British House of Lords inquiry into the Bank of England’s performance is a confusing array of contrary notions
On November 27, 2023, the Economic Affairs Committee of the British House of Lords completed…
On November 29, 2016, Mario Draghi, the President of the ECB wrote to Mr Jonás Fernández, a Spanish European Parliament member in reply to a request for clarification from the Chairman of the EP’s Committee on Economic and Monetary Affairs (ECON). The Letter discussed whether it would be legal under the Lisbon Treaty for the ECB to engage in direct monetary transfers to citizens bypassing the Member States and whether such a policy would be beneficial for economic growth. Several commentators have seized on the response from the ECB as saying that such a policy innovation would be both legal and beneficial. My view is that, in forming this conclusion, they have not fully understood the difference between a monetary and a fiscal operation. While I think the policy would produce positive results, in the sense that it would stimulate growth and employment and reduce unemployment, I also believe it would be illegal under the Treaty. Further, I don’t think it is a progressive position to argue that a group of unelected and unaccountable technocrats in the central bank should be in charge of economic policy. That should be the responsibility of the democratically-elected members of the government who are fully accountable every electoral cycle. The ECB should not become a fiscal agent. Rather, if the Eurozone elites cannot implement (which they cannot) a full federal treasury function then it should disband the monetary union in an orderly way.
The letter trail began on July 28, 2016, when Mr Jonás Fernández and Dutch MEP Paul Tang posed a question (Z-000081/2016) to the ECB – ECB-financed capital allocation for eurozone citizens – which required a written answer.
In that letter, Fernández and Tang explicitly asked the ECB to comment on statements that were in a research paper published by Frank Van Lerven (a prominent Positive Money proponent and associated with QE for the People) that:
It would be more effective … if the money intended for each NCB [national central bank] to conduct QE [quantitative easing] were divided equally amongst all citizens. In effect, the money that would have been created through QE would be paid directly into people’s bank accounts and would put additional purchasing power directly into people’s pockets. This increased purchasing power should translate into increased consumer spending, which would lead to higher incomes, a rise in output of goods and services as well as reduce unemployment.
See the comments (below) for clarification by Frank Van Lerven on the source of the statements attributed to him by the MEPs.
As an aside, I agree with the statement but more on that later.
Frank Van Lerven was then quoted in the Letter as saying that such a move by “the ECB would not actually be breaking any EU laws”.
The MEPs wanted to know if the ECB agreed with the legal view that direct transfers to Eurozone citizens from the ECB would be consistent with the ECB’s Treaty obligations and whether the ECB thought that such a policy innovation would be beneficial to the real economy of the Eurozone.
Mario Draghi replied on September 19, 2016 – Letter from the ECB President to Mr Fernández and Mr Tang, MEPs, on monetary policy – where he said:
The Court of Justice of the European Union (CJEU) … held that the ECB must act within the limits of the powers conferred upon it by primary EU law, have a legitimate objective of monetary policy, and use its available instruments for the purpose of implementing that policy. Any monetary policy measures adopted must also be proportionate to the objective of that policy and observe the prohibition on monetary financing laid down in Article 123 of the Treaty on the Functioning of the European Union.
So Chapter and Verse of the official Eurozone line about the ECB and the Treaties. No direct funding of Member State fiscal deficits.
Draghi also noted that the proposal outlined in the MEP’s Letter referred to “helicopter money”, which he had addressed in an earlier letter – Letter from the ECB President to Fabio De Masi, MEP, on monetary policy – on April 18, 2016.
He referred Fernández and Tang to that response.
Fabio De Masi, a German MEP on the Left had posed the question (Z-000023/2016) to the ECB – Helicopter money/citizens’ dividend:
1. Is the ECB considering unconventional policy measures, such as ‘helicopter money’ or a citizens’ dividend, i.e. where the ECB would directly pay money to residents of eurozone Member States to stimulate private demand?
2. Are such measures in accordance with the ECB’s mandate (regardless of whether or not they are currently being considered)?
3. Would such measures provide a sufficient economic boost to push inflation rates towards the ECB’s target?
So, the later question in November 2016 from Fernández and Tang was essentially asking the same thing, hence Draghi’s deference to his earlier response.
