Debt-Free Fiscal Stimulus? (part I)
BLOG ARCHIVE
(Originally published 17 April 2016)
What if it were feasible to use the central bank to fund stimulus spending without recourse to debt? What if the CB were to simply give government the money to pay for the fiscal stimulus – that is, a grant rather than a loan? What if, properly viewed, even a loan from the CB to government is in fact a form of debt-free finance? If this were the case, shouldn’t the CB be fully exploited to finance infrastructure and other socially useful expenditure as part of the stimulus package?
The belief that the CB should serve as a source of debt-free funding for government is one of the oldest themes of the ‘monetary populism’, which sees it as a legitimate use of the sovereign right to create money. Not surprisingly, this notion of debt-free funding has resurfaced strongly in the post-GFC years, as an easy response to the fiscal difficulties faced by governments. In the UK, it lies behind the slogan of ‘peoples’ QE (quantitative easing)’, which has been picked up recently by the Labour Party. In France, it is only a few years since the influential ecologist and would-be presidential candidate, Nicolas Hulot, proposed CB debt-free funding as the basis of his ‘plan of economic, ecological and social transition’ (Fondation Hulot, 2011). Just last year, a commission of the Assemblée Nationale put forward a report drafted by a communist deputy (Nicholas Sansu) arguing essentially the same proposition.
In the US, the idea had a win in late 2015 when Congress decided to raid the Federal Reserve Bank to the tune of $19 billion to help fund highways – overriding Fed objections. Part of the momentum for this move came from populist politicians, such a Representative DeFazio of Oregon, for whom the use of debt-free CB funding is a matter of principle.
Everywhere, the populists argue that providing debt-free funding is simply a more effective and fair version of QE. In implementing QE, CBs have engaged in large-scale money creation, but in a manner which has worked better to line the pockets of the rich (via higher asset prices) than to promote economic recovery. Surely it is better to apply newly created money directly to meet social needs, starting with infrastructure. Hence the slogan ‘people’s QE’.
Would it in fact be more financially advantageous for government than borrowing? How does the idea relate to proposals for the use of “helicopter money” (overt money financing)? Would it do any harm if used in a limited manner to fund a one-off fiscal stimulus? Can it help reduce the tension between fiscal stimulus and fiscal rules? What are the risks? These are the main questions considered in this blog piece. The legal barriers to such funding, which are well known, are not addressed here.
Debt-free funding of fiscal stimulus by the CB is possible. The question is whether it is desirable. But before considering this, it is important to be clear about what debt-free funding means and what it does not mean. It does not simply mean that the CB provides monetary accommodation of debt-financed expansionary fiscal policy – i.e. that the CB creates additional money at the same time that the government implements a fiscal stimulus financed by borrowing. Nor does it mean that the CB uses purchases of government bonds (whether directly from government or on the secondary markets) as the specific instrument for creating additional money. (The proposition that CB loans to government do not count as debt – discussed below – is wrong.)
The only way for the government to obtain debt-free funding is if the CB actually gives it the money to pay for fiscal stimulus. The simplest and most explicit way of accomplishing this is for the CB to credit the government’s bank account without receiving bonds in return, as advocated by Seidman (2013) and others. This is what happened in the US when Congress compelled the Fed to hand over the $19 billion.
There are at least two other frequently-suggested funding techniques which amount to the same thing. One involves the CB purchase from government of non-redeemable (‘perpetual’) zero interest rate bonds (Bossone, Fazi & Wood, 2014). Although dressed up as borrowing, such a transaction would in substance constitute a gift. It would also be treated this way in fiscal accounting, which would characterise the CB payment as government revenue rather than as a loan. (Because the so-called ‘bonds’ would by definition be worthless, any payment made to government by the CB to ‘purchase’ them would – because the bank is receiving nothing of value in return – be considered to be a grant to government.[1])
The other equivalent technique involves the CB purchasing government debt on the secondary market and cancelling it, with the government then re-borrowing an equivalent amount to fund the fiscal stimulus package. Here again, internationally-accepted fiscal accounting practice would treat debt cancellation as revenue.[2]
However it is packaged, debt-free funding always combines two things – a grant to government from the CB, and a matching injection of additional money into the economy.
Many of those advocating debt-free stimulus funding (e.g. Wood, 2013) think that they are marching in the same army as the economists calling for the use of helicopter money. However, CB grants to government and helicopter money are different things. The essential characteristic of helicopter money is the permanent expansion of the stock of base money. The means by which this permanent expansion is effected are not relevant to the concept. That helicopter money is not necessarily debt-free money becomes immediately clear when we note that the route which economists usually discuss for the injection of helicopter money into the economy is that the CB funds fiscal stimulus by purchasing bonds directly from the government and then holds onto those bonds permanently (i.e. never re-sells them to the public). Conversely, that debt-free money is not necessarily helicopter money is obvious when we consider that any new money which the CB creates by making a grant to government may be withdrawn from the economy subsequently via normal open market operations (sales of bonds to the public) – in which case the monetary expansion will turn out to have been temporary rather than permanent.
Debt-free funding of fiscal stimulus is also not the same as the CB simply cancelling part of its existing holding of government bonds – as advocated by former US Congressman Ron Paul (who in 2011 proposed legislation to achieve this) amongst others. As mentioned above, debt-free funding involves the combination of the grant – whether achieved via debt cancellation or another means – together with monetary expansion. The cancellation of government bonds which the CB already holds does not entail any monetary expansion.
Proponents of debt-free CB funding government think that is eases the financial constraints faced by government. They do so for essentially the same reasons that proponents of debt cancellation believe that government will be better off as a result. Neither proposition is, however, true. The reasons why will be explored in the next blog piece.
[1] This is true both the IMF’s GFS statistical standards, which is the basis of fiscal accounting in most countries, and in the IPSAS accounting standards, both of which value financial assets at market value. It is also true for the debt measure used by the EU for the purpose of the 60 percent debt limit – which values bonds at ‘nominal’ (I.e. face or redemption) value. For these reasons, the assertion of Pâris and Wyplosz (2013) that zero interest rate perpetual bonds would ‘remain indefinitely as an asset on the books of the’ CB is incorrect.
[2] GFS classifies ‘debt forgiveness’ as revenue. This impacts both on accrual-based budget balance measures, and also on ‘cash’ budget balance measures which are based on the GFS concept of net lending.