To G-20 Leaders: Urgent Need to Boost Demand in the Eurozone

The economies in the Eurozone are continuing to slide into recession and depression.  Senior officials of G-20 countries (including those in Australia, the host government) have not understood, or anticipated, that the Eurozone crisis is a major threat to global recovery. The officials have provided sub-standard advice to their leaders.  The deepening crisis must be addressed.  This article identifies a strong monetary/fiscal policy combination that could boost consumer and aggregate demand, and simultaneously address high public debt burdens and deflation.

The G-20 Conundrum: How to Ensure Economic Recovery

The G-20 Leaders may well endorse a higher global ‘growth target’ at the forthcoming meeting in Australia, but they will only pay lip service to this objective if they fail to outline the monetary/fiscal policy combination that is required to substantially lift aggregate consumer demand and economic growth.

G-20 Leaders will go to their meeting believing monetary and fiscal policies have reached their limits (as interest rates are at zero bound and public debt is excessive in afflicted countries).  As a consequence, they will focus not on the large-scale demand stimulus policies needed to pull the afflicted countries away from dangerous reefs, but on an elaborate check-list of supply-side structural and infrastructure policies.  The G-20 leaders will not be focussed on the major issue.

The IMF is reportedly examining 900 of these small-tug-boat-type policies.  And these 900 will, in future weeks, probably need to be joined by hundreds more to reach growth targets. The G-20 hope is that they will be able to organise a sufficiently large and impressive armada of tiny tugboats to push and pull at small crippled or malfunctioning parts of major economic blocks.

However, while structural reforms and infrastructure investment may always be desirable, the required locomotive power to substantially lift consumer demand and economic growth is far and away beyond that which can be harnessed from small tugboats.

The Failure of Current Policies

Throughout history, economic stimulus via monetary policy has been effected through two broad channels.

First, new money has been injected through the bank and financial market intermediation channel, which stimulates lending and spending by making additional purchasing power available to the private sector at lower cost conditions.

Lately, as a response to the global crisis and in a situation where policy rates had approached the zero bound level and financial intermediaries faced weak incentives to lend, new money has been injected through central bank purchases of longer-term and riskier assets directly from holders, with a view to affecting spending decisions through price and portfolio effects.  This has been the aim of quantitative easing (QE). QE programs have also been adopted as refinancing tools to help financial intermediaries to repair their strained balance sheets.

Second, new money has been injected in the economy through the public sector channel. Money has been issued to finance budget deficits, with the twofold objective of a) holding interest rates at low levels by limiting government recourse to the financial market to funds new debt issuances and b) supporting aggregate demand by making larger public spending or tax cut programs possible.

Currently, with fiscal policy restrained in most countries due to public debt sustainability concerns, and a widespread attitude from policymakers against monetary financing of public deficits, attempts to fuel the recovery in crisis-hit economies has mainly relied on QE interventions and other kinds of unconventional monetary policy. However, worries have been growing in many quarters lately ─ including at the Bank of International Settlements and the Financial Stability Board ─ that the ultra-low interest rate QE policies adopted by Japan and the United States are creating large risks in the form of risk mispricing, asset price overvaluation, and an inability to affect inflation expectations and real-sector spending to the extent required. Also, where QE has been attempted, the lack of coordination – if not outright inconsistency – between monetary and fiscal policies has created uncertainty and contributed toward overall policy ineffectiveness.

In the Eurozone, the countries running external surpluses and enjoying relatively safe and sound fiscal conditions have deliberately decided against boosting internal demand, thereby withdrawing potential stimulus from the global economy and providing none of the powerful locomotive potential they could provide to revive the Eurozone block.  The recessionary and deflationary tendencies among Eurozone countries are intensifying and spreading due to falling incomes and declining aggregate demand, aided by continued austerity policies.

What else should be done?

Overt Money Financing

The most effective solution for economies still mired in deep economic recession and distressed by large public debts would be to undertake ‘overt money financing’ (OMF) of budget deficits, that is, finance tax cuts or new public spending programmes with newly created money.

Defended in the past by such eminent and diverse economists as Henry Simon, Irving Fisher, John Maynard Keynes, Abba Lerner, and Milton Friedman as the most effective macroeconomic policy lever when it comes to stimulating a stagnating economy, the idea of OMF was resurrected by Bernanke (2002) when he indicated that the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities. Specifically – Bernanke argued – the government could adopt a broad-based tax cut, increase transfers or spending on current goods and services, or even acquire existing real or financial assets, and accommodate it with a program of open-market purchases to alleviate any tendency for interest rates to increase. This would stimulate consumption and hence prices and, even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values – Bernanke added – would lower the cost of capital and improve the balance sheet positions of potential borrowers.

