financing purposes by the central bank of the submitting member country. The national central bank would communicate to the Government its readiness to finance an increase in the fiscal deficit through permanent purchases of newly issued debt under the ELA facility. This OMF operation could be constructed in ways that would not require activating overdrafts or credit facilities in favour of EU public institutions or the purchase of public debt instruments.
Operationally, the permanence condition discussed above can be attained if OMF operations are executed either by (i) having the government issue interest bearing debt, which the central bank would buy and hold in perpetuity, rolling over into new government debt when the existing debt on its balance sheet reaches maturity (in this case, the government would face a debt interest servicing cost, but the central bank would make an exactly matching profit from the difference between the interest rate it receives on its debt and the zero cost of its money liabilities, and would return this profit to the government), or by (ii) having the central bank purchase special government securities that are explicitly non-interest bearing and never redeemable. In terms of the fundamentals of money creation and government finance, the choice of these two routes would make no difference (Turner 2013). The national central bank could also buy the bonds on the secondary market, under the same commitment to permanent purchases as in (i) above, and the government could use the resources saved on capital and interest payments to finance a public spending or tax reduction programme.
Alternatively, the Ministry of Finance of each country could issue certificates to households and businesses, which could be immediately exchangeable for Euros. Following a recent proposal discussed on the Italian media, the government could issue new bills called Tax Credit Certificates (TCC) by amounts necessary to gradually close the economy’s output gap, taking into consideration plausible values of the fiscal multiplier for an economy with large unutilized capacity where monetary policy operates under the zero lower bound.
TCC would represent government bills of exchange: the government would have no obligation to reimburse them in the future. Rather, two years after issuance, they would be accepted to fulfil any financial obligation towards the Italian state (taxes, public pension contributions, national health system contributions, etc.). The deferral would allow for output to start recovering and generate resources to offset the shortfall of the euro-denominated tax receipts that follows when TCC start being accepted by the state for payments of taxes and other obligations. The TCC would be a form of (quasi) money originated by fiscal fiat, their issuance would not generate new public or private debt, and their allocation would reach people with higher spending propensity.
TCC would be issued free of charge to private sector enterprises and employees. Enterprises and employees receiving TCC allocations could immediately cash them into euros and use them for spending. The market would discount them like any zero-coupon two-year (default-free) government bonds. Those deciding to hold TCC would use them past the deferral date to pay taxes and obligations to the state.
Enterprises would be allocated TCC based on their labour cost. TCC allocations would primarily aim to reduce the fiscal wedge between gross salaries paid by the enterprises and the net salaries received by the employees. They would cut enterprise tax bills and raise employees’ disposable incomes. Higher disposable incomes foster consumption, and labour cost reductions would encourage employment and improve competitiveness. The trade balance would reflect both the effect of lower labour costs on competitiveness and that of increased spending on imports. By partially offsetting tax-driven excess labour costs, TCC allocations would help enterprises to recover external competitiveness, thus balancing the effect that TCC allocations have on imports via higher demand.
Improving demand would stimulate investment and revamp banking. As expectations reinvigorate, private consumption and investment would bounce back, and the economy would re-approach full employment, the government would reduce and finally terminate new TCC emissions while tax reductions would become permanent.
The De Grauwe’s and Ji’s analysis is based on incomplete or misplaced fundamentals.
The application of large scale QE policy in the Eurozone would not, in and of itself, possibly raise inflation or generate jobs. It would, however, contribute to asset and share price inflation, it would distort debt/equity choices and the pricing of risk throughout the economy, it would deprive the elderly of riskless income, and it would distort the exchange rate. Ultimately, resources would be misallocated. Longer-term Interest rates might be lowered for a time, but that would distort the yield curve. It is hard to imagine that with policy interest rates so low, a further reduction in long-term rates would have a significant impact on consumer spending and fixed investment. And once implemented there needs to be an exit, which could greatly destroy confidence and destabilise markets.
