Macro policy coordination post crisis
The Great Recession has offered an important opportunity to discuss if and under what circumstances central banks might be required to coordinate their acts with governments in view of achieving specific macroeconomic objectives, such as fighting deflation and overcoming economic depression. Yet central bank independence has become such a strong tenet of contemporary economic thinking that no discussion has taken place post crisis of cases where it might be called into question. In summarizing the main conclusions of last April’s IMF conference on ‘Rethinking Macro Policy’, Blanchard (2015) notes that there was general consensus among participants “that central banks should retain full independence with respect to traditional monetary policy”.
Why have economists been so reluctant to address this issue?
The most probable reason is the concern that contemplating central bank-government coordination as a policy option might solicit governments to pressurize central banks into financing public deficits by money printing, thus weakening the fiscal budget constraint and raising the spectre of unchecked inflation. As candidly as Tony Yates (2014) puts it: “Allowing yourself tightly regulated helicopter drops is not time-consistent. Once government gets a taste for it, how could it resist not helping itself to more?”
In this sense, especially after the hard-won central bank independence, central bank-government policy coordination has become a sort of “taboo,” that is, a policy characterized not merely as being undesirable, but as something we should not even think about let alone propose (Turner 2013), lest the risk of re-creating perverse incentives for unscrupulous politicians to exploit.
When would macro-policy coordination make sense?
Coordination is optimal when policymakers recognize that combining monetary and fiscal policies yields the greatest ‘bang for the buck’ by effecting the largest demand shock achievable within the shortest time span possible at the least social cost practicable, based on given output gap and inflation target. Optimal policy coordination under exceptional circumstances (like, for instance, secular stagnation) would take the form of money financing of fiscal deficits, also known as ‘helicopter drops’ of money (henceforth, HM), whereby monetary and fiscal policies are jointly used to support aggregate spending consistently with full utilization of economic resources and low and stable inflation. An example of HM would be a broad-based tax cut or public spending program accommodated by a central bank program of open-market purchases to alleviate any tendency for interest rates to increase and dampen the impact of the tax cut on spending (Bernanke, 2002).
HM stimulates demand without raising public debt and by influencing spending decisions directly (and therefore more rapidly) by increasing public expenditures or cutting taxes rather than indirectly through changes in interest rates. In the case of tax-cut programs, consumers and businesses likely spend their extra cash on hand due to the tax cuts to the extent that the increase in the money stock is permanent, since no current or future debt-service burden is created to imply future taxes (Bernanke, 2003). Here, the key word is ‘permanent’ and is discussed below. Some economists even propose that instead of trying to spur private-sector spending through asset purchases or interest-rate changes, central banks should hand cash directly to consumers (or ‘people’s QE’), especially lower-income households who are more prone to consume and thus provide a greater boost to spending.
Such type of policy coordination would be especially useful in cases where the output gap is large, inflation is low or even negative, the level of public debt is high and fiscal space is limited. HM is certainly more effective than monetary policy alone, since under the latter the transmission mechanism needs to rely on indirect, uncertain, slow and possibly week interest rate and portfolio effects; the net wealth effect is smaller, all else equal, and the newly issued money only goes to agents who are already in possession of saleable assets and who likely feature lower than average propensities to consume.
HM is also more effective than fiscal policy alone, since a fiscal-only stimulus requires debt financing: in largely-indebted economies this could trigger market confidence problems and interest rate rises that would tend to neutralize the spending inducement effect. Being a combination of monetary and fiscal policies, HM is the most powerful reflationary policy tool available as it enables the (consolidated) public sector to create new purchasing power costlessly and to allocate it to agents who are more inclined to spend it immediately.
