Milton Friedman

The Euro Area in the Age of COVID-19

The founders of the euro had little doubt about the common currency’s role as a foundation for European peace and prosperity. Yet, they were not Pollyannas. For years before the start of monetary union in 1999, economists had warned that the member states of the European Union do not constitute an “optimum currency area” (see, for example, Milton Friedman). This means that a single policy interest rate might exacerbate, rather than mitigate, economic differences, creating severe strains among euro area countries.

Since the euro’s beginning, European leaders hoped and expected that as tensions arose, member states would come closer together—integrating their economies and financial systems, sharing burdens and risks. To a considerable extent, experience has borne out these hopes. Despite enormous challenges, no country has abandoned the euro and reintroduced a national currency. Today, an entire generation of people has come of age knowing only the euro. Moreover, as of November 2019, popular support for the single currency among euro area residents was at a record 76%, with sizable majorities in each member state (see Eurobarometer 92, pages 32-33).

And yet, over the past two decades, there has been only grudging progress toward a truly resilient monetary union. Politically and financially, the euro area remains divided. The COVID-19 crisis brings renewed tensions. With it comes a harsh reminder that standing still is simply not an option.

In this post, we review the progress toward completion of the European monetary union, and note key gaps that remain….

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Inflation is not (and should not be) a key worry today

A very simple version of 1960s monetarism has two elements. First, controlling money growth is necessary and sufficient to control inflation. Second, leaving aside a financial crisis, the monetary base―the sum of currency in circulation and commercial bank deposits at the central bank―determines the quantity of money. Putting those together means that, in order to control inflation, all central bankers need to do is ensure that their liabilities grow at the appropriate rate. Conversely, when the central bank’s balance sheet grows quickly, inflation inevitably follows.

This simple monetarist reasoning was still on display in 2010, when Ben Bernanke received this letter from a group of 24 economists warning against further large-scale asset purchases by the Fed. At that stage, the central bank’s assets exceeded 250% of their level in September 2008. Over just over two years, the Fed had purchased roughly $400 billion in Treasury securities and $1 trillion in federally guaranteed mortgage-backed securities. But, as Bernanke explained at the time, the purpose of these asset purchases was to aid the economy in recovering from the crisis-induced recession. Moreover, in contrast to prior norms, since October 2008 the Fed had been paying interest on reserves, raising the opportunity cost for banks to lend.

Subsequent experience proved the letter writers very wrong. The Fed’s balance sheet continued to grow, peaking at $4.5 trillion in early 2015. And, over the decade just ended, inflation (measured by the Fed’s preferred consumption expenditures price index) averaged 1.6%―below the central bank’s long-run goal of 2%. If anything, in recent years, and despite massive central bank balance sheet expansions, inflation both in the United States and in other advanced economies has been too low, not too high.

With central bank balance sheets now surging again, we recount this history in the hopes of blunting any inflation concerns, which we see as profoundly misguided. Over the six weeks ending April 22, the Fed’s assets have grown by the same amount as they did from September 2008 to March 2013. While this does raise some serious concerns, inflation is not high among them….

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A Primer on Helicopter Money

Helicopter money is not monetary policy. It is a fiscal policy carried out with the cooperation of the central bank. That is, if the Fed were to drop $100 bills out of helicopters, it would be doing the Treasury’s bidding.

We are wary of joining the cacophony of commentators on helicopter money, but our sense is that the discussion could use a bit of structure...

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