The idea of OMF has been further considered in greater depth. McCullay and Pozsar (2013) and Turner (2013) have compared it to existing policy alternatives concluding it to be superior, and Buiter (2014) has identified the conditions under which OMF increases aggregate demand. One of these conditions is the irreversibility of the new money base stock creation, which – by being irredeemable – constitutes a permanent addition to the total net wealth of the economy.

Such irreversibility can be attained if overt monetary financing operations are executed by one of two routes. The first would be by having the government issue interest bearing debt, which the central bank would buy and hold in perpetuity, rolling over into new government debt when the existing debt on its balance sheet reaches maturity.

In this case, the government would face a debt interest servicing cost, but the central bank would make an exactly matching profit from the difference between the interest rate it receives on its debt and the zero cost of its money liabilities, and would return this profit to the government.

A second route would have the central bank buy special government securities that are explicitly non-interest bearing and never redeemable.

In terms of the fundamentals of money creation and government finance, the choice between these two routes would make no difference (Turner 2013). Both would differ from conventional bond financing of budget deficits, in that the government would be under no obligations to repay the debt purchased by the central bank under OMF. The irreversibility condition would be required for if the policy was reversed, and the central bank sold the bonds to the private sector, public debt would instantly increase and the government would be under an obligation to repay it.

Other authors have submitted that a more effective form of OMF, as a demand management crisis tool, would be to allow the Treasury/Ministry of Finance to finance new budget deficits by issuing its own money, or a pseudo-money, since this would not require explicit irreversibility condition (see Wood (2012), Cattaneo and Ziboldi (2014), Bossone et al (2014)). These authors propose that in highly leveraged and depressed economies the Ministry of Finance be granted the power to issue a form of complementary money to finance fiscal deficits large enough to stimulate demand. The government would have full sovereignty on the issuance of the complementary money.

Interestingly, these proposals have an historical antecedent in the special government bonds that Germany issued in the 1930s, under central banker and minister of economics Hjalmar Schacht, to survive the Great Depression. The operation succeeded in pushing the German economy through a speedy recovery, reaching full employment without inflation.

In relation to OMF, the following propositions can be claimed.

First, OMF is the combination of monetary and fiscal policy that has the greatest impact in raising demand and output:

  • Unlike QE and other types of unconventional monetary policies designed to act on asset prices rather than consumer goods prices, OMF flows to households with a relatively high marginal propensity to consume ordinary goods and services.  Under OMF, demand and consumer goods prices both rise relatively early. For countries experiencing deflation this is a critical feature.
  • Unlike conventional bond financing, OMF creates no rise in interest rates and hence there is no crowding-out.

Second, OMF does not trigger Ricardian Equivalence effects (in contrast with conventional bond financing) since the intertemporal budget constraint of the state is permanently relaxed by the corresponding new money stock.

Finally, OMF does not affect the health of public finances, since it does not require new debt issuance. In fact, by stimulating output and price growth, OMF even improves debt sustainability looking forward.

Central Banks and Governments Under Different OMF Types

Different forms of OMF bear different institutional implications, which need to be carefully considered.

Monetizing fiscal deficits constitutes a joint monetary and fiscal policy decision. Where the central bank is an independent organ, as is today the case in many countries, cooperation between the government and the central bank is necessary to engineer OMF operations, and such policies require a specific framework for assigning duties and responsibilities to the two institutions (Bossone and Wood 2013). Obviously, this impairs or calls into question central-bank independence, but in times of crisis this kind of cooperation may be necessary for the collective good. Nothing makes the point more authoritatively than quoting the words spoken on this subject by former Governor Bernanke (2003):

“[I]t is important to recognize that the role of an independent central bank is different in inflationary and deflationary environments. In the face of inflation, which is often associated with excessive monetization of government debt, the virtue of an independent central bank is its ability to say ‘no’ to the government. With protracted deflation, however, excessive money creation is unlikely to be the problem, and a more cooperative stance on the part of the central bank may be called for. Under [these] circumstances, greater cooperation for a time between [central banks] and fiscal authorities is in no way inconsistent with the independence of the central banks, any more than cooperation between two independent nations in pursuit of a common objective is inconsistent with the principle of national sovereignty.”