Conditions for effectiveness
Buiter (2014) evaluates HM formally and identifies the conditions for its effectiveness in boosting aggregate demand. One of these conditions is the irreversibility of the new money base stock creation, which, as he explains, constitutes a permanent addition to the net wealth of the private sector and is made possible by the (‘fiat’) money base being irredeemable and constituting an asset for the holder but not a liability for the issuer:
“A helicopter drop of money is a permanent/irreversible increase in the nominal stock of fiat base money with a zero nominal interest rate, which respects the intertemporal budget constraint of the consolidated Central Bank and fiscal authority/Treasury— henceforth the State. An example would be a temporary fiscal stimulus (…) It could also be a permanent increase in the stock of base money through an irreversible open market purchase by the Central Bank of non-monetary sovereign debt held by the public—that is, QE. The reason is that QE, viewed as an irreversible or permanent purchase of non-monetary financial assets by the Central Bank funded through an irreversible or permanent increase in the stock of base money, relaxes the intertemporal budget constraint of the State.” (p.2)
Woodford makes the same point as he compares the effectiveness of HM and Quantitative Easing,
“It is possible for exactly the same equilibrium to be supported by a policy of either sort. On the one hand (traditional quantitative easing), one might increase the monetary base through a purchase of government bonds by the central bank, and commit to maintain the monetary base permanently at the higher level. On the other (‘helicopter money’), one might print new base money to finance a transfer to the public, and commit never to retire the newly issued money. Suppose that in either case, the path of government purchases is the same, and taxes are raised to the extent necessary to finance those purchases and to service the outstanding government debt, after transfers of the central bank’s seignorage income to the Treasury. Assuming the same size of permanent increase in the monetary base, the perfect foresight equilibrium is the same in both cases…”
The impact of HM and the importance of irreversibility can both be appreciated by considering the intertemporal budget constraints of the individual agents and the government, respectively. Since, under HM, additional deficits are irreversibly funded through money creation, the government budget constraint is permanently relaxed by an equivalent amount, implying that agents’ disposable incomes can be equally raised. Since irreversibility pre-empts Ricardian Equivalence effects, consumption increases permanently. And while Ricardian Equivalence may be generally considered of little practical significance, it might actually be relevant in economies with tight fiscal space and under strict budgetary rules.
On irreversibility and permanence
Thus, at least in those particular circumstances where HM is most needed (i.e., deep economic recession, high public debt, and limited fiscal space), the condition of irreversibility/permanence is critical. Now, we should be clear about this condition, which should not be understood as the irreversibility/permanence of the supply of money issued but rather of the underlying fiscal stance. To see this, notice that HM implies no new future government liabilities; operationally, this requires that
- The central bank buys the newly issued debt and commits to holding it in perpetuity, rolling over into new government debt when the existing debt on its balance sheet reaches maturity (in this case, the government faces a debt interest servicing cost but the central bank makes 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 returns this profit to the government)
- The central bank purchases special government securities that are explicitly non-interest bearing and never redeemable (Turner, 2013)
or else that
- The central bank buys debt in the secondary market, commits to holding it permanently. This would be equivalent to monetizing the debt purchased (Bossone, 2015).
Underlying these modalities is the central bank’s commitment to provide free money to the government and never to claim back any asset in exchange for it so that no new government liabilities are created against HM. No commitment is necessary, however, to keep the newly created money permanently in circulation. If in the future the central bank decided to withdraw part or all of the money injected under HM, typically by undertaking open market operations (OMOs), the latter would do nothing to undo the permanent relaxation of the government budget constraint made possible by HM, since the profile of public debt does not change under OMOs. Also, still under OMOs, swaps of money for bonds would only change the composition of private-sector wealth, not its level. On the other hand, if the central bank does not commit to holding the debt permanently (or if it breaches the commitment), say, by selling the securities covered by the commitment, the government would instantly become liable for their repayment, which would imply higher future taxes or new debt issuance, and the HM would be undone. Furthermore, if the central bank and the government would not agree to roll over indefinitely the debt reaching maturity, that same debt would have to be repaid by the government eventually.
