Helicopters to the Rescue?

Is helicopter money here? Do we need it now? Is it coming? The short answer to these questions is that it is not here and we currently do not need it, but should the economic disaster brought on by COVID-19 continue for much longer, that might change.

To be clear, the relief checks that governments are sending out to households and businesses are not helicopter money. Despite their enormous scale, the financing of these transfers is no different in character from that of traditional government benefits: governments are collecting taxes and issuing debt to the public.

Helicopter money is when the central bank finances government expenditure directly. In these circumstances, the fiscal authority, through its debt management policies, controls the size of the central bank’s balance sheet. This is monetary finance arising from fiscal dominance: to increase seignorage, the fiscal authority usurps the role of the independent central bank in determining the size of base money (currency plus reserves held by banks at the central bank).

Should monetary policymakers consider surrendering their independence in this way? In our view, a far better alternative is to peg the long-term interest rate at zero. Currently in use by the Bank of Japan, this policy of yield curve control allows central banks to retain a small, but significant degree of monetary control. It also captures the features of U.S. monetary policy from 1937 to 1951, when the Fed capped the long-term bond yield to support U.S. wartime finance (see here)….

Monetary Policy in the Next Recession?

In many advanced countries, lowering the policy rate to zero will be insufficient to counter the next recession. In the United States, for example, with the target range for the federal funds rate at 1½ to 1¾ percent, there is little scope for the nearly 5 percentage-point easing that is typical in recent recessions (see, for example, Kiley).

This is the setting for this year’s report for the U.S. Monetary Policy Forum, written with Michael Feroli, Anil Kashyap and Catherine Mann. Our analysis focuses on the extent to which the “new tools” of monetary policy—including quantitative easing, forward guidance and negative interest rates—have been associated with an improvement of financial conditions. The idea is that the transmission of monetary policy to economic activity and prices works primarily through its effect on a broad array of financial conditions.

The USMPF report does not challenge the views of many researchers and of most central banks that the new monetary policy (NMP) tools have an expansionary impact even at the effective lower bound for nominal interest rates (see also the 2019 report from the Committee on the Global Financial System). However, we find that these new tools generally were not sufficient to overcome the powerful headwinds that prevailed in many advanced economies over the past decade.

Our conclusion is that central bankers should clearly incorporate the new tools in their reaction functions and communications strategies, but should be humble about their likely success in countering the next recession, at least in the absence of other supportive actions (such as fiscal stimulus)….

Negative Nominal Interest Rates and Banking

The financial crisis of 2007-2009 taught us many lessons about monetary policy. Most importantly, we learned that when financial systems are impaired, central banks can backstop both illiquid institutions and illiquid markets. Actively lending to solvent intermediaries against a broad range of collateral, purchasing assets other than those issued by sovereigns, and expanding their balance sheets can limit disruptions to the real economy while preserving price stability.

We also learned that nominal interest rates can be negative, at least somewhat. But in reducing interest rates below zero―as has happened in Denmark, Hungary, Japan, Sweden, Switzerland and the Euro Area―policymakers face concerns about whether their actions will have the desired expansionary effect (see here). At positive interest rates, when central bankers ease, they influence the real economy in part by expanding banks’ willingness and ability to lend. Does this bank lending channel work as well when interest rates are negative?

Why should there be any sort of asymmetry at zero? Banks run a spread business: they care about the difference between the interest rate they charge on their loans and the one they pay on their deposits, not the level of rates per se. In practice, however, zero matters because banks are loathe to lower their deposit rates below zero….

Financial Crisis: The Endgame

Ten years ago this month, the run on Lehman Brothers kicked off the third and final phase of the Great Financial Crisis (GFC) of 2007-2009. In two earlier posts (here and here), we describe the prior phases of the crisis. The first began on August 9, 2007, when BNP Paribas suspended redemptions from three mutual funds invested in U.S. subprime debt, kicking off a global scramble for safe, liquid assets. And the second started seven months later when, in response to the March 2008 run on Bear Stearns, the Fed provided liquidity directly to nonbanks for the first time since the Great Depression, completing its crisis-driven evolution into an effective lender of last resort to solvent, but illiquid intermediaries.

The most intense period of the crisis began with the failure of Lehman Brothers on September 15, 2008. Credit dried up; not just uncollateralized lending, but short-term lending backed by investment-grade collateral as well. In mid-September, measures of financial stress spiked far above levels seen before or since (see here and here). And, the spillover to the real economy was rapid and dramatic, with the U.S. economy plunging that autumn at the fastest pace since quarterly reporting began in 1947.

In our view, three, interrelated policy responses proved critical in arresting the crisis and promoting recovery. First was the Fed’s aggressive monetary stimulus: after Lehman, within its mandate, the Fed did “whatever it took” to end the crisis. Second was the use of taxpayer resources—authorized by Congress—to recapitalize the U.S. financial system. And third, was the exceptional disclosure mechanism introduced by the Federal Reserve in early 2009—the first round of macroprudential stress tests known as the Supervisory Capital Assessment Program (SCAP)—that neutralized the worst fears about U.S. banks.

