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Eight years after the 2008 financial crisis the global economy is still stuck with slow growth, inflation levels that are too low and rising debt burdens. Massive monetary stimulus has failed to generate adequate demand. Money-financed fiscal deficits — more popularly labelled “helicopter money” — seems one of the few policy options left.

The debate on its merits can get lost in technical complexities. But the important question is political: can we design rules and responsibilities that ensure monetary finance is only used in appropriate circumstances and quantities?

If we lived in a simple world where all money was created by the government or central bank, and if the authorities created more money to increase public expenditure or cut taxes, some of the extra cash in people’s pockets would be spent. If the economy were at full employment, the only consequence would be faster inflation: if below full employment, some increase in economic activity could result. The scale of effects would depend on how much new money was created. If little, a small rise in prices or output would result; if a great deal, hyperinflation might be inevitable.

In the real world the technicalities are more complex. Most money is not created by central banks but by the banking system, with the total money supply a big multiple of the monetary base. In this world the initial stimulus to demand can be multiplied later by commercial bank credit and money creation. But the risk of escalation can be offset by imposing reserve requirements on those banks. And the fundamental point remains: the impact will depend on how much new money is created.

The crucial political issue is the danger that once the taboo against monetary finance is broken, governments will print money to support favoured political constituencies, or to overstimulate the economy ahead of elections. But as Ben Bernanke, former chairman of the US Federal Reserve, argued recently, this risk could be controlled by giving independent central banks the authority to determine the maximum quantity of monetary finance that was required to meet but not exceed the inflation target. The dangers of too big a stimulus can, in principle, be contained.

At the London School of Economics on May 10, however, Raghuram Rajan, India’s central bank governor, raised a diametrically opposite objection to monetary finance. People receiving newly created cash, he argued, might be so alarmed at “seeing the central bank governor throwing money out of the window” that they might save the money rather than spend it, thus negating the desired rise in nominal demand.

This might seem paradoxical to the point of impossibility: monetary finance is bad because it will inevitably produce both too much inflation and too little. But that proposition is not completely absurd. Given the political dangers of future excessive use, money- financed fiscal stimulus might initially produce increased saving and too little impact on demand, tempting the authorities into further stimulus, which eventually produces too much.

But the answer to the “too little” problem is the same as to the “too much” — the design of rules and responsibilities that can convince people monetary finance will only be used in appropriately moderate quantities. The trap of popular perception that Mr Rajan highlights is indeed to some extent circular. It is precisely because central banks have warned for decades that monetary finance is so dangerous that it must be prohibited, that any mention of it now evokes lurid analogies about “central bankers throwing money out of windows”. But if we can shift from a total ban to tightly defined discipline, people receiving newly created money will spend enough of it to give us a useful addition to the policy toolkit.

The key question on monetary finance is therefore political: can we design a regime that will guard against future excess, and that households, com­panies and financial markets believe will do so. The answer may turn out to be no: and if so we may be stuck for many more years facing low growth, inflation below target, and rising debt levels. But we should at least debate whether the problem can be solved.

The writer is former chairman of the Financial Services Authority and author of ‘Between Debt and the Devil’

Letters in response to this article:

‘Helicopter money’ is still debt, just in a different form / From Andrea Terzi

Helicopter money talk and the PPI precedent / From Paul Ormrod

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