The boosting effect of HM, thus, follows from the permanent relaxation of the government budget constraint, not from the permanent supply of the new money. The effect takes place always and anyway, if the stimulus is money-financed, and lasts until the stimulus persists: HM can be undone only by tax rises or new debt issuances by the government. Of course, as OMOs influence interest rates, the resulting portfolio rebalancing would affect private-sector spending; however, the direct impact on demand of any given money-financed fiscal stimulus (and its related permanent addition to private-sector wealth) could hardly be offset by the indirect (portfolio) effect of equivalent money withdrawals via OMOs. Ceteris paribus, for any given targeted demand stimulus effect, the money volumes required by OMOs (or Quantitative Easing, for that matter) would be much bigger than by HM. In other words, and in a hypothetical case, sterilized HM injections would still boost demand.
Limits to policy coordination
While theoretical considerations suggest that HM is especially effective under extreme economic circumstances (see above), only few economists have recommended its use even in the middle of the deepest crisis in almost a century. Instead, most economists have broadly split across two camps: those believing that monetary policy can do it all, on one side, and those thinking that only fiscal policy matters at the zero lower bound, on the other.
Guessing why HM has been neglected is hard. Besides the concern about weakening central bank independence recalled at the outset, another reason may be that in some countries (e.g., the UK and US) the policy views of the fiscal authorities did not coincide with those of the monetary authorities. With the exception of the quite close central bank-national treasury coordination that took place in the immediate aftermath of Lehman in an effort to avoid financial meltdown, and some short interval during which fiscal and monetary policies were both relaxed to counteract the demand shock, pretty soon the fiscal authorities became anxious of regaining prudence as their main concern was the rising level of debt and its repercussion on financial stability, while the responsibility to keep the economy going was thought to fall upon the monetary authorities.
There was no understanding that a central bank-government coordinated response was required; rather, it was expected that the monetary authorities would react and adapt their policy strategy based on the fiscal stance decided by government. Particularly revealing is the chart below comparing the US fiscal response (total government spending) during and after the Global Recession with previous responses, which shows how contractionary fiscal policy had become after the second year of the crisis at the same time that the Fed was undertaking massive monetary easing.
Coordination would have been extremely difficult in the Eurozone, if possible at all, between the ECB and national fiscal authorities, due to the presence of multiple actors on the fiscal side each wit its own policy objective and one single monetary policy for the whole area authority, even abstracting from the circumstance that national governments opted for going for fiscal austerity. A cooperative attitude, on the other hand, and a full appreciation of the benefits of HM, especially in terms of pulling large fiscal stimuli without impact on public debt (as discussed in part I of this article) might have persuaded both the fiscal and monetary authorities to undertake joint policy responses. Japan did adopt a coordinated approach under Abenomics, but policymakers there have badly failed to realize that monetary policy should have been committed to permanently purchasing government debt (thus de facto monetizing and cancelling it), while fiscal policy should have been directed at giving out money to agents most willing and prepared to spend it immediately. Such a HM program would have averted new debt accumulation and would have stimulated spending decisions much more directly and swiftly than trying to raise inflationary expectations first, hoping to encourage spending as a result.
Based on the analysis in part I, Japan’s QE program may have suffered from two critical, related drawbacks. First, it was not envisaged that the monetary authority would commit to permanently holding the government debt purchased under QE: the government budget constraint could not be relaxed by cancelling the purchased debt. Second, as debt continued to grow, the concern about its sustainability grew as well, to the point that the government raised the consumption tax: this sent a contradictory policy signal to the public and worked effectively to diminish the QE stimulus.
Challenges to policy coordination
The use of HM demands a high degree of central bank-government coordination, from strategy making to policy implementation, in order to make sure that their respective policy stances remain consistent throughout the time horizon needed to close the output gap and, afterwards, to keep inflation low and stable. For example, the three alternative modalities to execute HM discussed in part I would each require of:
- The central bank to stand ready, under specific circumstances, to finance, through money issuance, a given (emergency) fiscal package set to achieve a pre-determined macro target
- The government to issue new debt that would be sold to the central bank or the central bank to purchase existing debt on the secondary market
- The central bank to commit to permanently holding the debt purchased
- The government and the central bank to issue a joint communication explaining that HM will not raise public debt sustainability concerns, since the government’s newly issued securities will not be redeemed or sold back to the market by the central bank, they will pay no interests, and will not give rise to future government liabilities.
