Lowflation: Is helicopter money needed?
Madhur Jha Global Economist & Head, Thematic Research
29 Jan 2020
For those who thought that the last decade had seen significant changes in the way monetary policy supports growth, it appears that the next decade may well have more in store.
We are starting to see a push towards less central bank independence and more debate about unconventional stimulus measures, such as modern monetary theory or the use of helicopter money as a policy tool.
Most of the key drivers of lowflation are likely to intensify throughout the 2020s. The five biggest factors are a high global savings rate, high leverage, globalisation (in particular, competition from China), income inequality and rapid ageing.
Rapid ageing is one of the more controversial causes of lowflation, given the existing body of literature that argues that an ageing population is inflationary.
However, we see the opposite outcome. Rapid ageing creates the need for more precautionary savings, which drives down inflation. Income inequality adds to the challenge, as higher income groups generally have the lowest marginal propensity to consume.
‘Pushing on a string’
The continued presence of lowflation brings to mind the ‘pushing on a string’ phrase used in the 1930s to describe how policy easing by central banks had little impact on the economy.
The phrase (often attributed to John Maynard Keynes) was used by US Congressman T. Alan Goldsborough to support Fed Chairman Marriner Eccles’ view (during a Congressional hearing) that beyond creating easy money conditions the Fed could not do much to bring about a recovery from deep recession in 1935.
Today, it looks like a blurring of the lines between fiscal and monetary policy will be needed to deal with the modern-day problem of ‘pushing on a string’.
Without a more aggressive mix of monetary-fiscal policy, we may continue to see diminishing returns on quantitative easing and the adverse impact of negative interest rates as fiscal policy remains too tame to make a difference.
Former European Central Bank (ECB) President Mario Draghi, who stepped down in October 2019, leaves a legacy of ultra-loose monetary policy that helped turn the tide of the European debt crisis of 2012.
The shift to quantitative easing may be only the beginning of the policy changes to come throughout the 2020s. Draghi’s famous words that the ECB would do ‘whatever it takes’ to support growth have filled markets with confidence, and may point to even more unconventional policy measures ahead than he had thought possible.
Evolving policy frameworks
A comprehensive revision of policy frameworks in the 2020s would not be a major break with history (Figure 1), and may have already kicked off with the US Federal Reserve’s recent engagement with stakeholders.
Policy frameworks have been shifting for decades as economic situations have evolved. The 1980s were marked by ultra-tight conventional monetary policy by the Volker-led Federal Reserve – high interest rates to squeeze out ultra-high inflation from the system.
The 1980s and early 1990s were marked by attempts to fine-tune policy via monetary aggregate targets. Inflation targeting began with the Reserve Bank of New Zealand in 1997. Now, with many economies failing to achieve their stated inflation objectives even with ultra-loose monetary stances, it may be necessary to consider a new framework.
We believe that the lack of monetary and fiscal space globally to deal with the next potential downturn will be a challenge in the 2020s (Figure 2).
Helicopter money as a policy tool
Central banks and governments will need to adopt a more coordinated approach to ensure that monetary and fiscal policy complement each other, in our view. This could require policies as extreme as helicopter money or modern monetary theory.
The United States, euro area and Japan are all candidates for considering the more aggressive policy of helicopter money, which permanently monetises a portion of the fiscal deficit.
Some US Democratic presidential candidates support ideas such as modern monetary theory, which assumes that fiscal deficits can be widened dramatically with few repercussions and can be used as the main tool to boost economies.
If introduced effectively and in a controlled manner, unconventional policies could limit the downside to growth. However, if they are mismanaged and taken to extremes – with populist policies replacing central bank independence – this could risk creating a sudden spike in inflation expectations and triggering a financial crisis or a global recession.
Negative interest rates
Japan and the euro area have already implemented a negative interest rate policy. The policy is backfiring in both cases, in our view, as the banking sector struggles with distortions created by their inability to pass on negative interest rates to consumers.
Furthermore, with ageing populations, the likely income available at retirement is diminished even more by such a policy.
There is little evidence that negative interest rates have helped raise inflation expectations. A recent study by the San Francisco Fed suggests that inflation expectations fell after the introduction of negative interest rates in Japan.
There are no clear signs that policymakers in either Japan or the euro area plan to reverse their negative interest rate policies, however.
The challenge with shifting to unconventional policy stimulus measures that involve removing central bank independence is that this would risk unhinging inflation expectations.
After all, if the main drivers of weakening growth and lowflation are structural (such as a lack of productivity growth and a shrinking labour force), monetary policy alone can do little to resolve them.
How can central banks and governments support growth in a lowflation world? Click here to access the full report.
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