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A very interesting conference took place last Thursday and Friday at the Central Bank of Belgium. The theme of this conference was monetary and macroprudential policy in the current context. Among the many experts who spoke was Ricardo Reis (London School of Economics), an academic who was recently one of six experts chosen to present their work at the annual meeting of the world’s central bankers in Jackson Hole. Here are four key points from his presentation to help you better understand monetary policy today and tomorrow:
– The fact that banks are flush with liquidity as a result of quantitative easing policies will change the way central banks implement their monetary policy in the years to come. Central banks will certainly no longer « adjust the supply and demand for liquidity » to control interbank market rates, but will increasingly use the rate paid on excess reserves (often referred to as the « floor rate ») as a monetary policy tool. The Fed has already been doing this for several years, and it is likely that the ECB will do the same explicitly when inflation returns to the desired level (see the BIS article referenced on this point).
– Paying interest on bank reserves (or charging interest on these reserves) changes the way certain concepts are thought about. For example, we can no longer think of « debt monetization » in the same way as before (see this insight on BSi Economics on this subject): « monetizing debt » no longer has the same financial appeal for governments when the central bank pays interest on reserves.
For the same reason, a « helicopter money » policy is, in principle, as financially advantageous when conducted by the central bank as when conducted by the Treasury. A central bank pays interest on reserves that is very close to the interest that would be paid by its government for a similar loan (for example, Germany currently borrows at -0.49% for 5 years, while the interest rate on reserves at the central bank is -0.4%). Since the profits and losses of a central bank are the profits and losses of its government in the long term, it would be an illusion to believe that a « helicopter money » policy would be financially advantageous if it were conducted by the central bank.
Concepts such as the « money multiplier » become obsolete when banks are awash with liquidity and the central bank pays interest on reserves: economists will have to continue to set this concept aside for years to come.
Sources and additional information:
– Conference articles here https://www.nbb.be/en/publications-and-research
– BIS article http://www.bis.org/publ/work292.pdf (to understand how the central bank controls rates by paying a rate on excess reserves)
– Paper by Ricardo Reis here https://www.kansascityfed.org/~/media/files/publicat/sympos/2016/econsymposium-reis-paper.pdf?la=en
– On the non-gratuitous nature of helicopter money: « Les illusions de la monnaie par hélicoptère » (Le Monde) available here
