In a world that suddenly finds itself in the midst of an unprecedented health crisis, policymakers appear unprepared. Only after much deliberation do they realise the extent of the crisis and its severe economic repercussions. Economists have been mobilised to offer economic policy solutions (Baldwin and Weder di Mauro 2020), but it remains to be seen as to which solutions are feasible and politically up to the task.
I would like to argue that the fastest and most feasible way to respond is by breaking a taboo. In this column, I want to suggest ways in which to implement Jordi Galí’s proposal on Vox (Galí 2020a), arguing that it is the best way forward. In order to establish this route, it is necessary to outline a political scenario for implementation, with a practical institutional and legislative way forward.
The main idea proposed by Galí is one of ‘money-financed fiscal stimulus’. Rather than raising taxes and/or increasing government debt to finance the fiscal policy plans, the use of ‘helicopter money’ (direct, unrepayable funding by the central bank of fiscal transfers) is instead proposed. Galí (2020b) presents an analysis comparing this policy to conventional debt-financed stimulus. He proposes that when the ZLB is not binding, a money-financed fiscal stimulus has much larger multipliers than a debt-financed fiscal stimulus.
However, it is clear that such a policy (often used in the past with inflationary or even hyper-inflationary consequences) is seen as ‘blasphemy’ now. Galí quotes a passage from Turner (2013), who states that “the prohibition of money financed deficits has gained within our political economy the status of a taboo, as a policy characterised not merely as –in many circumstances and on balance– undesirable, but as something we should not even think about let alone propose… ”
In response, I would like to present a framework to ‘break’ this taboo in the current circumstances.
First and foremost, it is important to emphasise to policymakers and the public that the current situation has the following combination of crisis elements. This unique combination provides the rationale and justification for the subsequent discussion. The current crisis is:
- global crisis, on a humanitarian scale, and
- the worst pandemic since the 1918 Spanish flu.
At the same time:
- the economic crisis is one of significant declines in both supply and demand, and
- the economic toll is bound to be very high.
Consequently, it is necessary to put aside some of the conventional discussions in which we have been engaged over the past few decades. For example, the discussion on structural-cyclical distinctions is now irrelevant.
More importantly the use of debt finance (which was the subject of much debate since 2008) should be understood in the current context. Conventional debt-financed plans have serious drawbacks in the current situation. One aspect has been mentioned above, namely, it is a less effective policy. Another aspect is that it is essentially a taxation deferral plan. In political economy terms, it would lead us back to the ‘austerity saga’. Politicians and voters, following this massive COVID-19 shock, will have no appetite for another round of austerity measures.
The proposed political economy plan to break the money-financing taboo consists of two principle ingredients:
First, legislatures would enact specific emergency ‘COVID-19 legislation’, authorising the central bank to conduct ‘helicopter money policy’ for 90 days (within the current calendar year). This could then be extended for another 90 days if requested by the central bank. The bank can terminate the programme earlier, if it deems fit. The government, including the treasury, would have no legal authority in this policy process. This legislation would supersede any laws forbidding money finance of fiscal plans.
Second, a COVID policy committee would be set up with equal representation for the central bank (including its governor), the treasury (including the minister), and outside economic experts. Aided by professional staff, this committee will set the amounts of transfers, the breakdown into policy items, and the speed of implementation over the 90-day period(s).
The idea is to ensure that this is an emergency-only procedure and not a way to go back to money-financed deficits. The pivotal role of the central bank is meant to preserve central bank independence.
In the case of the euro area, the situation is, regrettably, different. While this is potentially an opportunity to undertake euro area measures (and have the ECB play a major role), it is difficult to see how these steps can be implemented. This is both because of legal restrictions on monetisation and the lack of political and fiscal union. The second element of the above plan may be feasible, but it is hard to see the first element ever being realised. This shows once more the limitation of the current EMU set-up, which has long been recognised as problematic.
I would like to be more specific about two elements of the above set-up.
In terms of the policy items, it would be reasonable to consider fiscal transfers which are directly related to the crisis situation, namely:
- Budgets for the health-care system, in particular labour costs (e.g. wages and other income for overworked medical staff), capital costs (e.g. testing apparatus, respiratory equipment, and protective gear), sick pay, and insurance subsidies.
- Assistance to households, in the form of direct monetary assistance and enhanced and lengthened unemployment benefits and income support.
- Assistance to firms, in the form of subsidies, transfers, and tax cuts.
- Assistance to maintain the functioning of markets, such as insurance and financial market access.
It should be noted that there may well be other items to add. It is important to be attentive not stray too far from the emergency situation mandate.
In terms of outside experts on the COVID policy committee, the idea is to engage leading public finance, macro, and monetary economists from academia, from the domestic private sector institutions, and from overseas groups as well. This would endow the committee with objectivity and respectability and facilitate overcoming the taboo, enhancing trust in this endeavor.
The idea, then, is essentially for a one-off emergency money-financed policy plan that would give the central bank the authority to act and the authority to (subsequently) get the economy back to the ‘no money-printing’ norm that we have been enjoying over the past few decades. This would avoid the pitfalls of having governments and their treasuries embarking on a path of recurrent deficit finance by money printing. All the while, it would enable a swift policy response to counter both the pandemic spread and its devastating economic effects.
Author’s note: I am grateful to Jordi Galí for comments.
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