‘Helicopter money’ and the deradicalisation of negative interest rates

By Adam Perkins, Ayan Banerjee

​Up to this point mainstream economic thought has been divided in three eras. Starting with the publication of the General Theory in 1936, the Keynesian era saw the economy being perceived as a beast that needed to be tamed with state intervention, as opposed to a self-correcting organism. Stagflation in the 1970s dismantled Keynesian theory, with high inflation and low growth revealing flaws in the paradigm. Milton Freidman’s monetarism took its place and provided solutions to problems Keynesianism could not explain. By the 2000s economists were drawing on a synthesis of Keynesian and Monetarist princples to answer policy questions. This period is also marked by central bank independence and flexible inflation targeting. Coronavirus presents another threat that will inevitably disrupt conventional economic policy. Traditional policy was already looking tired pre-corona. 2010s recovery was notoriously slow and both inflation and unemployment were inexplicably low. Two concerns that conventional economic wisdom had no answer for. Furthermore, monetary policy was facing the issue that rate of interest needed to generate enough demand was below zero or ‘reaching the zero-lower bound’. Quantitative easing (QE) was the solution to this, but its efficacy and viability as a long-term option are both in question. By far the biggest problem policymakers face is distribution. Many argued that the maldistribution of income was the root of stagnant economic growth. Pointing out that the rich have a higher marginal propensity to save and therefore as their share of income grows so will national saving. Simultaneously, Antitrust policy is in upheaval with the dominance of tech giants prompting a rethink. This made the standard economic paradigm increasingly fragile throughout the 2010s, so it shouldn’t be surprising that a once in a lifetime type event like coronavirus created the urgent need for a change in economic policy strategy. The virus created issues such as disrupted supply chains causing a price level surge and a sharp decrease in aggregate investment. Most concerning was that the job losses were not only significant in number but mainly focused on the hospitality sector where women, minorities and low skilled workers are overrepresented. Therefore, this crisis was unique in that the poorest in society were being affected the worst. This created a sense of urgency amongst policymakers and economists alike to find a new approach.
 
Modern Economists attitude to recovery policy can be sorted in three groups from most to least radical. Firstly, there are those that believe that monetary policy alone has enough firepower to reliably stimulate the economy. Many economists, including Ben Bernanke, state there is enough scope for further asset purchases and that consequently monetary policy alone would be sufficent to fight a recession. However, nowadays many doubt that asset purchases have the reach to deliver unlimited stimulus. Leading us to the  second school, who believe that budget deficits and fiscal stimulus are a more effective way to recovery. The more radical members of this group believe that central banks should act as enablers of public debt by allowing for cheap public borrowing. This idea is being pushed (particularly by Adair Turner former regulator) as a mainstream policy termed ‘helicopter money’. In traditional economic theory running such a high and prolonged deficit  would cause serious public debt issues. But with this new attitude, relying on central banks to backstop debt, high public debts become a less signifcant problem. This does challenge the idea of central bank independence and may compromise inflation targeting. Furthermore, the success of fiscal stimulus is almost completely dependent on how well it is targeted as too extensive a package could keep business’s alive that are meant to fail. Therefore, this route is effective in theory but is at the mercy of how it is executed. 

Economy can grow its way out of debt and borrow at no fiscal cost as long as growth is higher than interest payments

​What both of these approaches have in common is that they leave a bill to be paid in the future and have both been explored before. This combined with the aforementioned ‘urgency to find a new approach’ has led to the exploration of an approach that 10-15 years ago would’ve been considered very radical. Negative interest rates. Not that negative interest rates have never been considered and are even in place in some countries (Switzerland’s current bank rate is -0.75%) but they are still considered fringe by the mainstream. The notion of a negative bank rate is gradually becoming more appealing as the global public debt crisis grows. Furthermore, central banks extensive use of QE over the last decade has somewhat immobilized them as they cannot raise rates without paying interest on the ‘huge bill parked on it’ (The Economist, 2020). The classic criticism of negative interest rates is that customers will simply withdraw all their money and hide them under mattresses. Although this is still valid, the movement towards a cashless society means this problem is much closer to being solved now than it ever has been. One suggestion is to eliminate large denomination notes making storing large quantities of cash impractical. This kind of reform would need to sweeping as it the bank rate takes too long to transmit to real rates it will be ineffective. The proponents of negative interest rates say that experimental rates such as Switzerland’s are not radical enough and that negative rates of -3% are what is needed for benefit to be felt. 

This does however bring into question the reversal interest rate.

​This is the point at which rates become so low they actually deter lending and are therefore counter-intuitive to growth. The reversal rate is dependent on a number of factors such as strictness of capital constraints and bank holdings, so an actual figure is not known. One thing that is known QE use raises the reversal rate which does not bode well for the current economy. It is entirely possible that a more aggressive negative rate such as -3% could very well surpass the reversal rate and cause the policy to be counter-productive but this is not a certainty. One thing that is certain is that a change of perspective is needed. Inequality issues will only be exacerbated as dominant incumbent companies increase automation and workers bargaining power is diminished. Public debt is already at an all-time high and QE is showing its limitations. Perhaps negative interest rates are the new shiny weapon policymakers are looking for.