With more than 94,000 coronavirus cases and over 3,000 deaths at the time of writing, you could be forgiven for finding the debate over how macroeconomic policy should respond distasteful. But public health panics will invariably turn into economic crises if policymakers allow them to. A large economic recession and widespread panic and shortages would cause poverty and misery, so governments have to work out how to minimise the risk.
Bank of England deputy governor John Cunliffe spoke on a panel last Thursday and mused: “If it’s a pure adverse supply shock there is not much that monetary policy can do”. He continued: “In a disruptive shock, you won’t know what is supply and demand for some time.”
We have to hope that fellow colleagues on the Bank of England’s Monetary Policy Committee (MPC) colleagues put him right. First, in advance of a crisis, it does not serve to muse about a hypothetical thought experiment that is unlikely to bear any relation to reality, such as “a pure adverse supply shock”. The “if” – even as Cunliffe uses it to clarify his own thinking – elevates the thought to a policy response.
Even now it is clear that the interdictions in global supply chains – the phenomenon whereby goods cross borders back and forth up the value chain – are slowing and stopping production, and at the same time slowing demand too.
The most glaring example is the grounding of two-thirds of Chinese planes, which has halted the normally vast amount of Chinese tourism in the rest of the world. There is almost never such a thing as a “pure adverse supply shock”. Brexit will constrict supply by erecting trade barriers, but it is colouring views about the future and depressing investment and consumption too. The 2008 financial crisis was a throttling of the supply of credit, but it brought an inevitable collapse in confidence and demand. Monetary policy did not need to pause to identify the shocks.
A second problem with Cunliffe’s intervention – and others like it – is that, even on its own terms, the statement is not right. To the extent that supply disruptions are temporary, monetary policy does indeed have a legitimate role in nevertheless trying to boost demand through the disruption, allowing the consequences for inflation to play out. Monetary policy can’t resolve the difficulties in supply chains; you can’t replace missing spare machine tools with a central bank interest rate cut or an asset purchase. But it can boost spending somewhat to encourage people to buy through a period when manufacturers will have to source from alternative, more expensive suppliers, or face tightening borrowing costs as their financial viability is put under a spotlight.
The same logic applies to temporary oil price shocks, or interruptions in the supply of credit, which central banks fought in the last decade. Even if the supply constraints were permanent, there would be a role in smoothing the transition, allowing resources to flow across sectors, and ensuring that as few people as possible are consigned to unemployment.
The sense in which there is indeed “not a lot monetary policy can do” is the one sense in which Cunliffe probably did not mean it. Reuters reported him as noting that “Britain had plenty of scope to loosen monetary policy”. It is far from clear that this is true. The Bank of England’s base rate is currently 0.75 per cent. This is only 0.5 percentage points above what the MPC deems to be the lowest permissible rate in the UK. Before the 2008 financial crisis, interest rates stood at around 5-6 per cent in the developed economies (outside of Japan). They were quickly cut to their floor (around 0) as the crisis broke. Internally, staff traded estimates of where interest rates would ideally go if there were no lower bound, and numbers like such as -9 per cent (yes, minus 9 per cent) were not uncommon.
So the “plenty of scope” that Cunliffe refers to can mean some combination of two things. Either he thinks that the effects of the coronavirus on the economy can be dealt with through a cut in rates equal to 0.5 percentage points (to recap, that is around 1/30th the size of the rate cut that would ideally have been introduced during the financial crisis – 6 per cent to minus 9 per cent). This would be a supremely confident assessment at present.
Alternatively, Cunliffe is suggesting that further quantitative easing (under which the Bank of England buys long-term government bonds or private sector securities through electronically-created money) can take the strain. The bank’s balance sheet is still swollen by the QE undertaken after the financial crisis, to the tune of £435bn, or just under a quarter of UK nominal GDP. There is a fair amount of statistical evidence that prior rounds of QE worked by lowering longer-term interest rates (whether durably so is less clear). But whether further QE would work is less clear.
Cunliffe is probably not making an allusion to the possibility that the Bank of England could engage in “helicopter money” – the printing of new money to hand directly to the public. But last resort measures such as this might have to be on the agenda if the current crisis deepens. And as long as we live in a world where there is limited room for conventional monetary policy tools to operate, they will have to stay on the agenda.
The Hong Kong government’s announcement of a package of crisis measures, including cash handouts of $1,200 for all adults, superficially resembles helicopter money, which was perhaps why FT Alphaville subs ran with the headline “the helicopters are here” when reporting it.
The much-used phrase refers to a thought experiment entertained by Milton Friedman, who was not actually contemplating using helicopters to rain money down on the populace, but wanted to illustrate what would happen to prices if, say, the amount of money in everyone’s pockets suddenly doubled. The answer – in those halcyon days of “normal” interest rates – was that prices would double too.
But the Hong Kong government’s policy is not helicopter money. The handouts will be financed, along with all the measures in the emergency package, by raising money on the bond markets. “Helicopter money”, by contrast, is used by economists to refer to government spending (or a tax cut) financed by the creation of new money. Hong Kong follows a tight exchange rate target with the US dollar, so as long as the region sticks to that, money creation (and interest rate policy) has to be consistent and can’t allow for a large helicopter drop (unless mirrored in the US), which would mean lower interest rates for a period and a fall in the exchange rate against the dollar (i.e. more Hong Kong dollars for every US dollar).
This might sound like a bit of unseemly terminological warfare in the midst of a humanitarian crisis. But it is actually important. Many episodes of chronic hyper-inflation led to the erection of sturdy firewalls between finance ministries and central banks to prevent the latter from being leaned on to print money for the former’s pet spending programmes. In the case of Germany, which endured the harshest of hyperinflation in the 1920s, this led to a postwar constitutional provision that the Bundesbank should not be doing anything that constitutes “fiscal policy”.
These firewalls are therefore not to be taken down lightly. And if such a momentous step is to be taken, it is helpful to be clear what does and does not constitute prior evidence of its effects. Hong Kong’s cash handouts won’t qualify.
Even if Hong Kong is not undertaking helicopter money, it is quite possible that the major developed economies reach a situation where it might be contemplated. Interest rates are low throughout the US, the UK, the Eurozone (helicopter money seems a political impossibility in view of the Lisbon Treaty) Japan, Switzerland, Denmark, Sweden, Canada and Australia.
The first line of defence will be moderate interest rate cuts and further QE. Where politics permits, and since the cost of conventionally financed fiscal policy is so cheap (the positive consequence of ultra-low interest rates), old-fashioned tax and spending stimulus should take the strain and help the economy through the the coronavirus crisis. But if the economic outlook becomes more desperate, we may need correspondingly more desperate measures.
The Bank of England’s tone became more resolute yesterday and it was quoted as stating that it is “working closely with HM Treasury and the FCA (Financial Conduct Authority) – as well as our international partners – to ensure all necessary steps are taken to protect financial and monetary stability”.
It remains to be seen what that will entail. As the financial crisis deepened, major central banks agreed co-ordinated interest rate cuts and other collaborative action as a way to reassure markets that they were serious. A rather weak communique from G7 central banks and finance ministries on 3 March promised to use “appropriate tools” but did not agree any actual action.
Tony Yates is former professor of economics at the University of Birmingham