Fiscal expansion rather than fiscal contraction is required in the Eurozone. But QE plus bond financed fiscal expansion would not be effective. The required fiscal expansion cannot be financed by bond issuance, as that would increase public debt. It cannot be financed by raising taxation rates as that would further depress demand. It needs to be financed by new money creation accompanied by a permanent holding commitment clause.
Now more than ever, what the Eurozone needs is that injections of new money be directed to households, not to commercial banks and high wealth individuals, and that households be reassured that no new tax obligations will be imposed on them to foot future tax bills associated with higher debt. What needs to be done is to use monetary and fiscal policies in a coordinated manner with a view to ensuring that money is created and distributed to agents with a high propensity to spend it.
Archer D, and P Moser-Boehm (2013) “Central bank finances”, BIS Papers No 71, Bank for International Settlements, April.
Bossone B (2014) ‘Secular stagnation’, Economics Discussion Paper No 2014-47, November 19.
Bossone B and R Wood (2013) ‘Overt Money Financing of Fiscal Deficits: Navigating Article 123 of the Lisbon Treaty’, EconoMonitor July 22.
De Grauwe P, and Yuemei Ji (2015), “Quantitative easing in the Eurozone: It’s possible without fiscal transfers’, VoxEu, 15 January
Turner A (2013) “Debt, Money and Mephistopheles: how do we get out of this mess’, Cass Business School Lecture, 6 February
 See Bossone (2014).
 The Emergency Liquidity Assistance facility gives national central banks of the Eurozone the ability to support temporarily illiquid domestic institutions and markets over and above ESCB assistance, in exceptional circumstances and on a case-by-case basis. The ELA is not a function of the ESCB, and the power to use it lies with the national central banks and does not derive from their membership in the ESCB. Although the use of the ELA by national central banks is not constrained by the rules governing European System of Central Banks operations, restrictions apply:
- Prohibition of overdraft facilities for official bodies;
- Purchasing government bonds;
- Undertaking tasks that go beyond those of a central bank (ECB 2012a).
The ELA does not require explicit approval of the ESCB, yet it may be terminated by vote if it is deemed to run counter to the ESCB’ mandate. Moreover, the same degree of independence is required for national central banks performing ELA functions as they enjoy in carrying out ESCB-related operations.
 See Bossone and Wood (2013).
 Of course, these operations would weigh on the balance sheet of the central bank and, ultimately, on its capital. Such circumstance, however, is to be seen in the very special context of an institution that can always resort to ‘printing’ money in order to cover eventual balance-sheet losses and capital erosion. It becomes critical only when the need to create money for balance-sheet reasons conflict with the monetary policy objectives that the central bank pursues. See the important contribution by Archer e Moser-Boehm (2013). These consequences would not differ, obviously, if deficit financing were provided directly by the state treasury through the issuance of its own monetary instrument, and in the context of a consolidated public sector balance sheet.
 See the recent public Appeal for Italy and the Eurozone published by a group of Italian economists, and available in both Italian and English respectively at http://www.syloslabini.info/online/risolviamo-la-crisi-dellitalia-adesso/ and http://www.syloslabini.info/online/wp-content/uploads/2014/11/Apello-Inglese.pdf.
 A preliminary simulation exercise suggests that the Italian government could issue TCC at a 200-billion annual rate for 2015-2018, and phase out the program during 2019-2023. Assuming a fiscal multiplier effect of 1.2, conservatively spread across three years, and two alternative inflation scenarios, Italy would close the current output gap by 2017, never exceeding the Maastricht treaty 3% budget deficit limit, and steadily reducing its gross public debt/GDP ratio. Besides, a multiplier of 0.8 would be necessary for the shortfall of fiscal revenues in euro (due to TCC payments) not to cause the deficit to exceed the 3% limit. Note that, after TCC phase-out, the higher tax revenues due to GDP recovery allow for making permanent the demand support action (including the lower tax burden) initially financed with TCC.