Here is a lengthy and ambitious shopping list from Willem Buiter and Ebrahim Rahbari at Citi. Essentially, they want central banks to do more…. much, much more, including (with our emphasis):
(i) reducing rates, first by lowering them all the way to zero (UK and euro area), then by eliminating the effective lower bound on nominal interest rates (all four currency areas) [essentially: go negative, my friends]
(ii) carrying out more imaginative forms of quantitative easing (QE) & credit easing (CE), in all four currency areas, by focusing on outright purchases of and/or loans secured against less liquid and higher credit risk securities, subject to a sovereign guarantee (joint and several in the euro area) for all such risky central bank exposures
(iii) engaging in helicopter money drops (all four currency areas): a combined fiscal monetary stimulus [although they do note that the US and the UK may have already engaged in helicopter money drops that dare not speak their name.]
They argue that credit rationing and excessive funding costs for certain segments of the household and non-financial business sectors, and a weakness of effective demand in all four currency areas, imply that the case for arguments (ii) and (iii) is strong.
By contrast, lowering interest rates further and the less imaginative forms of QE and CE, which focus only on government securities, likely have little more to add as risk-free interest rates are already very low and market inefficiencies in high-rated sovereign debt markets are very small, or are associated with excessively low interest rates.
Buiter and Rahbari argue that the “obvious solutions” to the zero bound problem are:
(1) abolishing currency completely and moving to E-money on which negative interest rates can be paid as easily as zero or positive rates;
(2) taxing holdings of bank notes… or
(3) ending the fixed exchange rate between currency and central bank reserves (which, like all deposits, can carry negative nominal interest rates as easily as positive nominal interest rates, asolution due to Eisler (1932)).
Shockingly, the first two solutions do not seem currently acceptable to the powers that be… partly because the abolition of currency and the taxation of currency would take time and involve non-trivial administrative and implementation costs.
But, say Buiter and Rahbari:
[I]ntroducing a floating or managed exchange rate between commercial bank reserves with the central banks (dollars, say) and a new currency (rallod, say) could be implemented overnight.
The Citi strategists argue that simply lowering official rates would probably be insufficiently effective, by comparison.
To elaborate, they compare actual policy rates with those implied by different formulations of a ‘Taylor rule’ for monetary policy – which is a simple rule linking the policy rate to deviations of inflation from its target level and of actual output from its potential level (click to enlarge):
[T]he deviation between current policy rates and the rule implied target is in fact virtually zero in the US and the euro area. In the UK, the policy rates implied by the Taylor rules actually imply that policy rates should be higher than they currently are – owing to the persistent inflation overshoots relativeto the BoE’s target – while, in the case of Japan, the formulations of the Taylor rule used here would suggest policy rates which are substantially negative would continue to be appropriate.
Next, they argue that conventional QE and credit easing also won’t be enough anymore and will yield very little incremental benefit:
[F]or QE, mostly because base money is now plentiful almost everywhere and even risk-free longterm interest rates are very low. … we doubt whether effective demand by households and firms in the US and the UK today is being boosted materially by 10-year Treasuries being at 195 bps (on April 30, 2012) rather than 295bps in the US or at 211bps rather than 286bps in the UK. For those for whom the cost of funding is a major concern, lending spreads, not the risk-free rate – even at long duration – accounts for the bulk of the funding costs. The cost and availability of private funding (especially for SMEs and households) therefore is little affected by reductions in long-term sovereign rates…
Because, outside Japan, we have very few observations on economic policy at the ELB, the evidence cited in support of the effectiveness of QE through long-dated Treasuries relies either on ‘event studies’… or on correlations between balance sheet variables and asset yields or prices estimated over samples that include periods when the policy rate was not at the ELB (see Sheets (2012b)) as well as periods during which, unlike today, financial markets in the UK and the US, even at times the sovereign debt markets, were disorderly.
We believe these studies might overestimate the effects of QE and CE ‘lite’. The main reason we note is that they include or, in fact, concentrate on the acute periods of the financial crisis. During this period, the market inefficiencies that are at the heart of the effects of CE in particular were substantial. Today, these inefficiencies are much reduced outside specific areas where market liquidity is still much impaired.
But why not just go bigger?
With orderly financial debt markets, the financial market inefficiencies that are necessary for QE or CE to have any effect on anything, including long-term yields, can be argued to have become negligibly small for purchases of long-term sovereign debt or for Operation Twist. If the marginal impact from additional asset purchases by the monetary authority on long-term yields goes to zero quickly enough, then additional QE or CE could, regardless of the magnitude of these asset purchases or swaps, not drive down the secondary market yields of long-term sovereign debt. Of course, the potential scale of QE that is restricted to longer dated Treasuries is also capped by the size of that particular market. The Fed and the Bank of England already own substantial shares of the total outstanding stocks for the longer-dated maturities in particular.
Or a little bit more imaginative? In Buiter and Rahbari’s view:
[T]he Fed and the Bank of England should take a leaf from the ECB and focus their balance sheet expansions on less liquid and higher credit risk securities…
In the US, Japan and the UK this would mean that all domestic private securities purchased or accepted as collateral by the central bank should carry a full sovereign guarantee. Instead of a sovereign guarantee on each individual security of less than top-grade creditworthiness, held by the central bank, the sovereign could provide just a general guarantee against net credit losses.
In the case of the euro area, this would mean that all private and public securities that have a creditworthiness less than the highest level available in the jurisdiction, which is that achieved by a debt instrument jointly and severally guaranteed by all17 euro area member states, should carry a joint and several sovereign guarantee from all the euro area member states if bought outright or accepted as collateral by the Eurosystem. Again, a general joint and several guarantee or indemnity by alleuro area member states for the net credit losses of the Eurosystem would suffice.
And then there is the helicopter drop (à la Milton Friedman) which they argue is not necessarily inflationary or a solution to fiscal unsustainability but would be a a means of providing a temporary fiscal stimulus without adding to the stock of interest bearing, redeemable public debt:
This is a temporary tax cut, increase in transfer payments or boost to exhaustive public spending (including infrastructure investment), financed through a permanent increase in the monetary base. This will always be effective if it is implemented on a sufficient scale.
A helicopter money drop is not difficult to implement. It would most likely be politically popular. It just requires cooperation between the central bank and the Treasury. In the US and the UK, helicopter money may in fact turn out to be the trueface of the QE we are supposed to have seen these past years. If the asset purchases and monetisation are not reversed at some point in the future, QE willturn out to have been helicopter money after all…
The full note will be in the usual place.
By David Keohane and Kate Mackenzie