In his Letter to De Masi, Draghi wrote that the current policy suite adopted by the ECB was “working” and added that:
Helicopter money means different things to different people, but all these schemes are fraught with complexities from accounting, operational, and legal perspectives, especially as regards compatibility with Article 123 of the Treaty on the Functioning of the European Union.
In other words, Draghi considers that helicopter money (whatever it is) would violate Article 123 of the Lisbon Treaty (Treaty on the Functioning of the European Union), which says:
1. Overdraft facilities or any other type of credit facility with the European Central Bank or with the central banks of the Member States (hereinafter referred to as ‘national central banks’) in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the European Central Bank or national central banks of debt instruments.
2. Paragraph 1 shall not apply to publicly owned credit institutions which, in the context of the supply of reserves by central banks, shall be given the same treatment by national central banks and the European Central Bank as private credit institutions.
Apparently, not satisfied with that answer, Mr Jonás Fernández pushed ahead. On November 15, 2016, he posed a further question (Z-000107/2016) to the ECB (Extending the LTRO programme to households) which required a written answer.
He sought to clarify what Mario Draghi had meant in his April Letter to Fabio De Masi about helicopter money.
Explicitly, Fernández asked:
Since Article 123(1) of the Treaty on the Functioning of the European Union (TFEU) forbids lending to EU and Member State bodies and public sector companies, it is clear that direct lending to Eurozone households through the LTRO programme, for example, is not within the scope of this prohibition, since private citizens cannot, with all certainty, be considered in any way public entities.
Can the ECB President therefore explain what the ‘legal complexity’ of the said monetary policy option is in connection with Article 123(1) of the TFEU?
Draghi’s response (November 29, 2016) – Letter from the ECB President to Mr Fernández, MEP, on monetary policy – noted that:
1. “helicopter money as an instrument of monetary policy has never been discussed by the Governing Council.”
2. He once again referred Fernández to his reply to Fabio De Masi (as above).
3. On the legal issue (compatibility with the Treaty, he wrote:
While the governments of euro area countries would not be the direct recipients of a cash transfer involved in such a scheme, legal complexities could still arise if the scheme could be seen as the ECB financing an obligation of the public sector vis-à-vis third parties, as this would also violate the prohibition of monetary financing. In order to determine what constitutes a form of financing of the public sector’s obligations vis-à-vis third parties, an assessment has to be made of whether the task concerned is a central bank or a government task, i.e. a task falling within the responsibility of the Member State institutions mentioned in Article 123 of the Treaty.
Draghi finished by claiming that “the transmission of our monetary policy measures is proving to be very effective” and that there was no need for additional measures, such as “helicopter money”.
So the legalities come down to an assessment of whether a direct transfer of ECB funds to Eurozone citizens was a monetary operation or a fiscal operation. If it was deemed to be the former then it would be legal under Article 123. If the latter, then clearly not.
The QE for People group waded in claiming this interchange as some sort of victory.
On December 3, 2016 they wrote a blog – ECB confirms ‘helicopter money’ is legally feasible under conditions – where they cite Draghi’s November 29, 2016 Letter (above) as evidence that the ECB could hand out money directly to citizens of the Eurozone under Article 123.
QE for People is a group that considers the current QE program of the ECB to be “an ineffective and unfair response to the financial crisis” (Source).
Instead, they “propose an alternative form of QE which would make sure money is spent into the real economy and benefits those that need it the most. We call this concept ‘Quantitative Easing for People’.”
The same terminology came up when Jeremy Corbyn was campaigning to take over leadership of the British Labour Party. At the time, I wrote this blog about the proposal – PQE is sound economics but is not in the QE family.
Other blogs of relevance:
My opinion hasn’t changed since I wrote those blogs.
The QE for People think the ECB Letter means that “helicopter money must be framed as a monetary policy tool if it is to be legally implemented in the Eurozone” – that is, a “central bank task” (relating to monetary policy).
