Monetary financing against the COVID-19 crisis – safe or risky?

The FCI has previously remarked that the rising unemployment figures caused by the Covid-19 pandemic recall the period of the German Weimar Republic in the early 20th century. This period was also characterized by hyperinflation. It is allegedly for that reason that Article 123 of the Treaty on the Functioning of the European Union prohibits monetary financing, a concept that refers to funding budget deficits via the central bank. As hyperinflation is usually caused by governments turning on the printing press, the prohibition of monetary financing is justified with reference to the undesirability of political opportunism. Analysts have noted, however, that the Quantitative Easing (QE) programmes that we have witnessed in recent years were a way to circumvent the prohibition of monetary financing. As this prohibition does not exist in the US and the UK, these countries have had recourse to the instrument as a response to economic disaster that is currently unfolding.

Research has shown that QE hardly reaches the real economy, where the money is now urgently needed to cope with the pandemic. Alternatives to monetary financing also have the disadvantages of creating more debt and subsequent austerity to repay the debt. Different plans for monetary financing have meanwhile been proposed and many commentators are convinced this is the only way to avert a global depression. Proposals range from temporarily waiving Article 123 TFEU to issuing Emergency Euro Notes, according to Dutch think tank Ons Geld.

Economists Sony Kapoor and Willem Buiter also advocate monetary financing in light of “Covid-19’s economic impact on crumbling GDPs, collapsing tax revenues and ballooning fiscal deficits”. They explain that monetary financing can take two forms: central banks can either transfer cash balances to citizens (“helicopter money”) or to governments. As the Covid-19 crisis is not caused by insufficient demand and a proper digital infrastructure that gives citizens direct access to the central bank being absent, the first option is discarded. Instead Kapoor and Buiter argue for a “one-off transfer of 20%-30% of GDP worth of cash to governments by their respective central banks”.

What then about the danger of (hyper)inflation? If money creation powers are used in a disproportionate way, meaning that the money does not lead to a higher production but instead is used to buy a limited number of goods and services the price of which will increase due to increased demand, inflation may indeed occur. However, a study by University College London has noted that “historical trends and case studies suggest that monetary financing was an effective tool in supporting standard macroeconomics policy goals such as nominal GDP growth and industrial policy without excessive inflation”. While not excluding the possibility of inflation altogether, the researchers argue that “weak governance and tax-raising powers, corruption and war, loss of control over exchange rates or bottlenecks where the economy is at full capacity may be stronger candidates to explain extended periods of inflation or hyperinflation”.

In a subsequent episode, we will touch on another instrument to fund a global response to the pandemic, namely the issuance of Special Drawing Rights (SDRs) by the IMF.

Edited by: Dr. Olivier Vonk