In this post, we begin with a bit of background, highlighting the aggregate capital shortfall of the U.S. financial system as the source of the crisis. We then turn to the policy response. Because we have discussed unconventional monetary policy in some detail in previous posts (here and here), our focus here is on the stress tests (combined with recapitalization) as a central means for restoring confidence in the financial system….

Making Unelected Power Legitimate

Through what administrative means should a democratic society in an advanced economy implement regulation? In practice, democratic governments opt for a variety of solutions to this challenge. Historically, these approaches earned their legitimacy by allocating power to elected officials who make the laws or directly oversee their agents.

Increasingly, however, governments have chosen to implement policy through agencies with varying degrees of independence from both the legislature and the executive. Under what circumstances does it make sense in a democracy to delegate powers to the unelected officials of independent agencies (IA) who are shielded from political influence? How should those powers be allocated to ensure both legitimacy and sustainability?

These are the critical issues that Paul Tucker addresses in his ambitious and broad-ranging book, Unelected Power. In addition to suggesting areas where delegation has gone too far, Tucker highlights others—such as the maintenance of financial resilience (FR)—where agencies may be insufficiently shielded from political influence to ensure effective governance. His analysis raises important questions about the regulatory framework in the United States.

In this post, we discuss Tucker’s principles for delegating authority to an IA. A key premise—that we share with Tucker—is that better governance can help substitute where simple policy rules are insufficient for optimal decisions….

Bank of Japan at the Policy Frontier

Since Governor Haruhiko Kuroda took office in March 2013, the Bank of Japan (BoJ) has been the most aggressively expansionary advanced-economy central bank. Its announcement last month of a “new framework for strengthening monetary easing”—coming only six months after introducing negative policy rates—distances it even further from the pack.

That a central bank is willing to assess its performance transparently and to consider new approaches to achieving its key goals is something we have come to expect. While it’s much too early to tell whether the latest BoJ innovations will be more successful, there is reason to be skeptical. No less important, the new approach involves risks to the central bank and to financial market stability that may not be fully appreciated. Given the difficulties that other advanced-economy central banks seem to be having in raising inflation and inflation expectations, how the BoJ fares is of interest far beyond Japan.

How Low Can They Go?

Not long ago, nearly everyone thought that nominal interest rates could not go below zero. Now, we have negative policy rates in the euro area and Japan, while in Sweden and Switzerland, the lowest controlled rate is below -1%. And government securities worth trillions of dollars bear negative rates, too.

When we first wrote about negative rates a year ago, we argued that the effective lower bound (ELB, rather than ZLB) for nominal rates was determined by the transactions costs of storing and transferring cash. We reasoned that the ELB might be in the range of -0.50% (minus one-half percent). Below that, we thought, there would be a move into cash, facilitated by banks and others who efficiently manage the notes for clients.

But, at the negative rates that we have seen so far, cash in circulation has not spiked. So, how much further can nominal interest rates fall? And what role should negative interest rates play in the future?

Unconventional monetary policy through the Fed's rear-view mirror

On December 16, the Federal Open Market Committee is poised to hike interest rates, putting an end to the near-zero interest rate policy that began in December 2008. So, it’s natural to step back and ask what this episode has taught us about monetary policy at the near-zero lower bound for nominal interest rates. This is not merely some academic exercise. The euro area and Japan are still constrained by the zero bound. And, in this era of low inflation and low potential growth, policy rates in advanced economies are likely to hit that lower bound again (see, for example, here). How the Fed and other central banks respond when that happens will depend on the lessons drawn from recent experience...

The ECB's Not-So-Sweet 16th

Sixteenth birthdays can be momentous occasions. A coming of age of sorts. Well, New Year’s Day 2015 the European Central Bank turned 16. It is a momentous birthday, but not all that sweet.

To be sure, there is notable good news. The new headquarters in Frankfurt recently opened. Lithuania has entered the euro area. The frequency of ECB monetary policy meetings is about to decline. And there will soon be timely publication of minutes of these meetings.

But the risk of deflation amid sustained economic weakness makes for a very anxious birthday...

Should we really worry about currency wars?

In September 2010, Brazil’s former finance minister, Guido Mantega, made headlines when he accused the Federal Reserve, the European Central Bank and the Bank of England of engaging in a currency war. The complaint was that easy monetary policy was driving down the value of the dollar, the euro and the pound, at the expense of his country and those like it. More recently, similar charges have been levied against Japan: namely, that the Bank of Japan’s extraordinary balance sheet expansion is aimed at driving down the value of the yen, damaging the country’s trading partners and competitors...

Commentary

Money, Banking, and Financial Markets