Helicopter drops may have already arrived in stealth form, as monetary policy is forced into truly uncharted territory
By Mehreen Khan
19 MARCH 2016 • 7:00PM
The lords of finance are losing their touch.
Institutions which dragged the world from its worst depression since the early 20th century are finally seeing their magic desert them, if conventional wisdom is to be believed.
Eight years on the from the Great Recession, voices as authoritative as the International Monetary Fund and the Bank of International Settlements – dubbed the ‘central bank of central banks’ – have called time on the era of extraordinary monetary policy.
Having hoovered up $12.3 trillion (£8.5 trillion) in financial assets and carried out 637 interest rate cuts since 2008, central banks have been stunned back into action in the last six weeks.
The Bank of Japan kicked off a new round of global easing with its decision to cross the rubicon into negative interest rate territory on January 29.
Eurozone policymakers followed suit earlier this month with a triple whammy of interest rate cuts, €20bn in additional asset purchases a month, and an unprecedented move to allow commercial banks to borrow money at negative rates.
The Federal Reserve has also taken its foot off the pedal by slashing its expected interest rate hikes from four a year to just two.
But the new wave of policy accommodation has ushered in fresh panic that monetary policy is suddenly subject to dwindling returns.
Instead, talk has turned to governments finally pulling their weight to support the shaky global recovery.
Fiscal policy has been largely dormant in the wake of the crisis as countries have concentrated on bringing down debt and deficits levels, binding themselves to stringent spending rules in the process.
But without tax breaks and greater state investment, the world is at risk of another “economic derailment”, the IMF has warned.
In its latest communique the G20 paid lip service to the idea that global governments will adopt policies to “strengthen growth, job creation and confidence”.
Realistically, there are little signs that politicians are ready to jettison their fixations on low debt and balanced budgets to support global growth.
Central bankers have led the world out of recovery as politicians have stood on the sidelines
In Europe, it is an issue which is straining relations between central bankers and their respective governments.
Faced with accusations of impotence, Vitor Constancio, vice president of the ECB, launched a dogged defence of the central bank’s actions, claiming they have been responsible for two-thirds of all eurozone growth since 2014.
Not only is it wrong to start talking down monetary policy – it’s actually dangerous ECB vice president Constancio
Moreover, the very design of the euro actively prohibits governments from stepping in to stimulate weak economies, says Constancio.
“Stabilising fiscal policy is restricted by law in the EU. Countries that could use fiscal space, won’t; and many that would use it, shouldn’t.”
Amid such constraints, Constancio warns “not only is it wrong to start talking down monetary policy – it’s actually dangerous”.
Thinking the unthinkable
Faced with political intransigence, central bankers are openly talking about the previously unthinkable: “helicopter money”.
A catch-all term, helicopter drops describe the process by which central banks can create money to transfer to the public or private sector to stimulate economic activity and spending.
Long considered one of the last policymaking taboos, debate around the merits of helicopter money has gained traction in recent weeks.
ECB chief Mario Draghi has refused to rule out the prospect, saying only that the bank had not yet “discussed” such matters due to their legal and accounting complexity. This week, his chief economist Peter Praet went further in hinting that helicopter drops were part of the ECB’s toolbox.
“All central banks can do it”, said Praet. “You can issue currency and you distribute it to people. The question is, if and when is it opportune to make recourse to that sort of instrument”.
With 16 out of Europe’s 28 economies still in deflation and annual eurozone growth set to hit just 1.4pc in the middle of a cyclical upturn, the opportune moment may soon be upon us.
“We have had forward guidance, QE and negative interest rates, says Gabriel Stein at Oxford Economics.
“But none of these has proven a panacea and their shelf-life is getting shorter.”
Helicopter drops by stealth
For some observers, the next phase in extraordinary central bank action is already upon us, and it is Japan which is leading the way.
The Bank of Japan’s move to impose a three tiered deposit rate on banks is a covert attempt to inject funds directly to the private sector, argues Eric Lonergan, economist and hedge fund manager.
He notes that the BoJ’s decision to exempt some reserves from the negative rate represents a transfer of cash to commercial lenders at rate of 0.1pc.
The system “separates out the interest rate on reserves from that which affects market rates”, says Lonergan.
“It is taking the first step along the journey towards helicopter money and opens up a whole new avenue of stimulus”.
