Central banks have a problem.
Their usual methods of stimulating the economy, like ultra-low interest rates, don’t seem to be working as well as they used to.
Inflation and growth are stuck at low levels in the Eurozone after years of near-zero interest rates.
It’s time to get a bit more radical and central banks have talked of using so-called helicopter money — which involves creating new money and giving it directly to people to spend on whatever they want.
The idea has sparked controversy because it would probably need sign-off from politicians to be used in practice, raising questions over central bank independence.
For the European Central Bank, such a radical policy might breach the legal treaty that set it up. It would also likely be opposed by Germany, which has been scarred by its experience of hyperinflation in the 1920s and is generally more cautious when it comes to programs of printing money and buying bonds.
The most ECB President Mario Draghi has been able to do until now is to lend the money to banks at ultra low interest rates and hope it filters down to the real economy in the form of new loans. The plan has had limited success. The balance sheets of Europe’s banks are so weighed down with bad loans accrued before the crisis that they haven’t been able to offer enough new loans to stimulate spending and investment.
But, according to analysts at HSBC, Draghi and the ECB might have found a way to drop helicopter money onto Eurozone economies without anyone really noticing.
Last month, the ECB cut three benchmark interest rates, stepped up its lending to banks and boosted its bond buying program. The assault on low growth and inflation lowered the interest rates for government bonds so much that governments can now cut taxes and boost spending without having to borrow.
The HSBC analysts led by chief European economist Karen Ward argue that this is as close to helicopter money as its possible to get without handing governments the cash directly.
Here’s HSBC (emphasis ours):
We would argue that in a subtle form, the helicopters are already out in Europe. Thanks to the depressing effects of monetary policy on sovereign interest rates, fiscal policy is set to become considerably more expansionary in 2016. Indeed the key initiatives in the big four eurozone economies amount to 1.4% of GDP.
Governments haven’t been handed newly printed euros so it’s not helicopter money in the truest sense. But the fall in interest payments has been so large governments have been able to spend without issuing additional debt.
Here’s the chart:
Eurozone governments have loosened their purse strings to the tune of €102 billion by cutting labour taxes and increasing pay for public sector workers. So the covert helicopter money plan seems to be starting to work, especially when compared against non-Eurozone economic regions.
Here’s that chart:
There’s just one snag. Investment in public infrastructure, which is one of the quickest ways to stimulate the economy through government spending is still in the doldrums.
Here’s HSBC again:
Public investment in nominal terms is now less than half what it was before the financial crisis in Spain and Portugal, and about two-thirds in Italy. And even in Germany, which did not cut investment, it is still well below the eurozone average.
Here’s that chart:
So while the ECB, either through accident or design, has found a clever route to get helicopter money flowing in Europe, they can’t control where it goes once its in there.