European Policy Imperative: To Provide Economic Stimulus Without Increasing Public Debt

In December 2003, Willem Buiter demonstrated that creating new fiat money does not create a liability for the issuer: see ‘Helicopter Money: Irredeemable Fiat Money and the Liquidity Trap’, NBER Working Paper 10163.  Buiter has recently taken his analysis further (see: ‘What more can central banks do to stimulate the economy’, Citi, Economics, 9 May 2012).

Buiter argues, in essence and amongst other things, that in cooperation with the fiscal authorities, the central bank can finance a boost to public spending through an increase in the money base.  He suggests that this may be the most effective form of stimulus currently.

Buiter’s proposal warrants serious and careful consideration by policy-makers.  His proposal has potential implications for periphery countries, where demand and output are already falling and public debt is high and rising.  The latest IMF forecasts indicate on-going budget deficits for many years yet.  This means, all else equal, that public debt, already around default levels in some countries, will remain elevated, or go on rising.

The renewed economic downturn in periphery countries demonstrates that continued fiscal ‘austerity’ policies cannot be relied upon to create economic growth.  Monetary policy has limited capacity to stimulate investment, as policy interest rates are already very low, and aggregate demand is falling. Changing the shape of the yield curve has not delivered tangible results where it has been attempted. Microeconomic and structural reform policies cannot be expected to generate substantial supply-side growth when demand is falling, or turn aggregate demand around in a short time frame.

A new policy paradigm ― to provide economic stimulus without increasing public debt ― is urgently required to counter falling aggregate demand.

When the downturn occurred in 2008 the IMF called for widespread fiscal stimulus.  However, by way of comparison, this time around public debt is already very much elevated, dangerously so in some countries, mainly as a consequence of governments following that earlier IMF advice.  It follows that, this time, if a general stimulus is again called for at some point, the IMF message will need to be carefully thought through, and take into account consequences for future debt levels.  There is now little, or no, scope to propose new fiscal stimulus measures that are financed by the sale of government bonds to the private sector, as that would take public debt higher again. That scenario would quickly prove disastrous for countries already heavily laden with debt, and would precipitate defaults and a general financial crisis.

Could Buiter’s proposal deliver the required fiscal stimulus without raising public debt as measured and viewed by credit rating agencies (that is, by general government gross and net debt)?

Clearly, on the basis of his analysis, Buiter’s proposal could provide stimulus without generating a liability for the issuer of the new money used to finance the budget deficit.

Viewing the Treasury and central bank together ― call it the consolidated public sector ― there would be no overall net debt arising if the central bank created the new money and provided it to the Treasury to finance the deficit.  However, in some jurisdictions, private banks participate in the ownership or control of central banks. This is a grey area, but warrants caution when discussing the limits of the government sector, and the combined Treasury/central bank model.  As well, credit rating agencies ‘see through’, and recognise that government bonds sold to the central bank by the government in exchange for new central bank created money may be on-sold to the public at any time, thereby increasing the debt held by the public: another grey area.

In developing any plan to resuscitate ailing economies, there may possibly be a need, therefore, to be cautious and to address these grey area issues, or at least take them into account.  For instance, if the issuer of the new money was the Treasury, and not the Central Bank, then there would be no need for the Treasury to issue new government bonds to the Central Bank in order for it to be able to transfer new Central Bank money to the Treasury (to finance the budget deficit).  On this basis (or if the Central Bank and the Treasury swapped new currency tranches, and later swapped them back) there could be no actual or perceived increase in public debt.

From a macroeconomic policy perspective, with monetary policy aimed at lowering interest rates now largely ineffectual, it is difficult to identify alternative general policy solutions that deliver economic stimulus without increasing public debt.

Orthodoxy has failed.  Defensive monetary policies ― firewalls, bail-outs, and purchases of periphery bonds on secondary markets to contain rising bond interest rates ― do not address the underlying source mechanism driving public debt upwards (the new bond financing of deficits).  Economic stimulus is required, but policy makers would be acting recklessly indeed if they took any action now that exacerbates current debt difficulties.

A new macroeconomic policy paradigm is needed, whether countries stay inside the Eurozone or leave it.  Greater coordination between monetary and fiscal policy is essential. Fiscal consolidation is required, but may need to go on hold until aggregate demand and activity are better stabilised.  Active incomes and prices policies may assist in the more speedy restoration of competitiveness in periphery countries.

