Monetary Finance Is Here
There is no doubt that monetary finance is technically feasible and that wise fiscal and monetary authorities could choose just the “right” amount. The crucial issue is whether politicians can be trusted to be wise.
LONDON – In response to the COVID-19 pandemic, the US Federal Reserve will buy unlimited quantities of Treasury bonds, the Bank of England will purchase £200 billion ($250 billion) of gilts, and the European Central Bank up to €750 billion ($815 billion) of eurozone bonds. Almost certainly, central banks will end up providing monetary finance to fund fiscal deficits. The only question is whether they should make that explicit.
Monetary policy, on its own, is clearly impotent in today’s circumstances. Central banks have cut policy interest rates, and bond purchases are depressing long-term yields. But nobody thinks that lower interest rates will unleash higher consumer expenditure or business investment. Instead, depressed economic growth will be offset (as best possible) by increased government spending on health care, direct income support for laid-off workers, and a reduced tax take. This will inevitably result in unprecedented fiscal deficits.
In theory, funding those deficits by selling government bonds could raise bond yields, potentially offsetting the stimulative effect. But with central banks buying bonds and depressing yields, governments can borrow all they need at rock-bottom interest rates.