Various Kinds Of Monetary Policy Which The ECB Doesn’t Have

ECB niceTC

There is a lot of talk about Helicopter Money, a concept conceived by Friedman to revive the economy. This kind of monetary policy is very often referered to as special, beyond the frontiers of accounting, as if a central bank could actually get into a helicopter every day and drop bills from the sky “ex nihilo,” out of nothing.

But as Roche explains, HM is not special. It’s a measure similar to what the ECB is currently doing, an example of quantative easing (QE). But instead of buying public debt in the secondary market (and thus the cash has already been spent by the government), in the case of HM the central bank buys the debt directly at issue, in the primary market.

So this is a “strong”  monetization of debt which is immediate, not differed, as in the other example of QE. The image of Draghi getting into a helicopter, with trunks full of notes, and throwing them out over Europe’s capitals is an anachronism, or surreal.

It would cause a shortfall in a central bank’s balance sheet: the bank would be left without assets (public debt) to absorb excess liquidity once the recovery happened.

When it embarks on QE, a state buys debt in exchange for cash. This debt will then be used for the reverse operation when the economy recovers and inflation is a threat. If it were to throw a limitless amount of money out of the window, it would not have the means to recover this money later.

A central bank’s only obligation is price stability, but this is why it cannot be left without the resources to fulfill this.

Otherwise, it would be forced to recapitalise with money from the government, which would have to take on debt. The net difference in terms of debt is zero, so for that reason it’s better to do it properly from the start.

Furthermore, whenever the central bank carries out a monetary operation, there is an asset involved, whether it’s a loan with collateral or public debt (the collateral is usually short-term Treasury bills). (There are some people who say that there is nothing wrong in issuing money without any collateral, or if the central bank holds on to the debt permanently – which is as if it destroyed it. That would be a sign that things are very bad, incredibly bad, that the state is bankrupt. So better not to get to this scenario.)

So, the first conclusion: HM, like any kind of monetary expansion, always implies a fiscal policy. This is because any minimum intervention in the interbank market to raise or lower the interest rate affects the value of the debt and its yield. It’s one of its goals: increase or lower rates, with the difference that the bigger the operation is – QE with debt with a variety of maturity dates – the wider its reach and the more long term its impact. With open market operations, where there is no firm purchase but just a repo, the effect is only on the short term rate. This works in times of normality, but when the market is not sensitive – caught in the liquidity trap – more hard-hitting measures are required until the threat of deflation becomes a threat of inflation.

Indeed, the debt issued by the state can be earmarked as income for those who are most in debt, so they can reduce this. In the end, this is an expected effect of monetary policy, but it can be specifically directed towards this end. In any event, some people will inevitably feel offended in comparison with others. In my opinion, the least unfair policy is to cut personal income tax for everyone, with more of a reduction for those who pay more because of fiscal progression.

Now it’s easy to see why HM is impossible within the Eurozone: the treaties expressly forbid the ECB from directly financing governments’ deficits. But even if it wasn’t, it’s difficult to imagine that it would be technically possible.

The reason for this? The same one as always. In the Eurozone there are 20-odd governments, each one with its own “sovereign” fiscal policy: how much of each one’s deficit would the ECB finance? Would it be obligatory to have a deficit? What would happen to those countries with a surplus? Are the 20-odd governments all equally solvent? What would happen with the area’s joint fiscality, which is biased towards austerity? How would all this be coordinated?

Is it a problem? HM aims to ensure that the money for which governments issue debt gets more quickly into the  public’s hands. There is a timing difference between QE, which involves debt already issued some time ago, and HM, where debt is bought directly at issue. In the first case, the cash has already been spent by the government. What it does is alter the financial conditions so that the government can extend terms and finance itself, while the private sector is catatonic and deep in debt.

In the case of HM, the government directly transfers money to citizens with, for example, a tax reduction for everyone (or, perhaps, the most indebted) until the economy picks up. Afterwards, when this happens, presumably the increase in tax revenues would cover the deficit generated.
There are no gifts with monetary (or fiscal) policy, there are gaps. And these gaps, deferrals, are necessary in order for those who are most indebted to recover. They can improve their outlook and increase their spending without being expected to give back everything they owe right up to the last cent. In these gaps, interest rates fall to help rebalance the assets and liabilities of each sector. Monetary policy is absolutely always fiscal policy.

About the Author

Miguel Navascués
Miguel Navascués has worked as an economist at the Bank of Spain for 30 years, and focuses on international and monetary economics. He blogs in Spanish at: http://