Options for Europe – Part 67

The title is my current working title for a book I am finalising over the next few months on the Eurozone. If all goes well (and it should) it will be published in both Italian and English by very well-known publishers. The publication date for the Italian edition is tentatively late April to early May 2014.

You can access the entire sequence of blogs in this series through the – Euro book Category.

I cannot guarantee the sequence of daily additions will make sense overall because at times I will go back and fill in bits (that I needed library access or whatever for). But you should be able to pick up the thread over time although the full edited version will only be available in the final book (obviously).

Part III – Options for Europe

What is Overt Monetary Financing?



Abba Lerner’s second law of Functional Finance (see Chapter 18) advocated the central bank ‘printing money’ to match government deficit spending sufficient to achieve and sustain full employment. The idea is very simple and as we saw in Chapter 18 does not involve any printing presses at all. While the exact institutional detail can vary from nation to nation, stylistically, governments spend by drawing on a bank account they have with the central bank. An instruction is sent to the central bank from treasury to transfer some funds out of this account into an account in the private sector, which is held by the recipient of the spending. A similar operation might occur when a government cheque is posted to a private citizen who then deposits the cheque with their bank. That bank seeks the funds from the central bank, which writes down the government’s account and the private bank writes up the private citizens account. All these transactions are done electronically through computer systems. So government spending can really be simplified down to typing in numbers to various accounts in the banking system.

When economists talk of printing money they are referring to the process whereby the central bank adds some numbers treasury’s bank account to match its spending plans and in return is given treasury bonds to an equivalent amount in value. That is where the term ‘debt monetisation’ comes from. Instead of selling debt to the private sector, the treasury simply sells it to the central bank who creates new funds (or financial assets) in return. This accounting smokescreen is, of-course, unnecessary. The central bank doesn’t need the offsetting asset (government debt) to function given that it creates the currency ‘out of thin air’. So the swapping of public debt for account credits is just a convention.

Some OMF proponents have invoked the 1948 article by Milton Friedman as evidence that even arch free market economists support the money financing approach. There is a sort of security in this approach – it suggests the radical idea is not all that radical at all. This is a negative approach for progressives to take. The preferred option is to demystify and educate such that what the conservatives generally claim is taboo is in fact just a simple extension of logic once we understand how the monetary system operates. Friedman (1948: 5) wrote that “government expenditures would be financed entirely by tax revenues or the creation of money, that is, the use of non-interest bearing securities. Government would not issue interest-bearing securities to the public.” Adair Turner, then Chairman of the British Financial Services Authority, suggested that serious consideration be given to “extreme option” of “overt money finance (OMF) of fiscal deficits”, which would involve the “permanent monetisation of government debt” (Turner, 2013: 2). He certainly channels Friedman by concluding that Friedman argued “that government deficits should always be financed in that fashion” (Turner, 2013: 3). However, Wood (2014) correctly points out that Friedman’s proposals were part of what was known as the Chicago Plan (emanating out of the free market bastion of the University of Chicago), which proposed a broad regime change where private banks would be prevented from creating new money and public deficits would be the only source of new money. Equally, the government would run a balanced fiscal position over the cycle and destroy the money created in the downturn when they ran offsetting surpluses in the upturn. This is a very different proposition to the current suggestion for OMF, which is correctly seen as a policy change to address the current crisis. As Turner postulated “How do we get out of this mess?” Of-course, MMT advocates OMF as a permanent part of fiscal policy implementation a point we will expand upon in the final chapter.


Paul McCulley, former managing director of the large bond trader PIMCO, co-authored a research report in January 2013, which argued convincingly that the emphasis on monetary policy alone as the vehicle to resolve the crisis was ineffective, especially with fiscal policy being forced to take on a pro-cyclical stance due to the imposition of austerity (McCulley and Pozsar, 2013). They argued that the correct policy response in circumstances of low or falling inflation and massive spending shortages is to ensure “monetary stimulus is paired with fiscal stimulus”, a coincidence they referred to as a “helicopter drop”. The idea of a ‘helicopter drop’ was revived in the public debate by the former US Federal Reserve Chairman Ben Bernanke in 2002. In a Speech to the National Economists Club in Washington about avoiding deflation, Bernanke advocated a “money-financed tax cut”, which he said was equivalent to Milton Friedman’s anti-deflation proposal to drop money from helicopters in order to stimulate spending (Friedman, 1969: 4). Bernanke said that when there is a “collapse of aggregate demand” (spending), a nation faces rising unemployment and, ultimately, deflation, as “producers cut prices on an ongoing basis in order to find buyers”. As the recession deepens, interest rates drop to zero, which reduces the flexibility of monetary policy. Even in the mainstream eye of Ben Bernanke, these situations call for a significant increase in fiscal deficits to stimulate spending and kickstart confidence, with the central bank issuing new money to ensure to support the deficits.

