What more could the central banks do to deal with the crisis?

By Christophe Blot and Paul Hubert

The return of new lockdown measures in numerous countries
is expected to slow the pace of economic recovery and even lead to another
downturn in activity towards the end of the year. To address this risk,
governments are announcing new support measures that in some cases supplement
the stimulus plans enacted in the autumn. No additional monetary policy
measures have yet been announced. But with rates close to or at 0% and with a
massive bond purchase policy, one wonders whether the central banks still have any
manoeuvring room. In practice, they could continue QE programmes and increase
the volume of asset purchases. But other options are also conceivable, such as
monetizing the public debt.

With the Covid-19 crisis, the central banks – the
Federal Reserve, the Bank of England and the ECB – have resumed or amplified
their quantitative easing (QE) policy, to such an extent that some are viewing
this as a de facto monetization of debt. In a recent Policy
Brief, we argue that QE cannot
strictly be considered as the monetization of public debt, in particular
because the purchases of securities are not matched by the issuance of money
but by the issuance of excess reserves. These are distinct from the currency in
circulation in the economy, since they can be used only within the banking
system and are subject to an interest rate (the deposit facility rate in the
case of the euro zone), unlike currency in circulation.

Our analysis therefore makes it possible to look
again at the characteristics of QE and to specify the conditions for monetizing
debt. It should result in (1) a saving of interest paid by the government, (2) the
creation of money, (3) being permanent (or sustainable), and (4) reflect an
implicit change in the objective of the central banks or their inflation
target. The implementation of such a strategy is therefore an option available
to central banks and would allow the financing of expansionary fiscal policies.
The government, in return for a package of fiscal measures – transfers to
households or health care spending, support for businesses – would issue a
zero-coupon perpetual bond, purchased by commercial banks, which would credit
the account of the agents targeted by the support measures. The debt would have
no repayment or interest payment obligations and would then be acquired by the
central bank and retained on its balance sheet.

Monetization would probably be more effective than QE
in stabilizing nominal growth. It would reduce the risk to financial stability caused
by QE, whose effect depends on its transmission to asset prices, which could
create asset-price bubbles or induce private agents to take on excessive debt.
Monetization has often been put off because of fears that it would lead to
higher inflation. In the current environment, expansionary fiscal policy is
needed to sustain activity and to prepare for recovery once the pandemic is
under control. A pick-up in the pace of inflation would also satisfy the central
banks, and insufficient demand should greatly reduce the risk of an out-of-control
inflationary spiral. Monetization requires stronger coordination with fiscal
policy, which makes it more difficult to implement in the euro area.