Cooperation and coordination might as well be necessary after HM has taken place, if reversing its effect cannot be done by the central bank alone. In fact, depending on the size of the reversal operation, this might requires massive sales of central bank assets, which eventually may weaken the capital of the central bank. This is because for any given targeted demand stimulus effect the money volumes required by OMOs is much bigger than by HM. Therefore, government cooperation would be necessary in the post-HM environment if inflation becomes an issue, as the government should commit to ‘recapitalizing’ the central bank by providing it with the needed ‘fiscal backing’ by either raising taxes or selling more of its own debt (Wren-Lewis, 2015b). In either case, the government and the central bank would coordinate their acts with a view to taking money out of the system. Of course, nothing prevents the central bank from sterilizing money injections by raising the minimum reserve requirements and stopping remunerating reserves, in other words by ‘taxing’ the banking system. Alternatively, the central bank should be granted the power to issue debt and to sell its own bonds (Lonergan, 2015); yet the concern with central bank capital losses would persist, be it real or perceived.
As Cecchetti and Schoenholtz (2015) remark, the real or perceived threat arising from episodes in which there are significant central bank capital losses is political, not economic, since the expectation of recapitalization from the fiscal authorities might cause the central bank to operate with less independence (and, hence, less credibility) for it to be able to obtain, or to avoid the need for, recapitalization. Ultimately, the risk is one of “policy insolvency” or “policy bankruptcy” for cases where the only way for the central bank to assure long-run profitability – absent transfers from the government – is to increase base money at a rate inconsistent with the policy objective. Wren-Lewis (2015c) dismisses this argument as very weak, as it implicitly assumes that central bank independence is about protecting the public from a government that actively pursues high inflation. In fact, as he argues, a government that wanted high inflation would not let an independent central bank stand in its way anyway.
In any case, even if the risk of governments abusing central bank independence were real, it should be weighed against the benefits that policy coordination would deliver through HM in extremely serious economic circumstances of economic depression or deflation where, as recent experience indicates, other policy instruments (both conventional and unconventional) have proven to be useless, at worst, or inadequate and painfully slow to show results at best. Societies deserve better and, as for the risk, economists and policymakers should both identify ex-ante specific conditions under which policy coordination would be expected to be enacted by the appropriate authorities, and should define specific institutional devices aimed to minimize that risk.
“Silent enim leges inter arma”
Pronounced in a famous speech by Cicero, one of the greatest orators of Ancient Rome, these words translated in English mean: “In times of war, the law falls silent”, suggesting that during times of crisis Rome suspended democracy to allow a temporary dictator to run things as needed, since it was felt that decisions had to be taken more quickly and effectively than in normal times.
In today’s macroeconomic policy terms, this would suggest that temporary suspensions of usual law provisions might be contemplated during times of emergency or very serious crisis, when all relevant public bodies – as part of one nation state – would be expected to coordinate their acts together under government direction in the pursuit of collective aims considered to be priority or strategic objectives, and possibly in the context of well-defined limits and parliamentary controls. In particular, central bank independence might fall under this special suspension regime, if the objective were to use monetary and fiscal policies in combination with a view to reducing the output gap and to supporting prices as effectively and efficiently as possible.
On this Bernanke (2003) had a related point as he noted that:
“[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.”
Unfortunately, this important opinion has not resonated within the international academic and policymaking community, and has been totally ignored during the crisis. In fact, no lesson from the crisis has apparently been drawn that would point to how macroeconomic policies and institutions might need to be re-designed in crisis environments and, specifically, for crisis environments, to make sure that people’s welfare is protected as best as possible. Economists should not stop at taboos and should feel under an ethical obligation to explore all possible means to public safety in worst-case scenarios and extreme but plausible circumstances.
Archer D and P Moser-Boehm (2013), “Central bank finances”, BIS Papers No 71, April
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
Blanchard O (2014) “Ten takeaways from the ‘Rethinking Macro Policy. Progress or Confusion’?”
