By Christopher Dembik, economist at Saxo Bank
Despite the extraordinary measures implemented by the ECB, the euro area seems to be stuck into an extended period of low inflation, generating minimal economic wealth. The failure of the European quantitative easing and the negative interest rates threaten the central bank credibility. It is even getting worse for the ECB because, at the same time, the American Federal Reserve seems able to successfully reach its inflation target in the coming years. The underlying inflation, which is closely monitored by the central banks, reached 1.7% over one year in January in the United States, which corresponds to the highest level since July 2014. In the euro area, it was only at 1% over the same period. Even worse, it is continuing to slow down!
The question is rightfully raised to find out whether the mechanisms used by the ECB, whether it concerns the repurchase of assets or negative rates, are sufficiently appropriate to enable a recovery, of both growth and inflation. Will something else be necessary? One of the options now being explored is the helicopter money. What exactly do we mean by that?
Until now, the ECB has tried to reduce the costs of lending through the inter-banking market in order to stimulate the credit market. Nonetheless, it must be noted that the transmission of the accommodative monetary policy for the real economy does not work as well as initially anticipated. The cost of lending has diminished both for leading companies on the capital market, and for SME which borrow from commercial banks. The problem is that the low interest rates do not automatically entail a significant revival of private investment. They result, in particular, in increasing share repurchase and higher companies’ cash reserves. Furthermore, the SME still hesitate to lend due to a continuous lack of confidence in the future outlook. The ECB may push its rates down as low as possible, but if there are not enough loan demand, the growth and inflation will not restart. The fall in the velocity of money, both in the United States and in the euro area, is a perfect illustration of this tendency which has been accelerating since the financial turmoil of 2008.
Therefore, why not to distribute money directly to households as it does not work through the banks ? One way to accomplish this would be for the ECB to provide a specific amount to each household in the euro area which would be paid into a special bank account and which could only be used for the repayment of an existing debt. For the debtors, there would be an immediate effect: debt relief, regaining confidence in the future outlook, and, in turn, an increase in purchasing power and therefore consumption. What an immediate turnaround! For those who are not indebted, we could therefore assume that the money paid would be invested in European infrastructure projects, which would stimulate investment and enable a long-term yield.
Is this a good solution? It may appear to be a ridiculous idea but it could in the end have more macro-economic impact that the current measures which have many disadvantages, in particular the increase of speculative bubbles on several market segments.
Furthermore, Mario Draghi did not exclude this scenario during the press conference that he gave during the last ECB meeting. He described his position as follows:
“We have never really considered or raised the issue of helicopter money. It is a very interesting concept which is currently under discussion with academic economists and in various environments. But we have NOT YET analyzed the concept”.
The crucial issue to be drawn from this intervention is that it opens the door to this option. It is somewhat reminiscent of the similar remarks made several years ago concerning negative rates.
Yet, the implementation of such a procedure would not be easy. Helicopter money could meet technical problems and undoubtedly legal problems to begin with. It is very likely, in particular, that the Germans shall object and request an opinion from the German Constitutional Court.