From the perspective of MMT, a ‘helicopter drop’ is equivalent to an increase in the fiscal deficit in the sense that new financial assets are created and the net worth of the non-government sector rises. This is in contradistinction with QE, which just swaps assets in an existing non-government asset portfolio.

McCulley and Pozsar consider that “unconventional and radical policies” (p.16) such as QE and similar policies are not effective because they are “independent of the fiscal policy stance”, and so the imposition of fiscal austerity kills any growth potential that these monetary policies might have. Instead, they propose that monetary policy has to go “nuclear” (p.16) (reflecting the strength of the taboo) as part of what they call, “fiscal-monetary cooperation (‘FMC’)” (p.16). FMC means that monetary policy works to “support the fiscal authority in raising nominal demand, not to stimulate private borrowing per se” (p.17) by funding the deficit. They qualify their support for this policy option by suggesting that to overcome what they call technical constraints (by which they mean the voluntary constraints that force governments to issue debt to the private sector), the central bank can “underwrite government spending … by buying on the secondary market the same amount of bonds that the government has issued to fund the stimulus” (p.18). Readers will note that this is exactly what the ECB was doing under the aegis of their Securities Market Program (SMP). From an Modern Monetary Theory (MMT)
perspective, the preferred approach would be to eliminate any of the voluntary constraints on central banks so they could directly underwrite the fiscal deficits without the need for governments to engage in primary issuance of debt to the private markets.

This is a point that former Australian Treasury official, Richard Wood considered in his August 2012 article (Wood, 2012). Wood said that the austerity approach in Europe was a “self-defeating exercise” (p.1) which had “failed to restore the levels of sustainable growth needed to substantially reduce unemployment and to prevent the public debt burden spiralling upward”. In the Eurozone context, where according to the Treaty, governments are forced to issue debt to fund their deficits, the two major problems are “deficient aggregate demand, and high and rising public debt” (p.1). The deficient spending manifests as persistently high (and rising) unemployment and lost income. Wood argued that because the current situation is grave “policymakers will be required to consider the widest set of policy instruments to succeed” and the current failed orthodoxy “will need to be jettisoned” (p.2). In that vein, Wood outlined two policy options which would provide stimulus but not increase the level of outstanding public debt (p.4):

Option A is a pure ‘helicopter drop’ of new money by the central bank into private bank accounts.

Option B is the creation of new money to directly finance the budget deficit.

Wood also notes that a ‘helicopter drop’ is not a very targetted strategy and in the case of the Eurozone would run ‘parallel’ with the on-going fiscal deficits. In that sense, it would not break the institutional nexus between rising deficits and rising public debt levels. For those reasons, Wood advocates Option B, which from hereon we will refer to as the OMF option (see also Wood, 2013b). It is exactly what Abba Lerner was advocating back in the 1940s, and has been the basis of MMT since it became a coherent body of theory in the 1990s.

The idea of OMF was given further impetus in the public arena in March 2013 when Adair Turner proposed that, given the severity and persistence of the crisis, the pre-crisis emphasis on inflation targets was misguided and any recovery should be based on policies that explicitly give weight to achieving low unemployment as well as price stability. In addition to more aggressive use of fiscal policy, Turner said that he supported the “overt money financing” because it allowed fiscal stimulus to directly enter “the income stream” (p.25), a basic advantage of using fiscal policy. This which means that the impact of the spending is immediate – a dollar of extra government spending is immediately a dollar of extra income and output. This is in contrast to monetary operations such as interest rate cuts and QE, which are indirect and rely on consumers and firms responding to the changes. The impact is always uncertain and drawn out. We will consider the objections to OMF in a later section.

In April 2012, Italian economist Biagio Bossone focused the OMF proposal specifically in relation to the Eurozone and called for “radical action” (Bossone, 2013a, 2013b). From an MMT perspective, following Lerner OMF is a mainstream option that allows the currency-issuer to maximise its impact on the economy in the most effective manner possible. But in the neo-liberal world of taboo, ‘monetary financing’ is seen as a radical suggestion.