VoxEu, 25 May 2015
Blyth M and E Lonergan (2014) “Print less but transfer more: why central banks should give money directly to the people”, Foreign Affairs, September/October 2014 Issue
Bossone B (2015) “QE + permanent debt purchases + fiscal expansion = helicopter money: recipes for the Eurozone”, World Bank’s All About Finance, 26 January
Bossone B and R Wood (2013) “Overt Money Financing of Fiscal Deficits: Navigating Article 123 of the Lisbon Treaty”, EconoMonitor, July 22nd
Buiter W H (2014), “The simple analytics of helicopter money: why it works – always”, Economics, Vol. 8, 2014-28
Cecchetti S G and K L Schoenholtz (2015) “Do central banks need capital?”, Money and Banking, 26 May
Goebel R G (2005) “Court of Justice Oversight Over the European Central Bank: Delimiting the ECB’s Constitutional Autonomy and Independence in the OLAF Judgment”, Fordham International Law Journal Volume 29, Issue 4, Article 4
Lonergan E (2015) “Does the central bank’s balance sheet matter?”, Philosophy of Money, May 25
Muellbauer J (2014) “Combatting Eurozone deflation: QE for the people”, VoxEu, 23 December
Reichlin L, A Turner, and M Woodford (2013) “Helicopter money as a policy option”, VoxEu, 20 May
Stella P and A Lönnberg (2008) “Issues in central bank finance and independence”, IMF Working Paper, no 08/37, February
Turner A (2013) “Debt, money and Mephistopheles: how do we get out of this mess”, Cass Business School Lecture, 6 February
Yates T (2014) “Why I’m against helicopter drops”, Longandvariable, 23 October
Wren-Lewis (2015a) “People’s QE and Corbyn’s QE”, Mainly Macro, Sunday, 16 August 2015
Wren-Lewis S (2015b) “Helicopter money and the government of central bank nightmares”, Mainly Macro, 22 February
Wren-Lewis S (2015c), “Why helicopter money is a political economy issue” Mainly Macro, 27 May
 I wish to thank Charles Wyplosz for the discussion had on the issue of this article. Of course, the responsibility for the opinions expressed in it is only mine.
 See, for instance, Blyth and Lorgan (2014), and Muellbauer (2014). See Wren-Lewis (2015a) for a discussion of ‘people’s QE’.
 McCullay and Pozsar (2013) and Turner (2013) have discussed the greater relative effectiveness of OMF in analytical depth.
 See Reichlin et al (2013).
 Under this modality, the newly created money would not add to private-sector wealth but would permanently relax the government budget constraint.
 Also, the overall debt profile of the public sector following the open market operations would not change, since the government bonds swapped by the central bank in exchange for money are not covered by any permanence commitment (see above): they were and remain part of the stock of public debt. True, the government would be liable for paying interest on the debt that is now held by the private sector as a result of the open market operation, which until now was given back to the government by the central bank.
 The chart is taken by Kevin Drum’s post, “Chart of the Day: Here’s Why the Recovery Has Been So Weak”, Mother Jones, 18 August, 2015.
 I tried to work out a scheme for national central banks and governments in the Eurozone to coordinate monetary and fiscal policies at the national level in a way that would not breach Article 123 of the Lisbon Treaty, which prohibits the central banks that are members of the European System of Central Banks (ESCB) from purchasing public debt or from extending any forms of credit to State entities (Bossone and Wood, 2013). At that time I didn’t realize that central banks did not necessarily have to purchase debt from the governments for a HM operation to be effected, but they could do so in the secondary market (provided of course that they would commit to holding it permanently – see above). In any case, the very coordination required to take place between the national fiscal and monetary authorities might go against the constitutional rules governing the ESCB independence (Goebel, 2005).
 See Stella and Lönnberg (2008) and see, more generally, Archer and Moser-Boehm (2013) for a deep and comprehensive technical discussion of central bank finances.
 In “The Pro Tito Annio Milone ad iudicem oratio” (Pro Milone), a speech by Marcus Tullius Cicero in 52 BC.
 Even modern democracies practice this, as in the case of the Presidential War Powers Act in the U.S.