The spokesperson for QE for People wrote:
This clearly is the core question, but in fact the letter shows that the ECB already knows the answer: if a helicopter money programme is independently designed, decided and implemented by the ECB for the purpose of price stability, then clearly it is a monetary policy task.
The ECB letter does not say that helicopter money is legal under the Treaty. What it says is that the matter would come down to “whether the task is concerned is a central bank or a government task”.
That is, whether it is a monetary policy action or a fiscal action.
It is all very well to claim that because it is the central bank doing something, that that means it is a monetary policy action.
The ECB has been getting around the Treaty for years (since May 2010 when it instituted the Securities Market Program) by claiming that its massive bond purchase program in the secondary markets was to facilitate its liquidity management operations.
First, the scale of the bond buying exceeded any reasonable estimate of open market operation requirements by a considerable margin.
Second, the ECB was paying (through its standing facilities) interest on the excess reserves anyway, thereby avoiding the need to maintain its (low) interest rate target with bond sales. So it was creating the excess reserves through bond purchases and then paying income on those reserves – the latter being a fiscal action.
The QE program that the ECB embarked on in 2010 was clearly a fiscal action designed to keep bond investors happy and buying debt from troubled governments (for example, Italy) in the primary market to avoid a Member State becoming insolvent. The investors knew they would be able to quickly off load the debt at a profit in the secondary market courtesy of the ECB’s QE program.
The fact that the European Commission (and Council) turned a blind eye to it just tells us that the elites in Europe will do anything to defend their position.
So the ECB can clearly engage in fiscal actions, given the flawed way in which the monetary union was designed and implemented. It has been playing the role of federal fiscal agency for several years now.
As I wrote in the blog cited above (PQE is sound economics but is not in the QE family), it is highly misleading to conflate the current practice of quantitative easing, where the central bank swaps bank reserves for financial assets such as government and corporate bonds (purchased in the secondary market) with the proposal known as helicopter money.
While it sounds rather cute to call QE the policy for the banksters and elites and QE for the people (PQE), the two concepts are not akin.
Why is that?
PQE involves the central bank, which is one part of the consolidated government sector, the other being the treasury, using the currency-issuing capacity of the government to facilitate the purchase of real goods and services to build productive infrastructure or, alternatively, to provide direct transfers to citizens.
I think that PQE is an excellent strategy for any currency-issuing government to introduce. It exploits the currency-issuing capacity of the government directly and uses it to increase the potential of the economy to improve well-being.
But, the policy proposal should never have been called PQE because it is not similar at all to Quantitative Easing and the false analogy only opens the proposal to further, unwarranted criticism.
So the language is all wrong because the underlying economics is not fully articulated.
PQE is really just deficit spending without issuing debt whether it be on infrastructure or something else.
First, Quantitative Easing (QE) is a monetary operation that can be distilled down to being asset swap – bank reserves for a government bond.
Under QE, the central banks bids up the price of government bonds in the secondary markets, which forces yields (interest rates) down, given the inverse relationship between the effective yield and the price of the bond in fixed coupon assets.
Therefore, the only way it can impact positively on aggregate spending is if the lower interest rates it brings in the maturity range of the bond being bought stimulates borrowing and spending.
The problem is that borrowing is a function of aggregate spending itself (and expectations of where demand is heading) and if unemployment is persisting at high levels and governments are imposing harsh net spending cuts, the sentiment that might lead to increased borrowing is absent – lower interest rates notwithstanding.
QE is based on a false premise – that the banks need reserves before they can lend and that quantitative easing provides those reserves.
Mainstream macroeconomics create the illusion that a bank is an institution that accepts deposits to build up reserves and then on-lends them at a margin to make money. The conceptualisation suggests that if it doesn’t have adequate reserves then it cannot lend. So the presupposition is that by adding to bank reserves, quantitative easing will help lending.
This is clearly an incorrect depiction of how banks operate in the real world. Bank lending is not ‘reserve constrained’. Banks lend to any credit worthy customer they can find and then worry about their reserve positions afterwards.
If they are short of reserves (their reserve accounts have to be in positive balance each day and in some countries central banks require certain ratios to be maintained) then they borrow from each other in the interbank market or, ultimately, they will borrow from the central bank through the so-called discount window. They are reluctant to use the latter facility because it carries a penalty (higher interest cost).