Bossone considered that the existing Emergency Liquidity Assistance (ELA) facility which the ECB says can provide “central bank money and/or any other assistance that may lead to an increase in central bank money” through a “Eurosystem national central bank (NCB)” to any solvent financial institution “facing temporary liquidity problems, without such operation being part of the single monetary policy” (ECB, 2014b: 1). While the rules prohibit the ELA being used to provide “overdraft facilities for official bodies”, purchase “government bonds” etc (ECB, 2012b), Bossone points to precedents in the current crisis (in Belgium, Ireland and Greece) where the ELA facility “has been used … as a source of additional bailout funding”. However, the ECB decision in the case where the Italian Ministry of Finance sought permission to use the ELA via the Banca d’Italia in “a guarantee scheme for the liabilities of Italian banks” (ECB, 2012b: 1). The ECB permitted the scheme on the proviso, among others, that “the Banca d’Italia must comply with the monetary financing prohibition in Article 123 of the Treaty” and “all the guarantees must be financed from the State’s budget” (p.5).

This raises the question of whether the ELA facility could truly be used to fund government deficits on an on-going basis. Bossone is cogniscant of the issue and suggests that the ECB could “extend its legal interpretation of Emergency Liquidity Assistance”, to allow it to be used as “last-resort demand management tool to fight local recessions and preserve monetary and financial stability in the Eurozone”. It is unlikely, however, that the ECB could extend that ‘flexibility’ without coming up against Artcile 123 of the Lisbon Treaty, a matter we consider in a later section of this chapter.


Overt Monetary Financing enters the European debate

On April 24, 2014, the ECB presented its Annual Report 2012 (ECB, 2012) to the Committee on Economic and Monetary Affairs (ECON) of European Parliament. The ECB is accountable to the European Parliament. Following the protocol and clearly exercising its political functions, ECON considered the 2012 ECB Annual Report on June 11, 2013. The Rapporteur of the Committee and Deputy President of the Parliament, Gianni Pittela tendered a draft ECON response (Committee on Economic and Monetary Affairs, 2013a), which was intended to motivate the discussion and provide the basis for their final Report.

Under the heading Monetary Policy, the draft ECON report contained two interesting paragraphs (9 and 10) (Committee on Economic and Monetary Affairs, 2013a: 4-5)

9. Considers that the monetary policy tools that the ECB has used since the beginning of the crisis, while providing a welcome relief in distressed financial markets, have revealed their limits as regards stimulating growth and improving the situation on the labour market; considers, therefore, that the ECB could investigate the possibilities of implementing new unconventional measures aimed at participating in a large, EU-wide pro-growth programme, including the use of the Emergency Liquidity Assistance facility to undertake an ‘overt money financing’ of government debt in order to finance tax cuts targeted on low-income households and/or new spending programmes focused on the Europe 2020 objectives;

10. Considers it necessary to review the Treaties and the ECB’s statutes in order to establish price stability together with full employment as the two objectives, on an equal footing, of monetary policy in the eurozone;

Referring back to Chapter 18, these proposals resonate strongly with the foundation principles of Modern Monetary Theory (MMT) and would serve to redress some of the social and economic damage that the flawed design of the EMU and the subsequent implementation of austerity has caused.

The draft report was then subjected to a lengthy process of debate, which resulted in 247 amendments (Committee on Economic and Monetary Affairs, 2013b). By the time the ECON process had worked it way through to the Final Report (Committee on Economic and Monetary Affairs, 2013c), which was released on November 13, 2013, we had learned a lot about European politics and why the current monetary system is unworkable. The Final Report bore little relation to the Draft Report and appears as a largely innocuous document that will engender no significant changes. But the process did provide impetus to the debate in Europe about the taboo topic of monetary financing.

A lot can be learned about European mentalities by studying the ECON amendment process for this report. Amendment 116, proposed by the German conservative member Werner Langen to replace Paragraph 9, is illustrative (Committee on Economic and Monetary Affairs, 2013b: 54):

Considers that the monetary policy tools that the ECB has used since the beginning of the crisis may have provided welcome relief in distressed financial markets in the short term, but the easy money policy has done nothing to bring about a lasting economic recovery; considers, therefore, that the only way to promote growth is through sustainable economic policy and purposeful structural reforms, that the ECB must concentrate primarily on the goal of price stability, and that ECB financing of government debt is unlawful and must be prevented at all costs;

In the context of the debate, where unemployment was rising to record levels, youth unemployment in some nations had risen to around 60 per cent, and the monetary union economy had entered a period of protracted stagnation,the claim that the ECB must resist OMF “at all costs” is an extraordinary statement of priorities. But, of-course, that is the nature of this taboo – the simple idea that a central bank should facilitate government deficits through money creation invokes immediate claims that this choice would be highly inflationary, and also, within the European context, strikes at the heart of the paranoic fear among Germans of hyperinflation.


