The European Central Bank will probably open the monetary spigots again at its policy meeting next week. But unless the governing council reaches outside of its usual toolkit, further monetary easing is unlikely to make a real difference.
Lowering interest rates from here will not stimulate investment. Despite the economic recovery and hyper-accommodative monetary policy since 2015, the euro area’s investment activity as a share of gross domestic product has lagged behind historic levels.
Another stab at interest rates will not change that — especially now that utilisation rates and confidence numbers are falling, and inventories are inching up. Companies see limited opportunities for investment. The main effect of further easing could be another boost to asset prices, with the attendant risk of fuelling bubbles.
Rather than trying once more to pull the interest rate lever, the time has arrived to bring the helicopters out of the hangar. When targeting consumer price inflation, aiming directly at consumer spending makes sense. What has become known as “helicopter money” is such a direct approach.
How could it work? The ECB could commit to making a monthly transfer to every euro-area citizen with a checking account, until inflation hits 2 per cent. It could apply a sliding scale, adjusted monthly, by paying €200 into every account if annual inflation stands at 1 per cent or below. This payment would be reduced by €20 for every 10 basis points beyond 1 per cent, reaching zero upon inflation hitting 2 per cent.
With the ECB’s current inflation forecast of 1.4 per cent in 2020, that would lead to an average monthly helicopter drop of €120 per account, falling thereafter. Extrapolating that forecast further, price rises would hit the desired level in 2023 and the helicopters could be returned to their hangars.
The non-governmental design and introduction of this approach, as well as the close link to monetary targets, would repel arguments that this is monetary financing of government spending, which is explicitly outlawed by Article 123 of the EU Treaty.
Suppose the drops began this October and were to terminate in December 2022; each account holder would receive a cumulative €3,300. That is a meaningful sum. The median annual household income in the euro area was €18,725 in 2017, but only €13,948 for single parent households.
Assuming there are 275m adults with checking accounts in the euro area, the total cost of the programme would be €908bn, some 8 per cent of the euro area’s GDP in 2018 (although less than half of all government bonds bought through QE).
Assume, furthermore, that citizens spend only a miserly one-quarter of their booty, then average yearly demand would rise by 0.6 per cent of GDP. A sizeable impact on demand and thus inflation would surely be expected. Helicopter money would channel most funds directly towards households with a high propensity to spend, which should secure a strong transmission.
To be sure, the drop comes with risks attached. Even if it succeeds in returning inflation to target, the capital of the eurosystem would be hit hard. Capital and reserves stood at €107bn in mid-2019, 2 per cent of its assets.
Conservatively assuming the latter remain unchanged until 2023, the helicopter operation would reduce the eurosystem’s capital-asset ratio to minus 17 per cent in 2023.
But keep in mind that contrary to commercial banks, a central bank does not require capital, which is why most central banks have very little of it. The capital ratios of the Federal Reserve and the Bank of Canada, for example, are close to zero. For central banks such as those of Israel and Chile, the ratio is negative. If the ECB’s helicopter drop succeeds in returning inflation to target, the negative net worth should not undermine the eurosystem’s policy credibility.
Helicopter money also has political attractions. It would stop the weakening of reform disincentives for governments that have come to count, lazily, on the ECB pushing down their costs of borrowing. It would provide forceful headwinds to Eurosceptic populists upbraiding the European project as an elitist ruse to the detriment of the common man. Finally, Europe’s use of helicopter money might fly better with the US than its current approach.
Remember the testy reaction of President Trump to Mario Draghi’s Sintra speech, when the ECB head alluded to further rate cuts. It is harder to construe the padding of citizens’ accounts with central bank money as “currency manipulation”. The risks of a damaging and deflationary transatlantic trade war would be reduced.
No attractive choices are left. A helicopter drop may be the least unattractive option. It is better to try out something new than continue with an increasingly risky strategy that has failed to deliver. Christine Lagarde, the incoming president, should consider it. What better time to get the rotor blades whirring than when a new commander-in-chief takes charge?
The author is chief economic adviser of Acreditus, a risk consultancy headquartered in Dubai