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Column: Central bank stimulus is here to stay, but what if it fails?

By Anatole Kaletsky

If anyone still doubted that central bankers all over the world will keep interest rates at rock-bottom levels, those doubts should have been dispelled this week. Janet Yellen's statement on Thursday to the U.S. Senate that the Fed has "more work to do" to stimulate employment, and that "supporting the recovery today is the surest path to returning to a more normal approach to monetary policy," capped a series of surprisingly clear commitments to easy money from central bankers this week. On Wednesday Joerg Asmussen, a member of the executive board of the European Central Bank, and Ewald Nowotny, the Austrian central bank governor — both of whom had previously been reported as voting against last week's surprise ECB rate cut — said that they might in fact support further rate cuts and even negative interest rates, as well as the possibility of breaking the taboo against U.S.-style purchases of government bonds. And Mark Carney, the Governor of the Bank of England, reiterated more strongly than ever that any early increase in British interest rates was out of the question, despite the fact that the outlook for the British economy has turned out to be much better than the BoE had expected.

But what if these zero interest rate policies produce disappointing results in the year ahead, as they have in each of the past four years? What if the world economy fails to spring back to life or just plods along with sub-par growth, despite all this stimulus, as has happened in each of the past four years?

With luck, these questions will not need answering because fiscal austerity has acted as a powerful headwind to economic recovery in the U.S., Europe and Britain and these budget consolidation efforts are now being relaxed. The new records on Wall Street and other stock markets suggest growing confidence among investors that monetary stimulus will finally deliver decent levels of growth next year — and this does indeed seem likely. But what if the optimism turns out to be wrong? What if the U.S. and Britain fail to grow by at least 3 percent next year, and what if Europe stays stuck with sub-1 percent growth and mass unemployment? In that case, the monetary and fiscal policy experiments since the Lehman crisis would have to be judged as failures — and that judgment would open the way to much more radical ideas than zero interest rates and QE. Such radical ideas would be of two opposing types.

If there is no significant improvement in growth and unemployment by this time next year, many conservative politicians and economists will argue that the post-Lehman stimulus policies were not just ineffective, but directly counter-productive. The whole approach of the past five years should therefore be reversed: politicians and central bankers should admit that they cannot "manage" employment and economic growth; governments should concentrate on getting their finances in order, stop manipulating interest rates and allow market forces to do their work.

Whatever the theoretical arguments for such reversals — for example, that tougher budgetary policies would boost business confidence, that higher real interest rates would improve credit allocation and purge the economy of inefficient zombie firms — there is no chance in practice that governments in any of the major economies would respond to growth disappointments by doing less instead of doing more. The political risks would simply be too great for any government, regardless of its theoretical leanings, to impose tougher fiscal austerity or higher interest rates in an environment of weak growth and intractable unemployment.

A much more likely reaction to failure of the present stimulus attempts would be bolder experiments with new measures that act directly on consumer demand. The obvious way to do this would be to combine monetary and fiscal policy into a new form of unified stimulus that would put money directly into consumers' pockets, instead of relying on trickle-down effects from financial markets, where wealthy investors become even richer because the central bank boosts asset prices by buying government bonds.

As this column has repeatedly argued, the Fed could have delivered vastly more powerful economic stimulus through its QE program if it had sent out a check of $270 every month directly to each of the 315 million U.S. citizens, instead of transferring the same $85 billion monthly to bond investors, as it has been doing now for over a year.

This kind of monetary "helicopter drop" was what Milton Friedman recommended for economies still facing persistent unemployment after interest rates were reduced to zero and Ben Bernanke strongly advocated "helicopter money" for Japan before he became Fed chairman.

Even a few months of free money distributions to ordinary American households would almost certainly have done more to encourage consumer spending and economic activity than years of conventional bond purchases by the Fed. Helicopter money would therefore have revived the economy more quickly and with much less expansion of the Fed's balance sheet than conventional QE. So helicopter money would actually have been a more cautious form of monetary stimulus than QE, with less inflationary potential.

Why then was helicopter money never seriously considered, either in the U.S., or in Britain and Japan, where central banks have printed even more new money than the Fed, relative to economic size? Apart from the obvious vested interests of bond investors, bankers and other financial market participants who profit by acting as the conduit for monetary stimulus, the main obstacle to helicopter money is an ideological totem: central bank independence.

Helicopter money is economically equivalent to a tax cut that the government finances by selling bonds to the central bank. Monetary and fiscal policy are blended into a single decision and that means the barriers between central bankers and politicians are removed.

Since most central bankers are passionate about protecting their political independence, any discussion of combining fiscal and monetary decisions is today still taboo. But if current monetary policies fail to deliver an adequate economic recovery by next year, political pressure to break the monetary-fiscal taboo could become overwhelming and central bank independence will be doomed. No wonder central bankers are more committed than ever to economic growth.

(Anatole Kaletsky is a Reuters columnist. Opinions are his own. )

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