It is critical in such times to have an appropriate framework in place for emergency policy actions. This framework should specify which institutions do what under which circumstances, and under which accountability rules. It should also be clear who is responsible for activating the emergency framework. In other words, just as in wars or national emergencies ordinary rules may be suspended and decisions delegated to a chief commanding body, so might economic policy decisions be delegated during particularly severe systemic crises.

This issue is automatically resolved in those cases where money is issued directly by the government, as in the alternative OMF proposals recalled above. Here the Ministry of Finance subsumes the money issuing function in relation to the OMF operations to be performed. OMF operations run directly by the government promise to be more effective since they only require a fiat decision by the government, and do not involve the central bank. For the very same reason, however, the consequences should be carefully considered of granting “monetary sovereignty” directly to the government. The independence gained over the years by central banks in many countries worldwide has removed from these countries the risk of possible monetary policy abuse at the hand of profligate governments. Based on such considerations, the provision of government-run OMF should be accompanied by stringent rules and control mechanisms precisely aimed to avert such risk.

Why Is All This Important?

The issues discussed in this note are critically relevant.

First, if the arguments above are not clearly understood, then the policy of overt money financing could be misinterpreted, and its significance not appreciated, including by key policy makers who have, to date, seemingly turned a blind eye to it.

Second, there can be no question that the policy mix so far adopted in crisis-hit countries has failed to deliver what was promised. Conventional and unconventional monetary policy tools have shown significant limitations, and the lack of consistency – not to mention coordination – between monetary and fiscal policies has been at the heart of the major failure of helping crisis-hit economies to exit from recession.   A new approach to demand management policy needs to be developed to deal with economies, especially those constrained by limited fiscal space, which are trapped in deep recessions and are under threat of price deflation. Such economies are incapable of escaping the recession by resorting to large-scale bond financed deficit spending.

Third, Eurozone countries are again sliding into depression and deflation.  Current policies need to be radically altered to create the requirements for widespread and strong economic recovery.

Fourth, Japan’s public debt levels are unsustainable, and the deflation tendency remains despite successive rounds of quantitative easing and bond financed budget deficits.

Finally, there has been much conjecture about whether or not some advanced countries have entered an era of ‘secular stagnation’.  Macroeconomists should treat secular stagnation as a ‘shock’ leading the economy to a persistent underemployment equilibrium, and should develop appropriate policies to counter it.  Overt money financing offers the most effective monetary and fiscal policy response.


No doubt, under their powerful communication weapons, the G-20 Leaders will give the impression that a vast armada is being marshalled to attack the global growth problem.  It will look impressive.  Some tug boats are already waiting at the docks, having been provisioned in earlier years but not yet ordered to sea.  Others will remain mere plans on drawing boards.  Some of the tugboats will have delayed launches (as with ‘the third arrow’ of Japan’s Prime Minister Shinzo Abe), and still some others may simply never complete their journeys, or, worse still, go belly-up on route.

But besides the communication strategy success, the truth remains that, in the absence of a major reconsideration of macroeconomic policies, the G-20 meeting in Australia in November will be another non-event.


Bernanke B (2002) “Deflation: Making Sure ‘It’ Doesn’t Happen Here, Remarks by Governor Ben S. Bernanke before the National Economists Club, Washington, D.C., November 21.

Bernanke B (2003) “Some thoughts on monetary policy in Japan”, Remarks by before the Japan Society of Monetary Economics, Tokyo, 31 May.

Bossone B, M Cattaneo and G Zibordi (2014) ‘Which Options for Mr. Renzi to Revive Italy and Save the Euro?’, Economonitor, 3 July.

Bossone B and R Wood (2013), “Overt Money Financing: Navigating Article 223 of the Lisbon Treaty”, EconoMonitor, 22 July.

Buiter W (2014)  ‘The Simple Analytics of Helicopter Money: Why it Works – Always’, Economics, Vol. 8, 2014-28.

Cattaneo M and G Zibordi (2014)  La Soluzione per l’Euro, Hoepli, Milano. (English version forthcoming) – See more at:

McCulley P and Z Pozsar (2013) ‘Helicopter Money: Or How I Stopped Worrying and Love Fiscal-Monetary Cooperation’, Global Society of Fellows, 7 January.

Turner A (2013) ‘Debt, Money and Mephistopheles: How Do We Get Out of This Mess’, Cass Business School Lecture, 6 February.

Wood R (2012) ‘The Economic Crisis: How to Stimulate Economies Without Increasing Public Debt’, CEPR POLICY INSIGHT No.62, August.