Wise fiscal policy is not about helicopter money

Op-ed by Mr Claudio Borio, Head of the Monetary and Economic Department of the BIS, published in Il Sole 24 Ore, 8 November 2019.

Before the Great Financial Crisis it would have been inconceivable. But there is a growing recognition that monetary policy in some key advanced economies is nearing its limits. It has taken the brunt of nursing the recovery. And now, like an exhausted runner, it needs to take a breather and regain energy. A more balanced policy mix is needed.

The limits are not technical. If they wanted, central banks could push interest rates further into negative territory. They could engage in bigger and broader asset purchases. They could provide more generous funding to banks.

The limits are of an economic and political economy nature. The longer central banks extend extraordinary measures and the further they take them, the smaller the benefits and the larger the costs. These costs reflect, for example, the impact on financial intermediation, risk-taking, debt accumulation and the allocation of capital across sectors and firms.

A wise use of fiscal policy can help make up for the shrinking monetary policy room for manoeuvre. "Wise" means that its deployment should not endanger long-run sustainability. Even with interest rates as such low levels, not all countries can prudently expand, especially once society's looming aging costs are taken into account. "Wise" means reversible, to avoid a further upward creep in debt-to-GDP ratios, now at peacetime peaks globally. Automatic stabilisers are important. And "wise" means, above all, growth-friendly: designed to improve countries' longer-term productivity and resilience, such as by reducing taxes on employment, removing subsidies to debt, or executing efficiently well-chosen infrastructure projects.

"Wise" also means avoiding the deceptive lure of variants of so-called "helicopter money" or, in less colourful language, debt monetisation. Given the considerable confusion surrounding this topic, it is worth dwelling on it for a moment.

Helicopter money conjures up a powerful image -- money falling from the sky directly into people's pockets. Choreography aside, though, it amounts to two rather mundane steps. The first is simply crediting individual accounts, just like the government does when paying out unemployment benefits or tax rebates. The second, less well understood, step is allowing the additional money to swell banks' deposits with the central bank (technically, boost "excess reserves") -- that is where the money ends up.

We have a pretty good idea of what their respective impact is; neither step is new. Transfers are the largest component of government spending. And the main central banks have operated with excess reserves for quite some time now. There is a consensus that simply adding to the reserves has little effect of its own on economic activity. It pushes on a string. The action is on the asset side of the central bank's balance sheet, ie with the large-scale purchases of government securities that drive down bond yields, even into negative territory. But, as already noted, this is precisely what people look at when concluding that monetary policy is reaching its limits. It would simply be more of the same.

What is different with helicopter money is the explicit link with government deficits and its governance. Neither aspect speaks in favour of the scheme, regardless of the variant. It is simply politically unrealistic to expect that the central bank could be in charge of deciding how much to transfer, when to transfer and, above all, when to stop - as some proposals suggest. Not least, raising rates when exiting would require absorbing back the excess reserves or paying interest on them. Both would lower central bank remittances to the government, resulting in an outsize cost on public finances. Thinking of the consolidated government-cum-central bank balance sheet, large-scale central bank purchases of long-term government debt financed with bank reserves amount to a big debt management operation: replacing long-term debt with short-term (overnight) debt. This would make little sense economically: the government would be better off locking in the unusually low bond yields by extending maturities rather than relying on monetary financing. And it would also risk putting political pressure on the central bank to avoid raising rates regardless of the economic circumstances - a form of fiscal dominance.

All the talk about monetary financing diverts attention from the main task. The only way of boosting sustainable growth is to work hard on structural reforms that make economies more competitive, more vibrant and better able to embrace innovation. Central banks do not have a magic wand.