The proposed Amendment 136 to Paragraph 10 from the Dutch born libertarian politician Derk Jan Eppink, who was a Belgian member affiliated with the right-wing List Dedecker party, also was illustrative of the way conservatives in Europe prioritise policy ends. He proposed the following wording, which eliminated any reference to full employment as a policy target “on an footing” with price stability (Committee on Economic and Monetary Affairs, 2013b: 64):

Underlines that the primary mandate of the ECB is to maintain price stability in the Euro area, and that the achievement of this mandate overrides subordinate objectives such as supporting economic growth and job creation;

It was clear that the conservatives were obsessed with inflation control and believed it was necessary to subjugate peoples’ jobs and income to it. In that sense, it was also obvious that developments in macroeconomics that could deliver both full employment and price stability were unknown to this lobby. Ignorance rules!

Would OMF be consistent with Article 123 of the Lisbon Treaty?

While treaties can be renegotiated the urgency of stimulus in Europe suggests that desirable policies, which retain the Euro, should be conducted within the existing Treaty of Lisbon. The question then is whether OMF would be consistent with that Treaty, in particular, Article 123 which we discussed in Chapter 18. This is the Article that prohibits so-called monetary financing.

Economists Biagio Bossone and Richard Wood investigated the possible legality of the Paragraph 9 proposal detailed above to introduce OMF (Bossone and Wood, 2013). They argued that “greater coordination between monetary and fiscal policy could provide substantial policy synergies needed to stimulate economic growth without increasing public debt”. They considered that QE was not an effective response to the many nations that “are entrapped in austerity straitjackets”. Their preferred solution is OMF, which would “resolve the problems of insufficient demand and high public debt simultaneously” by providing the necessary funding for expanding fiscal deficits without further debt being issued to the private bond markets.


Additional references

This list will be progressively compiled.

Bank of England (2014) ‘Money creation in the modern economy’, Quarterly Bulletin, Quarter 1. www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q102.pdf

Bernanke, B. (2002) ‘Deflation: Making Sure “It” Doesn’t Happen Here’, Speech to the National Economists Club, Washington, D.C., November 21, 2002. http://www.federalreserve.gov/boardDocs/speeches/2002/20021121/default.htm

Bossone, B. (2013a) ‘Time for the Eurozone to shift gear: Issuing euros to finance new spending’, VoxEu, April 8, 2013, http://www.voxeu.org/article/time-eurozone-shift-gear-issuing-euros-finance-new-spending

Bossone, B. (2013b) ‘Italy, Europe: Please do something!’, EconoMonitor, April 19, 2013. (http://www.economonitor.com/blog/2013/04/italy-europe-please-do-something/

Bossone, B. and Wood, R. (2013) ‘Overt Money Financing of Fiscal Deficits: Navigating Article 123 of the Lisbon Treaty’, July 22, 2013. http://www.economonitor.com/blog/2013/07/overt-money-financing-of-fiscal-deficits-including-navigation-through-article-123-of-the-lisbon-treaty/

Committee on Economic and Monetary Affairs (2013a) ‘Draft Report on the European Central Bank Annual Report for 2012’, European Parliament, ECON/7/12316, June 11, 2013. http://www.europarl.europa.eu/meetdocs/2009_2014/documents/econ/pr/939/939362/939362en.pdf

Committee on Economic and Monetary Affairs (2013b) ‘Amendments 1-247 – Draft report – on the European Central Bank Annual report for 2012’, European Parliament, ECON/7/12316, July 12, 2013. http://www.europarl.europa.eu/sides/getDoc.do?pubRef=-%2f%2fEP%2f%2fNONSGML%2bCOMPARL%2bPE-516.605%2b01%2bDOC%2bPDF%2bV0%2f%2fEN

Committee on Economic and Monetary Affairs (2013c) ‘Report on the European Central Bank Annual report for 2012’, European Parliament, ECON/7/12316, November 13, 2013. http://www.europarl.europa.eu/document/activities/cont/201311/20131113ATT74398/20131113ATT74398EN.pdf

ECB (2012a) ‘Monthly Bulletin, 05/2012. www.ecb.int/pub/pdf/mobu/mb201205en.pdf

ECB (2012b) ‘Opinion of the European Central Bank of 24 January 2012 on a guarantee scheme for the liabilities of Italian banks and on the exchange of lira banknotes (CON/2012/4). https://www.ecb.europa.eu/ecb/legal/pdf/en_con_2012_4_f.pdf

ECB (2013) ‘Annual Report 2012’, European Central Bank. http://www.ecb.europa.eu/press/key/date/2013/html/sp130424.en.html

