This clearly is one of the key problems facing global economy:
- Demand has collapsed
- Central banks the first line of defence have tried a lot but cannot really do anything barring printing money and hoping somebody takes it. The research guys are at near war figuring whether mon pol worked or not in the crisis.
- Fiscal policy guys tried but hands were tied mainly because of already high debt levels. As additional tax flows were difficult to come because of falling growth, the governments issued more debt to stimulate the growth. This added to the debt levels leading to sovereign debt crisis in major economies.
- For the Krugman camp this was not an issue as debt was being issued at record levels. And once economy recovers, automatically the debt levels would come lower. The others typically European policymakers differed and ushered fiscal austerity which did not really revive growth prospects..
Hence, the issue became how does one really stimulate economies without adding to debt levels.
Richard Wood, a long serving economist at the Treasury in Canberra, has written this interesting paper (voxeu has a summary as well).
He says instead of central banks buying bonds doing QE, the c-banks could just give the money directly to the governments:
I put forward the case for ‘monetisation of budget deficits’. This policy option is not evil, and it is not really radical in the context of today’s economic circumstances: deficient aggregate demand and high public debt. Indeed, deficit monetisation has been referred to for possible consideration by John Maynard Keynes, Abba Lerner, Milton Friedman, Ben Bernanke, Max Corden, Richard Wood, Willem Buiter and Ebrahim Rahbari, Martin Wolf, and Anatole Kalestsky.
Under this plan, new money creation would be used not for further quantitative easing (to the benefit of unproductive bank reserves) but, rather, to finance ongoing budget deficits and to provide fiscal stimulus (benefiting consumers, public infrastructure and the low-income disadvantaged) without increasing public debt. Under this approach, sharp austerity policies could be relaxed, and public debt would stop rising. This would go a long way to avoiding a major financial crisis and to restoring confidence in governments and the economy. The policy could be applied whether periphery governments stayed in the Eurozone or left it.
How does the plan work? Option A is helicopter drop of money into private banks which deos not work as QE itsef has not worked. Option B is what he proposes:
Under Option B it is first required that a money issuing authority creates new money and, second, that the new money is made available to the treasury. This operation needs to be done in a way that does not increase ‘public debt’: public debt is conventionally measured by ‘general government debt’. In the US, for instance, if the Fed created new money and sought to pass it to the US Treasury (so that the Treasury could finance the deficit) then ‘public debt’ would increase. This follows because, in exchange for the provision of the new money to the US Treasury, the Fed would need to receive new government bonds from the Treasury, and this transaction raises general government debt, the measure of ‘public debt’ relied on by credit rating agencies. This is so for two reasons: 1) because the Fed is defined as an outside investor, and 2) because credit rating agencies ‘look through’ and see that government bonds held by the central bank could be sold to public at any time.
Under deficit monetisation, new money would be created to finance budget deficits.
There is a nice IS-LM graph which shows how this could be done theoretically. However could not understand how this will work practically?
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This simply means central bank icreases its liabilities.
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There are two ways – printing currency notes or increasing bank reserves.
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On assets side it buys either doemestic or foreign govt bonds. They buy gold as well but is limited in modern c-banking
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Central banks doing QE have just increase bank reserves and on assets bought govt. bonds etc.
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So what goes up in liabilities and assets?
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In this case it could also mean c-bank increasing the govt. deposits latter maintain with former. Though not sure what will go up an assets. However, the author rules this out..
Traditionally c-banks have expanded liabilities by increasing bank reserves buying domestic govt. bonds. This is what is called as monetisation of deficit as well. Now, c-banks buy these bonds in secondary market and not primary auction market. So it is not the typical monetisation of deficit which meant buying bonds in pimary auctions. But via QE, c-banks do take up large amount of debt in secondary markets as well..And this helps indirectly in budget deficits as well..
So not sure how will this work. How can c-banks provide money without adding to the debt?
Infact, the more I study c-banks balance sheets the more I find this whole thing really fascinating..
