The U.S. economy is recovering from the Great Recession, but Europe remains in bad shape. Much of the continent is flirting with deflation, and yet the European Central Bank’s solution is to try to force over-indebted households and firms to borrow more. The latest example: On Thursday, the central bank cut borrowing rates further and announced a new stimulus plan that involves buying financial assets. The move comes as the eurozone has barely grown during the past year, even though interest rates are in negative territory.
So why do all this when the underlying problem is simply that Europeans are not spending enough?
The core problem is that central banks are using 19th century tools to solve 21st century problems. When central banks were first formed, governments charged them with providing liquidity to banks in order to prevent bank runs and with financing the government bond market. To do this they either controlled the interest rate or swapped assets for cash.
They still have those tools today, and not much else. It’s time we gave them a new tool: the ability to bypass the financial sector and give cash directly to households.
Direct cash transfers boosts spending and does not discriminate against borrowers or savers, which is the case with manipulating interest rates. It also allows individuals to decide what to do with their money. Some spend it. Some invest it. Some use it to repay debt (a good thing, particularly if debt is holding back growth). Some may just save it, but even that helps banks rebuild their balance sheets and lend more without going through the convoluted mechanics of quantitative easing and the like.
Not only is this far preferable to central banks attempting to force borrowers and savers to act against their wishes, but all empirical evidence suggests that cash rebates boost spending far more effectively than roundabout policies such as large-scale bond purchases and infrastructure spending. Taking the effects of the 2008 economic stimulus as a guide suggests that transferring less than 5% of GDP to households would create a recovery in the eurozone stronger than the recovery generated by the 20% of GDP involved in quantitative easing globally since 2008.
To be clear, politicians should not have this tool at their disposal. The role of politicians would be limited to legislating this tool and determining the rules governing distribution. Thereafter politicians would have nothing to do with the policy. Central banks would remain independent and would adhere to their inflation targets. They would simply be given a new tool to fulfill their mandates. When faced with recession or deflation, central banks can transfer an amount they deem appropriate directly to households. The bank decides when and how much to transfer. When its inflation target is reached, it stops the policy. Period. Yet, if this policy is so simple and studies have shown it is effective, why has it not been tried?
One reason is turf battles. When the ex-governor of the Bank of England Mervyn King was asked about cash transfers he dismissed it as ‘fiscal policy,’ and not the job of the central bank, a sentiment the governor of the Bank of Japan echoed earlier this year. But this is semantics: monetary policy is whatever we ask the central bank to do. If we grant it the power to make payments to households, it becomes monetary policy.
Others object that so-called ‘money-printing’ and inflation are synonymous. This is not the case: all schools of economics agree that inflation depends how much is printed, and under what conditions. With direct cash transfers, central banks would print a fraction of what they would have to do with quantitative easing, and they would transfer funds only if they believe it would help meet medium-term inflation-targets—targets that the ECB, for example, is missing month after month with current policy. If cash transfers can revive demand and create self-sustaining recoveries, central banks can then normalise interest rates, cutting off inflation at the root, but only after a real recovery has taken hold.
Far from proposing something revolutionary, all we are advocating is better plumbing and a more efficient use of existing resources. We have asked central banks to solve problems that they were never meant to address. It is only fair that we give them the tools to do the job we ask of them.
Mark Blyth is a professor at Brown University and the author of Austerity: The History of a Dangerous Idea. Eric Lonergan is a hedge fund manager living in London and the author of Money. This piece is based off their article Print Less but Transfer More in the September/October issue of Foreign Affairs magazine.
