Our Central Bank (ECB) has officially entered the Twilight Zone. The actions announced on Thursday (March 10th, 2016) were unprecedented. Not even Japan has gone this far before. The confusion and disbelief among journalists in the press conference was palpable.
I won’t describe the actions in detail in this blog post, because there are good summaries available on Bloomberg and Reuters. It’s telling that this massive package of Quantitative Easing (QE) is being described as “bold”, “surprising”, “unprecedented”, and … wait for it … “a bazooka”.
Now the ECB is printing money not only for buying increased amounts of government bonds, but also for buying corporate bonds. The interest rate on cash parked overnight by commercial banks is lowered to minus 0.4 percent. At the same time the ECB introduces new borrowing facilities for banks (TLTRO), allowing the banks to borrow for 4 years at a zero interest rate, and even at lower rates if banks are nice enough. Yes, that's right – the ECB is paying banks for lending out money.
Many of the actions presented were unthinkable just a few years ago. To put it bluntly, the ECB is so afraid of deflation that they are willing to do whatever it takes to get inflation up.
Why is deflation so terrifying? For the simple reason that we are living in an overleveraged world. As I wrote in a previous blog post, the financial crisis – which was caused by a global credit bubble – did not result in a reduction of indebtedness, or deleveraging. Instead all major economies have today higher levels of debt to GDP than they had in 2007.
If we don’t get inflation up and running, it will be impossible to deal with the ever-growing debt mountain. But what happens if even these massive measures can’t do the job?
Why not go for helicopter money? Sounds like a joke, but it's a serious idea made popular by the economist Milton Friedman in 1969. The basic principle is that if you want to raise inflation when the economy is struggling and nothing else will do the job, then just simply give everyone direct money transfers. In theory people should then start to spend more, which would stimulate economic activity and push inflation back up.
So when a journalist asked about helicopter money during the ECB press conference, it wasn’t a total surprise to hear Draghi say "We haven't really thought or talked about helicopter money but it's a very interesting concept.”
I’ve got a feeling it will be more than just an interesting concept in the future.