Sunday 25 September 2016

Option of ECB gifting cash to citizens cannot be ruled out

Published 20/03/2016 | 02:30

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There is been a lot of talk that the ECB is running out of ammunition in its attempts to stimulate the eurozone economy and thereby bring inflation closer to the target it is mandated to achieve (of just under 2pc annually). This talk is entirely wrong.

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It is not much of an exaggeration to say that any central bank which presides over a paper money system ultimately only runs out of options when the world runs out of paper on which it can print bank notes. We are - very clearly - light years from that position in Europe now.

Thus far, the ECB's unconventional measures - from cheap, long-term lending to quantitative easing (QE) - have focused on stimulating the economy via the financial system.

This is quite understandable.

Financial systems exist to get money from those who have it but don't need it, to those who need it but don't have it.

In theory, the first port of call for a central bank attempting to stimulate an economy when interest rates are already very low is via the existing financial system.

But as the financial system played a large part in causing the problems that we are in now facing in Europe (very low growth after huge misallocations of capital caused a financial crisis), using that misfiring system to encourage more credit creation has understandably always had its critics.

Another argument against the type of measures which are being taken by the ECB is that the evidence from across the world suggests that they don't make a big difference when it comes to bringing inflation and growth back up to healthy levels.

About the best thing that proponents can claim is that such measures have prevented matters from getting worse than they would been without action.

The US and UK deployed unconventional monetary measures early in the crisis and they have done better than a lot of other developed economies, even if the link between the measures and better economic performance is tenuous and pretty much impossible to prove.

At the other extreme is Japan. That country first resorted to QE 15 years ago. Despite its repeated and radical QE actions, which - as the chart shows - have been far greater in magnitude than those of other central banks, Japan has not emerged from weak growth and under-shooting inflation.

Although the ECB only launched its own QE programme a year ago, it has certainly not been sitting on its hands during the crisis. Again, as the chart shows, it has expanded its balance sheet by as much as its British and US counterparts in its efforts to get the eurozone economy moving.

The latest moves by the ECB, announced 10 days ago, remain entirely focused on improving the functioning of the financial system by incentivising it in various ways to lend more money to the real economy. This included the printing of even more money and the use of some of that money to buy corporate bonds.

These measures, along with the cutting of interest rates and additional loan facilities for banks, should make some difference to the amount of new credit that flows into the real economy of the eurozone. But it is difficult to see these measures changing the trajectory of the eurozone.

So what's left?

A possible additional measure could be for the ECB to lend directly to businesses.

The main argument against this is that the European system of central banks, which (despite employing between 40,000-60,000 people across the zone) does not have the capacity to evaluate companies' applications for loans and then to manage those loans once they are issued. There is a great deal to this argument.

That leaves the option of the ECB dealing directly with individuals and households.

And with that we come to the 'helicopter drop' of cash we have heard about in recent weeks.

Dropping banknotes on the general population was originally mooted by the great 20th century economist Milton Friedman. He famously held that "inflation is always and everywhere a monetary phenomenon". As such, the printing of more money and the handing of it to private individuals, if done in sufficient amounts, can be guaranteed to raise inflation, no matter how depressed an economy is.

For decades, the helicopter drop idea was to economics what time travel was to futurologists - a fascinating and fun 'thought exercise'. But with very weak output growth in the euro area, inflation at historic lows across much of the world and a risk of outright deflation, the idea is slowly creeping up the agenda.

How would it work? In theory, it is simple.

The ECB would simply transfer newly created cash to citizens and/or residents of the single currency area. In practice, doing so would not be simple, of course - making sure that everyone who is entitled to the cash got it and preventing scammers from getting any would be a challenge.

But in terms of giving the economy a shot in the arm and pushing up prices, the ECB would likely get much more bang from its buck by giving cash to people than flushing ever more liquidity into the financial system.

For example, a transfer of €1,000 to every person aged 18 and over in the eurozone would come to €276bn, just 15 weeks of what it is currently spending.

Militating against this much more radical option is some strong general opposition, as well as some very strong opposition from some particular quarters - those quarters are not unexpectedly in German-speaking parts of the eurozone.

The usual argument against such measures is that they could set in train a chain of events leading to hyperinflation. The case of Robert Mugabe's Zimbabwe often comes up in this regard.

Readers may recall that that African country's economy was destroyed by inflation caused when its central bank, at the behest of its dictator, printed too much cash.

But with inflation as dead as it is in the eurozone and zero chance that a very independent ECB would be forced by politicians to print more than it believed necessary, the Zimbabwean comparison is not a good one.

The greatest risk of taking such unprecedented action is political.

If voters believe that their ills can be solved by printing money and if interest groups think that there is an inexhaustible source of free money sitting in Frankfurt, the clamour for handouts could leave the Frankfurt offices of ECB permanently besieged. It could also ease pressure on governments to undertake economic reforms which are painful but necessary.

Indicative of the view among Teutonic economists is the latest annual report of the German Council of economic experts.

Last November, they concluded that even the ECB measures in place before those announced 10 days ago were unjustified. The report stated that "core inflation, the GDP deflator and long-term survey-based forecasts of inflation show no signs of a dangerous self-reinforcing deflationary trend."

The use of the term 'no', rather than, for example, 'few' or 'very limited' gives some indication of how strong and rigid is the hostility in the eurozone's largest economy to monetary experimentation.

This alone probably means that Germany would rather see the euro break apart before countenancing what has been called, in somewhat populist fashion "QE for the people". But if growth doesn't pick up, the eurozone crisis will flare up again sooner or later. That itself would imperil the euro.

There is a very strong case for a grand bargain, including radical measures, such as gifting newly printed cash to households, along with deeper reform efforts by governments (in a recent paper I flesh this idea out*).

It is worth concluding by mentioning Mario Draghi's response to a question about helicopter money at the post-meeting press conference 10 days ago. Interestingly, he responded by saying that his institution had not looked into it - but he was in no way dismissive or hostile.

If it ever does come on the agenda, it will make all previous battles among the central bankers in Frankfurt look like mere spats.


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