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Insight: The Price of Money

The Quantity of Money  An economic theory which proposes a positive relationship between changes in the money supply and the long-term price of goods. It states that increasing the amount of money in the economy will eventually lead to an equal percentage rise in the prices of products and services

Radical Monetary Policy: The Quantity of Money

Options under the broad heading of “the price of money.” Here, we discuss the quantity of money. By Roubini Econoteam

Stealth Helicopters and Eurobonds

Amid signs that the global economic expansion may be running out of steam, the concept of “helicopter money”—fiscal stimulus financed by central bank purchases of government bonds—has reentered the policy debate. With the efficacy of quantitative easing, negative rates and other unconventional monetary policy measures now in doubt, proponents of airborne central banking say helicopter drops are the next logical step in the battle against stagnation and deflation.

A “stealth” version of helicopter money might in fact already be in operation. The key distinction between quantitative easing and a helicopter drop is the intended duration of the central bank’s balance-sheet expansion—“temporary” under the former, “permanent” under the latter (covering the government’s deficits and ultimately monetizing the debt thereby incurred). This distinction might seem semantic, but it is substantial.

A central bank might not “promise” to permanently enlarge its balance sheet, but this might stealthily  occur in practice, given numerous rounds of quantitative easing and a policy to reinvest principal payments from maturing bonds. However, the effectiveness of central bank debt monetization is minimized if investors and households believe that at some point the debt has to be repaid via higher taxes or lower expenditure.

Bank of Japan

The Bank of Japan’s balance sheet has never returned to its pre-quantitative easing levels, and the rapid increase in the size of the balance sheet following the introduction of quantitative and qualitative signals that it will take a long time to reverse this build-up. Additionally, the Bank of Japan might eventually swap any maturing bond with consols—i.e., perpetual bonds. This would be a further step toward a more explicit helicopter money policy.

Bank of England

The Bank of England has an explicit policy to start selling gilts, but its balance sheet remains as large as it was when quantitative easing was in place. Further, the rising odds of a new round of monetary accommodation will push back any prospect of a reduction in the Bank of England’s balance sheet.

European Central Bank

The European Central bank might be forced to undertake multiple rounds of quantitative easing, especially as long as eurozone fiscal policy remains unnecessarily tight. Instead of national government bonds, the Bank might soon find itself buying an instrument that does not currently exist: Eurobonds.

If a single eurozone finance ministry were one day created, it would probably be in a position to issue a new financing instrument, a liability of the eurozone as a whole. This point would only be reached if another round of the euro crisis occurs first, one that can only be solved by the mutualization of risk.

For the time being, the European Central Bank buys ESM bonds and a sort of synthetic Eurobond deriving from the fact that national sovereign bonds are purchased in proportion to countries’ contributions to the ECB’s capital.

Riksbank and Swiss National Bank

In Sweden, the Riksbank can afford to keep buying Swedish government bonds as long as the government increases its deficit (including in structural terms, as occurred in 2016). It will need to continue expanding its balance sheet as long as the European Central Bank does the same to prevent currency appreciation. In Switzerland, the Swiss National Bank’s balance sheet has not decreased, even after the currency floor was abandoned.

Fed

Also, the Fed has no intention of winding down its balance sheet “until normalization of the level of the federal funds rate is well under way.” Clearly, if the Fed eventually decided to adopt explicit or “stealth” helicopter money, the balance sheet will not be wound down.

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