UBS: Print prescription

Have central banks run out of ways to cure the illnesses that afflict the economy? This has become the constant fear: zero rates were tried, forward guidance attempted, quantitative easing (QE) was implemented, and negative rates appear to be approaching their natural limit. Yet growth remains moderate at best and inflation expectations look ridiculously low.

So now attention is turning to the 'nuclear option' of 'helicopter' money. What if the central bank prints money and simply gives it straight to the government? Giving it to the government would allow for tax cuts or higher spending, hence helicopter money is often referred to as monetary financing, or simply monetisation.

Monetisation is not a revolutionary concept. Of course there are the historical precedents that led to hyperinflation in Germany, Zimbabwe and elsewhere. But in fact, monetisation already happens every year in almost every country. As the economy grows the money supply needs to be increased in line with that growth to keep inflation positive. Who benefits from this newly created money? The government. This is known as seignorage, but QE also generates some monetisation because the central bank pays the interest back to the government (QE is like an interest free loan). The Fed transferred about USD 100 billion back to the US Treasury in each of the last two years.

So how is the rest of QE different from monetisation? Because QE is temporary, while monetisation is permanent. Suppose the central bank introduces QE by buying EUR 50 worth of bonds in each of two years (chart 1a). The stock of money is up by EUR 100 in year two and stays there until the debt starts to mature and the stock of money begins to decrease. There is some permanent effect from the money the government saved on interest payments.

With permanent monetisation (chart 1b) the increase is never reversed. That means the extra money (EUR 100 in our example) ends up in the private sector and remains in the system forever, contributing to inflation. Inflation expectations should therefore be pushed higher. The interest that the government does not have to pay is also effectively a monetisation, and that increases every year (at least compared to the base case).

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