As the pandemic spreads, so too do fears of recession or worse. Respected forecasters speak of 30-50% declines in US gross domestic product, the broadest measure of economic activity. Unemployment could spike to 20% or higher. In some countries, such as Italy, the economic consequences could be even worse. Left unaddressed, it is no exaggeration to say that a major economic depression could ensue.
Little wonder, therefore, that governments and central banks are pulling out all the stops to mitigate the adverse economic consequences of the pandemic. Previously unthinkable solutions are now in discussion, among them ‘money printing’ (more formally, the monetization of government debt) by central banks, including the US Federal Reserve.
In the minds of many, money printing remains an anathema. Hyper-inflation and images of 1923 Germany, when wheelbarrows of paper money were required to purchase a loaf of bread, come to mind.
That’s not likely now, for reasons we outline below. Rather, judicious financing of emergency government debt issuance can help stabilize the economy through the turbulence that lies ahead. Nor is this new. The Fed acted in a similar fashion to finance US government borrowing to fight the Second World War and to help the transition the country to peacetime, after which it returned to the independent management of monetary policy.
It is now time for the right kind of money printing – here’s why.
The COVID19 pandemic necessitates massive fiscal stimulus and an accompanying surge in Treasury borrowing. Part of that new lending to the Treasury will come from the Federal Reserve System, which already has announced plans to buy at least $500 billion in Treasury securities. The effectiveness of QE expansion of the Fed’s balance sheet in the current COVID19 crisis will reflect more than the typical textbook exposition where Fed securities purchases aid the economy by lowering lending rates and flooding banks with more reserves to lend. Such a process is often seen as potentially ineffective “pushing on a string” if banks are unwilling to lend and borrowers are reluctant to add more debt. In the current setting, however, Fed purchases of Treasury debt will be financing quick Federal cash infusions to the household and business sectors.
As the Treasury borrows to finance the cash injections to the household sector, the Federal Reserve will be buying Treasury securities. In textbook jargon, this is labeled as “monetization of the national debt”.
Of course, there’s more debt service accompanying more national debt. But that debt service should not have negative effects on current and future taxpayers for two reasons. First, the Fed can roll over maturing Federal securities as opposed to requiring taxpayers to “pay back” the Fed. Second, the interest that the Fed collects on its securities is mostly returned to the Treasury. In sum, there’s no net debt service burden on taxpayers.
Generations of economists and their students have believed that Fed monetization of the national debt will ultimately raise inflation (and the inflation premium in interest rates). The reason for that belief is that debt monetization means that the overall (household, business, foreign sector and government) aggregate demand for goods and services will rise faster than the supply of those goods and services. However, in the current setting net household purchasing power is being replaced as jobs and related wages and salaries decline. There’s no net rise in aggregate purchasing power. If the Federal government continued the cash infusions after households’ incomes and demand recovered, then aggregate demand could exceed supply and raise inflation. But in the current setting the cash infusions should continue only until jobs and related incomes start to recover.
The coronavirus pandemic presents extraordinary challenges. The public health policy response has already crossed lines never before imaginable, including complete quarantines of cities and regions. It is time for economic and monetary policy to similarly cross lines and to dip into those parts of the toolkit reserved only for extreme crisis. Fiscal and monetary policy must join forces to combat the coming economic crisis.