Cover Story

Author: Ronald Fink


Some say that this debate leaves two alternatives, neither of which is viable. One is so-called “helicopter money,” in which central banks deliver money directly to the public via their bank accounts—thereby avoiding the so-called “transmission failure” we’ve seen with quantitative easing, in which the Fed buys financial assets only to see sellers sit on the proceeds. Even former Fed chair Ben Bernanke embraced the idea in theory, when he was an academic (hence the nickname of “Helicopter Ben”). But he never considered it, once he took the helm of the Fed.

Duy says the idea has been “completely verboten” for decades now, calling to mind as it does the experience of such practitioners as Zimbabwe, whose monthly inflation rate peaked at roughly 80 billion percent in late 2008.

The other alternative is fiscal stimulus through tax cuts or new government spending, both of which are off the table, in many markets—including the US—because of political gridlock. No wonder Summers worries that the US economy will lurch between asset bubbles and recessions, a scenario he describes as “secular stagnation.”


That scenario is more of a political than an economic problem, to some observers. They contend the public and most politicians fail to understand or appreciate the Keynesian idea that public spending is needed to offset private savings when the so-called “natural” interest rate is near zero or even negative on a real basis, as they say it currently is.

“There is no need to suffer secular stagnation if the government offsets private sector deleveraging with fiscal stimulus,” wrote Koo in a chapter in an e-book on secular stagnation published by the Centre for Economic Policy Research. “However,” Koo continued, “until the general public understands [that], democracies will struggle to implement such policies during balance sheet recessions.”

Koo nevertheless says the Fed should start shrinking its balance sheet now, instead of merely slowing new bond purchases. Otherwise, he contends, inflation is likely to rise rapidly when US households and companies stop deleveraging, which he expects to happen relatively soon. And at that point, Koo says, long-term rates are likely to soar. To prevent that from sending the economy into a new recession, he says the Fed should keep the Federal funds rate near zero. But he says the Fed under Yellen is currently pursuing the opposite policy, slowing bond purchases but considering a rise in the Fed funds rate within the near future.

Other observers contend more fiscal stimulus is necessary to get the US economy to grow at a rate more in line with its potential, citing needs such as infrastructure, education, research and development, fairer and more efficient tax systems and less-burdensome regulation. Yet that hardly seems in the offing. Says Willem Buiter, chief economist of Citigroup: “We have many fiscal problems, and none of them is being addressed.”

Koo, Nomura Research Institute: There is no need to suffer secular stagnation if the government offsets private sector deleveraging with fiscal stimulus.
Buiter, Citi: The Fed Should have extended swap lines to other central banks during the taper tantrum, as it did after the failure of Lehman Brothers.

That leaves management of the economy to central banks at a time when they may no longer have sufficient means to deal with it. Buiter contends the Fed needs to develop “contracyclical” tools to encourage banks to lend when demand is weak and vice versa, like ones the central banks of England, Hong Kong and Singapore are now using. The Bank of England, for instance, has a capital buffer in place to adjust banks’ capital requirements based on the gap between the ratio of credit to GDP and its long-term trend (see chart, p 24).

Buiter also contends the ECB must do much more to stimulate demand in the eurozone than it has done to date, notwithstanding bank president Mario Draghi’s recent “surprise” announcement of $1 trillion in asset purchases. Buiter insists Draghi must also buy the sovereign bonds of the eurozone periphery countries, despite the opposition of Germany.

Some observers say such measures may not be needed. All central banks need do, they contend, is raise expectations of higher inflation by raising their inflation targets. Yet that idea inspires opposition from inflation hawks. And others think it’s easier said than done. Says Duy: “I’m not convinced you can shift expectations as easily as it is often thought.” Koo dismisses the idea as an academic theory that fails to work in practice. “The real world is nothing like that,” he says.

All of which would seem to make a central banker’s job these days well nigh impossible. “The Fed is in a tight spot because of fiscal policy,” observes Dimitri Papadimitriou, president of the Levy Economics Institute. Papadimitriou says the long-standing idea that monetary policy is more powerful than fiscal policy is “a fallacy,” adding that it is “very hard to say to the banking sector:  ‘Lend!’” when demand is weak, especially at a time of regulatory constraints. He describes such a stance as “oxymoronic.”


Still, Adam Posen, a former Bank of England governor who now heads the Peterson Institute for International Economics in Washington, D.C., told a gathering at the European Central Bank in May that central banks must continue to take measures that some mistakenly consider extraordinary. “Central banks will only be able to meet their goals by engaging in intervention,” said Posen. “To the extent that this becomes fiscal policy, it is well within precedent… It is not a religious matter.”

Duy agrees, arguing that too much of the debate over monetary and fiscal policy is about “morality,” based on the notion that “debt is bad” in any circumstances because of the role it played leading up to the financial crisis. If the discussion could move beyond that oversimplification, he says, there could be better coordination between monetary and fiscal policy, and that coordination, in turn, would go a long way toward eliminating the possibility of secular stagnation, and with it, a reliance on financial bubbles for growth.

Achieving such coordination, though, could remain difficult. Even in Japan, where Prime Minister Shinzo Abe has made much of his so-called “Triple Arrow” policy, a three-pronged effort involving monetary, fiscal and regulatory policy to stimulate the long-moribund domestic economy, the government raised sales taxes on April 1—slowing GDP growth in the second quarter.

Complicating efforts at coordination are global flows of capital—hence the so-called “taper tantrum” last year, when the Fed’s initial talk of slowing its asset purchases sent many emerging markets’ currencies plummeting in value against the dollar. This prompted big capital outflows and complaints of indifference to their fate on the part of the Fed by the new and widely regarded head of the Bank of India, Raguhram Rajan, not to mention heads of state such as Turkish president Recep Tayyip Erdoğan.

Buiter says the Fed should have extended the same sort of swap lines to central banks during the taper tantrum that it extended to them after the failure of Lehman Brothers. “Our currency, your problem,” is how he sums up the Fed’s more recent approach, noting that Lehman was an exception to a policy he described as generally “imperialistic.”

Philippine central bank governor Tetangco contends that post-tantrum, “communication by the Fed has improved,” adding that “there is greater clarity as to what the Fed is planning to do, and that has helped.”

One is left to hope Posen’s optimism about the ability of central banks to rise to the occasion is justified. In an interview, Posen said it is not yet clear whether the contracyclical tools that Buiter cites as critical can work as advertised, though he agrees with Yellen about the merits of macroprudential regulation and calls the BIS position that interest rates should instead be used to control bubbles “absurd,” ignoring, as it does, the results of roughly two decades of financial deregulation in the lead-up to the crisis.

Posen dismisses concerns over QE. “The Fed can raise interest rates as fast and as high as they need to,” Posen points out. As for the difficulty of a central banker’s job today, he says: “I’m sick of central bankers whining about how hard their job is. Grow up and do it.”