With interest rate cuts and policy reforms lacking the power to kick-start a Eurozone recovery, is it time for “helicopter money”?
Mario Draghi surprised markets last week with a further cut in interest rates and a Quantitative Easing plan to start purchases of assets to expand the European Central Bank (ECB) balance sheet. These two actions were welcomed, as was the change in content and tone of his comments which emphasised (finally) the need for strong policy actions in Europe.
Unfortunately, the fear remains that this may be too little, too late. While the ECB’s plan to buy assets could expand its balance sheet over the coming months, the growth may just return it to the size it was several months ago. It is true that purchases of certain assets could have a stronger impact than the previous rounds of bank lending, but even this might not be enough.
And when it comes to interest rates, while the ECB has finally reached zero, it took so long that in the last months the Euro area has seen a dangerous move towards very low inflation. And, as inflation went down, real interest rates went up. Below is a chart that compares real interest rates in the Euro area and the US. (Real interest rates are calculated as the central bank interest rate minus the one-year inflation over the previous year).
Most striking is that since the summer of 2012 real interest rates have increased in Europe while remaining broadly stable in the US. During the last two years, while real interest rates have increased by more than 1% in Europe, they have gone down by about 1% in the US. This is all the result of the difference in behaviour in inflation, which may be linked to the differences in policies we saw during 2011, with much higher interest rates in the Euro area than in the US.
If the recent ECB actions are not enough, what else is to be done? Maybe if European governments start listening to Mario Draghi we could see a reversal of fiscal policy, possibly in a coordinated fashion across Euro members. In the absence of this, the ECB has very few tools left at its disposal. It could try to increase inflation expectations, hoping that this would translate into increases in wages and prices. But raising inflation expectations would require very strong communications possibly making explicit that a temporary deviation of inflation above 2% would be welcome. Or even better, an explicit increase in the inflation target of the ECB (which could be temporary, for X years).
The only other alternative is "helicopter money", which implies a permanent increase in the monetary base/supply via either permanent purchases of assets or direct transfers to the governments or households (read Simon Wren-Lewis’s explanation for the difference between QE and helicopter money or Willem Buiter ‘s discussion on why helicopter money always works). There has been some recent talk among central bankers about this idea but it has always been ruled out because of legal or practical constraints, which are likely to be more binding in the case of the ECB.
The discussion around helicopter money in the US led to the expression "helicopter Ben" to refer to the former chairman of the federal reserve, Ben Bernanke. Maybe it is time to see "helicopter Mario" do whatever it takes to save the Euro area. Finding a picture to illustrate what this would look like is so much easier with Mario Draghi...