Europe's QE Quandary

If demand and inflation fail to get back on track in Japan and Europe -- and if the disappointing fourth-quarter figures for U.S. gross domestic product are a sign that America's recovery is failing too -- monetary policy won't be enough. The shock that's required is hybrid macroeconomic policy, meaning an approach that explicitly combines fiscal expansion with monetary accommodation.

The idea is for governments to run bigger budget deficits - - with tax cuts and/or higher public spending -- then finance them not with borrowing but with newly created money. The most eye-catching variant is direct cash payments by central banks to households, or so-called helicopter money.

In ordinary times, such a policy would be reckless in the extreme -- it's a classic formula for letting government spending and inflation surge out of control. But when demand is persistently weak and the usual tools for boosting it aren't working, more spending and higher inflation should be part of the remedy.        

Compared with negative interest rates and ever-expanding QE, the economics of printing money to pay for fiscal stimulus is simple. There's little doubt such a policy would raise total spending and get you out of a persistent low-demand trap. Sufficient popular support seems achievable. Institutional resistance to the idea is strong, though, because it overthrows the hallowed principle of central-bank independence. In effect, the policy puts the central bank under the control of the finance ministry, an arrangement that often ends badly.

Again, in ordinary times, it would be a terrible idea -- but these aren't ordinary times. Political resistance would be intense in the U.S., and in Europe "direct monetary financing" is forbidden by EU rules that would be hard to change. Perhaps Japan is better placed. Since Kuroda likes surprises, he might reflect on the case for springing this one.
 

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