The problems of banking systems need urgent, separate, solutions. A central authority, presumably the ECB, needs to assume certain responsibilities for the on-going functionality, supervision and viability of the Eurozone banking system as a whole (not necessarily individual banks).  In the meantime, capital flight, where it occurs, may need to be contained by exchange controls, if that could be feasible and effective.

Sovereign governments need to assume responsibility for macroeconomic policy coordination, and for taking all necessary action to stimulate their economies to avoid depression.

Further details can be found in EconoMonitor articles ‘Turning Periphery Economies Around: Moving from Austerity to Economic Growth’, May 22, and ‘A Call for Greater Coordination Between Monetary and Fiscal Policy’, April 19th.

4 Responses to "European Policy Imperative: To Provide Economic Stimulus Without Increasing Public Debt"

  1. Curt   June 8, 2012 at 11:19 am


    I think this could be helpful, since all else has failed, but!

    If this situation was not going to have the large possibility of ruining my life and yours it would be funny at this point.

    A couple of times people did the right thing, but of course the wrong way. We went the exercise of having bank stress tests. In other words we tried to figure out where the bad debts were. Not too hard and not too well and not so the average person could understand, but rather so Wallstreet would have confidence and we could go on with the game. How many economist would it take to get a really good idea were the bad debt is.
    5,10, 50, 5000. If it took 5000 economist to find the bad debt and we paid each 1 million dollars than it would cost 5 billion dollars to find the bad debt. Not only should we stress test banks, but governments, households, corporations, and any other organizations which are significant to the economy. So maybe that will take 10,0000 economist and because we use so many maybe we will have to pay them 2 million a piece. Then the project will cost 20 billion which is small potatoes compared to the trillions at risk.

    Then we say ok here is where the bad investment has been. So now who is going to pay for it? So we need some plans to figure out who is going to pay for it in plain English,German,Xhinese and French. We need some smart people on this.

    So lets hire another 10 thousand economist and pay them each 4 million dollars( 40 billion) to come up with the 10 plans. 40 billion. Now we have spent 60 billion to save the world.The face book ipo went for what 107 billion.

    Yes I am being funny because today we have created all sorts of funny money. And now the best solution is to create more funny money. This is comical.

    Again my solution is figure out went wrong and then figure out who should pay for it. Once we figure out who will really own what then we can figure out who is worth lending money to in the future and we can get back to normal business. Austerity is not the confidence fairy. We do need confidence restored, but that will come with some common sense honesty and work. In the mean time I have never seen so many attempts to hide the real story from a public that does not want to know thru transparently opaque schemes. I still like this one. With modern computer networks it is actually possible to generate our own personal currency. I have modeled this and it is a lot of fun. What will the Roubini be worth compared to the Obama,the Curt, the Romney, the Merkel, or the Jolie.
    My guess is the Jolie will the strong currency.

  2. Tony Westerberg   June 8, 2012 at 12:10 pm

    Curt –

    "..Figure out what went wrong…?" An incompletely congealed dream as the basis for a complex construct between soverign entities, who have centuries of history of conflict, making the unavoidable end game of the dream (relinquishment of individual Sovereignty) impossible. It was always going to fail. From my view, all the noise over preservation of the paradigm is just so much hope (benevolent and selfishly motivated), and greed, likely motivated by self dealing to extract embedded financial assets for as long as it can be held up, in the hopes of getting out as cleanly as possible. The situation is really quite simple. It was poorly conceived to begin with.

    It has already failed. LTRO and all ther other stall tactics be damned, in the end, the market is catching up to the can.

  3. diatoo1   June 9, 2012 at 9:31 am

    Print any amount of Euros, throw it upon first demand at states and banks, lie to people that inflation will be neither imminent nor be high at a later time, it robs all people with savings, salaries and retirement payments, it will come into the hands of those who handle already tremendous amounts of finance and let them amass more of it, AND it will NOT solve any structural problems in any of those countries which are in need of reforms.

  4. Richard Hattwick   June 19, 2012 at 2:43 pm

    This is an excellent proposal. Dean Baker periodically makes the same argument in his Beat the Press blog.