Yes, Central Banks Can Create Inflation. Just Ask Argentina
Argentina’s experience illustrates why central banks are so reluctant to employ ‘helicopter money’
Argentine Finance Minister Alfonso Prat-Gay, shown earlier this month at an event in Washington, D.C., wants to restore the traditional boundaries between monetary and fiscal policy. PHOTO: NICHOLAS KAMM/AGENCE FRANCE-PRESSE/GETTY IMAGES
By GREG IP
Updated April 27, 2016 10:31 a.m. ET
With inflation in the U.S., Japan and the eurozone stuck below their 2% targets, central banks are asked regularly if they have the tools to prod it higher. A better question would be: Do they have the will?
There is a tool virtually guaranteed to create inflation. It’s called helicopter money—named for the image of dropping cash from helicopters—and consists of a central bank explicitly printing money to finance increased government deficits.
Embracing helicopter money would erase the boundary between highly politicized fiscal policy and scrupulously independent monetary policy. That boundary is sacred not just to central bankers, but also to governments that correctly view it as a bulwark against economic adventurism. That’s why the world economy will have to look a lot worse before central banks and governments go down that road.
To understand the taboo, examine a country—Argentina—only now extricating itself from years of de facto helicopter money, which is also called monetary finance.
After Argentina defaulted in 2001, some bondholders refused to accept the government’s settlement and, through the U.S. courts, locked Argentina out of global capital markets. Unable to borrow from underdeveloped domestic markets and unwilling to cut its deficit through lower spending or higher taxes, the government turned to the central bank. Central bank temporary advances and transfers of profits to the treasury, both forms of money printing, shot from 4 billion pesos in 2007 to 159 billion pesos last year, equal to 3% of gross domestic product.
“The central bank was lender of first resort to the treasury,” Alfonso Prat-Gay, who ran the central bank from 2002 to 2004 and is now the country’s finance minister, said in a recent interview.
Money printing had the predicted effect: Inflation skyrocketed. Exactly how much is not known because under the previous president, Cristina Kirchner, the data was manipulated. Elypsis, a private firm, reckons inflation was 25% last year, up from 6% in 2009. Other factors fueled the rise, including import and capital controls that undermined the economy’s productive potential.
Mauricio Macri ousted Ms. Kirchner as president last November and set out to undo her epic mismanagement of the economy. As his finance minister, Mr. Prat-Gay quickly worked out a settlement with the holdouts from the 2001 default. Last week, he oversaw Argentina’s return to global capital markets with an oversubscribed $16.5 billion bond issue, proceeds of which were used to pay the holdouts.
Regaining access to the markets is essential to ending the treasury’s dependence on monetary finance and thus bringing inflation down to earth. Mr. Prat-Gay has promised to limit borrowing from the central bank this year. Inflation, after spiking as utility subsidies are withdrawn, should fall sharply next year.
Mr. Prat-Gay wants to restore the separation between monetary and fiscal policy that is taken for granted in other countries. Indeed, when I asked him a question about monetary policy, he admonished me, “You would not ask that question of Jack Lew, would you?” (No, the U.S. Treasury Secretary doesn’t comment on the independent Federal Reserve.)
Just because monetary finance was disastrous for Argentina doesn’t mean it has to be. In 1942, the Fed promised to buy as much debt as necessary to finance the U.S. war effort and by 1945, it had bought debt equal to 9% of annual GDP, most of which it never sold. To meet both military and civilian demands, the economy went into overdrive. The resulting boom in productivity and employment lasted well after the war ended.
It also resulted in inflation which, despite wartime wage and price controls, averaged 7% from 1940 to 1948. That was enough to make the Fed determined to wriggle out of the Treasury’s grasp, which it did, in 1951.
If the Fed could create inflation then and Argentina’s central bank can now, why has it proven so difficult for the Fed, the European Central Bank and the Bank of Japan? It’s not enough to print money; the money has to be spent. Whereas Argentina printed money because the government needed it to finance spending, the Fed, ECB and Bank of Japan acted independently, at a time when their governments have been trying to rein in their borrowing.
True helicopter money means the government announces a big spending boost or tax cut and the central bank promises to print money to finance it, and to never withdraw that money from circulation. This persuades households that taxes won’t go up but prices will. That amplifies the impact on both spending and, by altering inflation expectations, actual inflation. This is not a surgical operation; once expectations become unanchored, there’s no guarantee inflation will rise to 2% and stop.
The Argentinian central bank’s temporary advances and transfers of profits to the treasury, both forms of money printing, shot from 4 billion pesos in 2007 to 159 billion pesos last year, equal to 3% of gross domestic product. PHOTO: VICTOR R. CAIVANO/ASSOCIATED PRESS
These are bridges today’s central banks aren’t ready to cross. Bank of Japan governor Haruhiko Kuroda will try almost anything to raise inflation. But not helicopter money, he insisted in a recent interview: “No. Monetary policy and fiscal policy are decided and managed by separate authorities.”
Most central banks today feel the same way. The ECB is constitutionally barred from monetary finance. Asked about helicopter money last week, its president,Mario Draghi, noted it is “fraught with operational, legal and institutional difficulties.”
Monetary independence is not itself a goal; it’s a means to an end, which means low unemployment and inflation around 2%. Unhappy as they are with today’s low inflation and weak growth, central banks and the public are not unhappy enough to risk 7% inflation, much less 25%. Things are going to have to get a whole lot worse.
Write to Greg Ip at firstname.lastname@example.org