ECB (2014a) ‘Introductory statement to the press conference (with Q&A)’, Mario Draghi, President of the ECB, Frankfurt am Main, 3 April 2014. http://www.ecb.europa.eu/press/pressconf/2014/html/is140403.en.html

ECB (2014b) ‘ELA Procedures’, Accessed April 18, 2014. https://www.ecb.europa.eu/pub/pdf/other/201402_elaprocedures.en.pdf

Eurostat (2014a) ‘Euro area annual inflation down to 0.5%’, Flash Estimate March 2014, published March 31, 2014. http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-31032014-AP/EN/2-31032014-AP-EN.PDF

Eurostat (2014a) ‘Euro area unemployment rate at 11.9%’, February 2014, published April 1, 2014. http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-31032014-AP/EN/2-31032014-AP-EN.PDF

Frankfurter Allgemeine (2012) ‘Die Angst vor der Inflation’, September 23, 2012. http://www.faz.net/aktuell/wirtschaft/eurokrise/schuldenkrise-die-angst-vor-der-inflation-11899733.html

Friedman, M. (1969) The optimum quantity of money, and other essays, Chicago, Aldine Publishing Company.

Lagarde, C. (2014) ‘The Road to Sustainable Global Growth-the Policy Agenda’, Speech to the School of Advanced International Studies, Johns Hopkins University, Washington, DC, April 2, 2014. http://www.imf.org/external/np/speeches/2014/040214.htm

McCulley, P. and Pozsar, Z. (2013) ‘Helicopter money: or how I stopped worrying and love fiscal-monetary cooperation’, Global Society of Fellows, 7 January 7, 2013. http://www.interdependence.org/wp-content/uploads/2013/01/Helicopter_Money_Final1.pdf

MNI (2014) ‘Interview with Jens Weidmann’, March 21, 2014. http://www.bundesbank.de/Redaktion/EN/Interviews/2014_02_28_weidmann_mn.html

Turner, A. (2013) ‘Debt, Money and Mephistopheles: How do we get out of this mess?’, Speech to Cass Business School, London, February 6, 2013. www.fsa.gov.uk/static/pubs/speeches/0206-at.pdf

von Goethe, J.W. (1888) ‘Faust: A Tragedy’, London, Ward Lock and Co.

Weidmann, J. (2012) ‘Money Creation and Responsibility’, Speech at the 18th colloquium of the Institute for Bank-Historical Research (IBF), Frankfurt, September 28, 2012. http://www.bundesbank.de/Redaktion/EN/Reden/2012/2012_09_20_weidmann_money_creaktion_and_responsibility.html

White, W. (2013) ‘Overt Monetary Financing (OMF) and Crisis Management’, Project-Syndicate, June 12, 2013. http://www.project-syndicate.org/blog/overt-monetary-financing–omf–and-crisis-management

Wood, R. (2012) ‘The economic crisis: How to stimulate economies without increasing public debt’, Policy Insight, No. 62, Centre for Economic Policy Research, August. http://www.cepr.org/sites/default/files/policy_insights/PolicyInsight62.pdf

Wood, R. (2013a) ‘Conventional and Unconventional Fiscal and Monetary Policy Options’, EconoMonitor, June 20, 2013. http://www.economonitor.com/blog/2013/06/conventional-and-unconventional-fiscal-and-monetary-policy-options/

Wood, R. (2013b) ‘Overt Money Financing and Public Debt’, September 3, 2013. http://www.economonitor.com/blog/2013/09/overt-money-financing-and-public-debt/

Friedman, M. (1948) ‘A Monetary and Fiscal Framework for Economic Stability’, American Economic Review 38, June, 245-264.

(c) Copyright 2014 Bill Mitchell. All Rights Reserved.

This Post Has 3 Comments

  1. How was government spending carried out before the setting up of the Fed or the central bank? In England, the BoE was only nationalized in 1946. Before that time, it was a private bank. How *exactly* does this work? One might presume that the two systems worked somewhat differently in the period between c1913 and 1946. Would such a presumption be correct? If not, what would be the individually substantive differences? A person asking such questions would hope for a ‘concrete’ example as part of the answer.

  2. There is clearly this dentency for unil labour costs to drift apart. Even if full employment were restored, how could we prevent further deviation?

    One easy answer would be to impose tax on wages, and reimburse employers with proceeds. A flat tax would be simple to understand and implement, adjustable as needed, and would basically give a tool for macroeconomic management to are where there does not exist a single tool today.

    But is there a room for simple answers anymore?

  3. It could even work in reverse: tax the employers and give it to the workers. If germany is ‘too competitive’ now they could fix it with this.

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