The point is that building bank reserves will not increase the bank’s capacity to lend. Loans create deposits which generate reserves.
Please read the following blog – Building bank reserves will not expand credit – for further discussion.
Bank lending is never constrained by a lack of reserves.
Second, QE does not change the net financial asset position of the non-government sector. This is a crucial point. It is an asset swap. The non-government sector just rearranges is wealth portfolio – more cash, less bonds. No net change.
That is the essence of a – monetary policy operation – which alters the liquidity in the economy. It does it by portfolio swaps and in doing so influences the interest rates and the term structure.
Third, PQE is not QE because it is a fiscal operation – as is any so-called ‘helicopter drop’. What does that mean?
PQE (like a helicopter drop) would increase the net financial assets in the non-government sector because it would increase national income (via spending on infrastructure).
That is the hallmark of a fiscal operation.
In deciding whether the ECB would contravene Article 123, the matter would be decided on understanding the intrinsic differences between a monetary operation and a fiscal operation, not whether the central bank was involved or not, or not whether it was acting independently or not.
The flawed structure of governmental institutions (treasuries and central banks) in the Eurozone mean that the distinction between these operations is even more important given the centrality of the ECB in the EMU and the absence of any federal treasury function.
It is clear that the proposal for the ECB to directly hand out euros to Eurozone citizens (a policy that has merit) would be a fiscal operation, which would normally, if the structures were sound, be done through a government agency, even though the central bank would be involved as the government’s bank.
The spending (direct transfers) would boost the bank deposits of the recipients (the citizens), which increases their net financial assets or net worth.
Their banks would then have more reserves and matching liabilities (the citizen deposits).
Under QE, the central bank buys a bond in exchange for a bank deposit. The Assets of the bond holder would be unchanged but altered in composition (more cash less bonds). For the bank of the bond holder, deposits rise (liabilities) as do assets (reserve balances).
The essential difference is in terms of the impact on the net wealth of the non-government sector. QE leaves that position unchanged, whereas PQE increase net wealth via the net spending effects.
From the perspective of Modern Monetary Theory (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 increases.
It occurs when the government uses its currency-issuing capacity (linking treasury spending to central bank operations) without matching its deficit spending with debt-issues to the non-government sector.
So the central bank adds some numbers to the treasury’s bank account to match its spending plans and in return may be given treasury bonds to an equivalent value.
Instead of selling debt to the private sector, the treasury simply sells it to the central bank, which then creates new funds in return.
This accounting smokescreen is, of course, unnecessary. The central bank doesn’t need the offsetting asset (government debt) given that it creates the currency ‘out of thin air’. So the swapping of public debt for account credits is just an accounting convention.
In the Eurozone case, the matter would become even more simple because there is no federal treasury although the meaning of the term ‘fiscal deficit’ becomes blurred.
The ECB would in effect be deficit spending if it started to hand out direct transfers to citizens. It wouldn’t be accounted for in that way, but in terms of meaning and intent, that is the nature of the helicopter transfer, because it injects new net financial assets into the non-government sector and directly stimulates aggregate spending.
That is why:
1. I would not start an organisation called QE for People and have as my main policy – helicopter drops (or OMF).
2. I think the Court of Justice of the European Union would see through the bluster and understand the difference between a monetary operation and a fiscal operation and declare the proposal as being consistent with the latter.
3. The whole design of the Eurozone is dysfunctional and explains why the bloc is in such a parlous state some 9 years after the GFC started to manifest.
The discussion also raises questions of who who should be in charge of economic policy – the democratically-elected members of the government who are fully accountable every electoral cycle or a group of unelected and unaccountable technocrats in the central bank.
Clearly, proposing that the central bank take over fiscal operations because the Member State governments are constrained by ridiculous fiscal rules doesn’t appear to be a very progressive position to take.
It would be better to challenge the whole logic of the EMU than to give further fiscal capacities to the unelected ECB board.
That is enough for today!
(c) Copyright 2017 William Mitchell. All Rights Reserved.