by Bill O’Grady
Since the 2008 Financial Crisis, developed economy central banks have been implementing a series of unconventional policy measures, including quantitative easing (QE), zero interest rate policy (ZIRP) and negative interest rate policy (NIRP). Although these measures likely prevented a deeper financial calamity, such as a repeat of the Great Depression, these actions by the central banks have not led to a strong economic recovery. In particular, inflation rates have remained very low and growth sluggish. The lack of growth is partly to blame for the rise of populist movements in the U.S. and Europe.
Economists and other market analysts have pondered whether the central banks have effectively “run out of ammo.” In terms of conventional and some unconventional policies, the answer is probably yes. It is hard to imagine how additional QE could boost any of these economies, and the impact of NIRP has, thus far, been mixed.
However, there is one remaining policy tool that is virtually guaranteed to lift inflation and would almost certainly boost growth. Using monetary policy to directly fund fiscal spending, formally called “monetary funded fiscal spending” (MFFS) and often referred to by its more colloquial name, “helicopter money,” remains within the policymakers’ tool boxes. However, it is a potentially dangerous policy that is appropriate only in the most extreme circumstances.
This topic has geopolitical importance because of current global integration. Although nations generally are given some latitude in setting domestic monetary and fiscal policy, MFFS would likely have a significant impact on foreign exchange markets. If the policy is perceived as a deliberate attempt to weaken one’s currency, it could trigger protectionist policies and bring about a “currency war.”
In Part 1 of this report, we will describe MFFS and barriers to its use. In Part 2, we will examine two historical examples when forms of it were implemented, Japan during the 1930s and the U.S. during WWII. In Part 3, we will note some observations from the historical record and look at the likelihood of MFFS being deployed in today’s world, focusing on which nation is most inclined to use it. As always, we will conclude this series with expected market ramifications from MFFS.