In the same vein, the ECB has also signaled its intention to move towards targeted attempts to boost private sector credit demand.
From June, eurozone banks will be paid as much as 0.4pc to borrow from the ECB for four years – a scheme dubbed ‘Targeted Long-Term Refinancing Operations’ (TLTRO’s). Lenders who do the most to pass on cheap loans to customers will be rewarded with the most favourable rates.
Erwan Mahe, chief macro strategist at HPC, calls the ECB’s moves a “veritable revolution” in monetary policy which marks the end of an erstwhile central bank taboo.
“For the first time in the history of central banking, private-sector agents will be able to borrow money from the ECB and give back less than the capital borrowed,” says Mahe.
“As long as fiscal authorities do not act to offset the counter-cyclical lag in aggregate demand, [TLTRO’s)] will probably play an increasingly important role” in eurozone policy, he notes.
“I wish they’d done it an awful lot sooner”, says Lonergan, who says that for all its institutional constraints, the ECB still boasts a number of tools to boost bank lending.
With government borrowing costs at rock bottom across the eurozone, even more QE would be unnecessary at this stage, he says.
TLTRO’s however, “open the possibility of two different rates where you can leave the policy rate unchanged but lend to banks at lower and lower rates contingent on them lending to the real economy” he adds.
“It is much cleverer way of doing things because savers do not suffer.”
Smashing the taboo
But central bank ingenuity – however welcome – raises separate concerns about the accountability of institutions whose independence is sacrosanct but where decision-making is often insulated from public view.
Lord Adair Turner, a former chairman of the Financial Services Authority, and one of the earliest advocates of helicopter money, calls for more transparency in a bid to finally smash the taboos around injecting money straight into the hands of consumers or governments.
“I think it is more dangerous for central banks to forever deny what they are doing,” says Lord Turner.
He calls Japan’s move to issue government debt at a rate of 40 trillion yen, while the central bank expands its balance sheet at a rate of 80 trillion yen a year, “a de facto debt monetisation”.
“You are effectively replacing government debt with central bank money,” says Lord Turner. “It would be better for authorities to publish a statement, laying out the rules and assuring the world it is not too much.”
Lord Adair Turner has been a long standing supporter of a scheme of “money financing” between central banks and governments
But with much of the global economy witnessing steady if unremarkable expansion, any such admission is unlikely to come before another full-blown crash.
Mapped: Where in the world have rates turned negative? (click to view map)
Until then, debate will rage over the optimal way to engineer helicopter drops and the dividends they could bring to a subdued global economy.
For critics, the world’s recent oil price crash is an ominous sign that consumers are still not ready to spend any free windfalls. The boost to global spending from this effective tax cut has not been as direct as economists would have expected, as people continue to pay down their debts or save for rainy day funds.
In the eurozone meanwhile, still stuck in a low-growth and high unemployment morass, the political barriers to extraordinary measures should not be underestimated.
Where is the government Draghi can turn to if he ever wanted to fire up his helicopter? Ashoka Mody, former IMF bail-out chief
For all the exasperation aimed at the political class, the ECB still faces insurmountable barriers to action in an incomplete monetary union.
“Where is the government Draghi can turn to if he wanted to fire up his helicopter?” asks Ashoka Mody, a former assistant director at the IMF.
Seeking technocratic solutions to intractable economic problems also risks further damage to the fabric of the single currency, already facing huge challenges from migration flows and the rise of political extremism.
“By substituting so directly for fiscal policy, helicopter money becomes a profoundly political act”, says Mody, who led the IMF’s bail-out of Ireland from 2011.
“Europe has tried to govern itself through technocratic rules, especially the budget limits, and it has never worked.”
The challenges of the eurozone – where 19 differing governments are under the aegis of one central bank – are a far cry from Japan, where both fiscal and monetary policy are working in tandem to revive the economy.
“I think we will be lucky if Europe does as well as Japan did during its lost decade”, says Mody.
But the debate around helicopter drops has given way to a welcome fightback from central bankers who reassert that they are never powerless to generate inflation.
Citing Milton Friedman’s maxim that “inflation is always and everywhere a monetary phenomenon”, economist Tim Congdon is adamant that monetary policy is still the only game in town.
“Monetary policy can never – repeat, never – ‘run out of ammunition’”, he says.