The Fed says monetary financing might be needed. How long will the ECB deny it?

The Federal Reserve “might legitimately consider” using monetary financing of fiscal operations in “extreme circumstances”, when there is very weak growth or deflation, Fed Chairwoman Janet Yellen said at a press conference few weeks ago.


Answering to a question from Greg Robb, a journalist from MarketWatch, on whether “it would be a good thing for the Fed to put helicopter money in its toolkit in case there was a downturn in the United States”, the Fed’s chairwoman replied:


“In normal times I think it is very important that there be a separation between monetary and fiscal policy, and it is a primary reason for independence of the central bank. We’ve seen all too many examples of countries that end up with high or even hyperinflation because of those in charge of fiscal policy direct their central bank to help them finance it by printing money and maintaining price stability and low and stable inflation is very much aided by having central bank independence.

Now that said, in unusual times where the concern is with very weak growth or possibly deflation — rather rare circumstances — first of all, fiscal policy can be a very important tool. And it is natural that if it can be employed that just as monetary policy is doing a lot to try to stimulate growth that fiscal policy should play a role. And normally you would hope in an economy with those severe downside risks, monetary and fiscal policy would not be working at cross-purposes, but together.

Now whether or not in such extreme circumstances there might be a case for close coordination where the central bank playing a role in financing fiscal policy. This is something that academics are debating. And it is something that one might legitimately consider. I would see this as a very abnormal, extreme situation where — I warn you it’s an all-out attempt — and even then it’s a matter that academics are debating — but only in an unusual situation.”


Yellen did not elaborate on what type of scheme the Fed would consider using. However, it is relatively safe to assume that it would most likely resemble some form of money-financed “helicopter drops” as advocated by Yellen’s predecessor – Ben Bernanke. In Bernanke’s proposal, the Fed would use newly created money to finance a tax cut or direct cash transfer to households, such as a one-off citizen’s dividend.

Using central bank money to directly finance spending in the real economy has been taboo for over fifty years. In accepting that the central bank of the world’s biggest economy might have to create money to stimulate the real economy, Yellen is implicitly suggesting that central banks might need to update their toolkits – exactly what we have been saying in the context of the eurozone for the past few months.

 In the eurozone, monetary financing for governments is prohibited under the Lisbon Treaty, which leaves the ECB no other option than using the so called ‘helicopter money’ (distribute money directly to individuals) or channelling QE towards publicly owned banks such as the European Investment Bank and its national equivalents (both options are legal). 

However all those options have so far been dismissed by the ECB’s officials, despite the fact that we live in very ‘abnormal circumstances’ where the injection of more than 1 trillion euros into the financial sector (via QE) has had little positive effect on growth and inflation (which is still around zero).

How long will it take until the ECB wakes up to the fact that QE is not working and realises that innovative instruments are needed to reach its 2% inflation target?

Credit Picture CC Day Donaldson

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