LIBERA UNIVERSITÀ INTERNAZIONALE DEGLI STUDI SOCIALI “LUISS – GUIDO CARLI” DEPARTMENT OF ECONOMICS AND FINANCE DEPARTMENT OF BUSINESS AND MANAGEMENT MASTER OF SCIENCE IN “CORPORATE FINANCE” HELICOPTER MONEY AS AN ALTERNATIVE MEASURE OF UNCONVENTIONAL MONETARY POLICY: AN ENFORCEABILITY STUDY Chair: International Financial Economics SUPERVISOR CO-SUPERVISOR Guido Traficante Mauro Visaggio CANDIDATE Isabella Oteri Student Number: 691801 ACADEMIC YEAR 2018 - 2019 Acknowledgments I want to express my gratitude towards my thesis supervisor Guido Traficante, who was patient enough to support me and always help me with pieces of advice, interesting materials and new ideas to present the thesis that I had in mind since day one. I could have not done this alone, thanks. To the ones who have always been close to me, family and friends, during this amazing journey; all the efforts that I made were only to see the pride in your faces. TABLE OF CONTENTS INTRODUCTION 1 UNCONVENTIONAL MONETARY POLICIES 3 1.1 CONVENTIONAL SCENARIO OF SHORT-TERM RATE SETTING 3 1.1.1 HOW CENTRAL BANKS MANAGE SHORT-TERM INTEREST RATES 4 1.2 WHEN INTEREST RATE FALLS: THE “ZERO LOWER BOUND” 6 1.2.1 WHEN INTEREST RATE FALLS: THE LIQUIDITY TRAP 13 1.3 PECULIAR RECESSIONS: UNCONVENTIONAL MONETARY POLICIES 18 1.2.1 THE TRANSMISSION CHANNELS OF “BALANCE SHEET POLICIES” 21 1.4 IMPLICATIONS AND FLAWS OF UNCONVENTIONAL MONETARY POLICIES 24 QUANTITATIVE EASING AND FORWARD GUIDANCE: AN IN-DEPTH ANALYSIS 28 2.1 QUANTITATIVE EASING 30 2.1.1 QE IN THE EUROZONE 31 2.1.1.1 Negative interest rates 34 2.1.1.2 The effects of unconventional monetary policies on bank stability in Europe 36 2.1.2 QE IN THE UNITED STATES 37 2.1.3 QE IN ENGLAND 38 2.1.3.1 Effects of QE on savers and pensioners: a tiny focus on the British case 40 2.1.4 QE IN JAPAN 41 i 2.2 THE MACROECONOMIC EFFECTS OF ASSET PURCHASES 43 2.3 FORWARD GUIDANCE 45 HELICOPTER MONEY: A STUDY REVIEW ON ITS ENFORCEABILITY 50 3.1 THE REASONS BEHIND THE NEWLY OBTAINED FAME 52 3.1.1 HELICOPTER MONEY IN PRACTICE: QE FOR THE PEOPLE 57 3.1.2 HELICOPTER MONEY IN PRACTICE: TAX CREDIT CERTIFICATES 59 3.1.2.1 The outcomes of a post-Recession fiscal stimulus: the Australian case 60 3.1.3 HELICOPTER MONEY IN PRACTICE: DEBT MONETIZATION 62 3.2 THE DIFFERENCES BETWEEN HELICOPTER MONEY AND QUANTITATIVE EASING 66 3.3 HELICOPTER MONEY UNDER THE LENSES OF ANALYTICAL MODELS 67 3.3.1 HELICOPTER MONEY AND ITS EFFECTIVENESS IN LIQUIDITY TRAP. A FIRST BY BUITER (2003) 68 3.3.2 AN EXTENSION OF THE PREVIOUS WORK, BUITER (2014) AND THE BROADER EFFECTIVENESS OF HELICOPTER MONEY 72 3.3.3 HELICOPTER MONEY AND FISCAL STIMULUS IN OPEN ECONOMY. A STUDY BY DI GIORGIO AND TRAFICANTE (2018) 77 3.3.4. GALÌ (2019) AND PUNZO AND ROSSI (2019) ANALYSIS ON THE EFFECTIVENESS OF A MONEY- FINANCED FISCAL STIMULUS 80 3.4 THE ARGUMENTS AGAINST HELICOPTER MONEY 84 3.4.1 THE EFFECTS OF HELICOPTER MONEY ON THE EUROPEAN CENTRAL BANK’S BALANCE SHEET AND THE LEGAL IMPLICATIONS 88 3.4.2 WHY IT WOULD BE WRONG TO CONSIDER A HELICOPTER MONEY POLICY AS A “FREE LUNCH” 90 3.5 CONCLUDING REMARKS ON HELICOPTER MONEY 92 ii CONCLUSIONS 93 REFERENCES 95 SITOGRAPHY 99 iii INTRODUCTION The economic scenario that characterized the last decade saw many changes of paradigms and approaches finalized at the stabilization of the system. The greatest transformations regarded the measures that central banks from all over the world had to fulfil in order to face the downturns of the Great Recession, which compromised the global economic solidity. The monetary institutions, indeed, in different times and manners shifted from conventional approaches – price stability through the setting of the short term interest rate, thus via open market operations – to unconventional measures, that can be broadly summarized in two procedures: quantitative easing and forward guidance. A decade past by since the burst of the crisis, central banks undertook many measures to contrast the negative conditions of the state of the economy, but still there is not a unanimous opinion on the effectiveness of the policies implemented so far. In the last few years the academic and institutional debates saw an increase of suggestions that proposed helicopter money as an alternative unconventional monetary policy. Originally theorized by Friedman as an academic example of how the process of money creation works, nowadays it can be defined as a hybrid measure: a money-financed fiscal stimulus. Hence it would need a close collaboration between the Central Bank and the Treasury who would respectively inject liquidity in the system and directly distribute it to the households. The thesis is divided into three areas, that gradually explore the evolution of monetary policies with the help of data, theoretical and empirical studies of literature. The first chapter presents the standard tasks of central banks, and how they used to manage the conditions of the system (i.e. expansionary or restrictive monetary policies). Through the application of IS-LM and AS-AD model was presented the case of the reaching of the zero lower bound, a crucial condition that is at the core of the necessity of the fulfilment of unconventional measures. The latter are indeed broadly portrayed at the end of the chapter, presenting their transmission channels, the strong features and the flaws. The second chapter displays a deeper focus of both quantitative easing and forward guidance. The analysis comprehends the historical origin, and a detailed description of what and when measures were taken by the four main central banks: the European Central Bank, the Federal Reserve, the Bank of England and the Bank of Japan. The approach used was the same for both quantitative easing and 1 forward guidance, thus the chapter presents both theoretical and empirical results, and the contribution of the literature that explored the positive and negative results. Last but not least, the third chapter explores helicopter money, starting from the theoretical proposals that are now used as a reference point to suggest it as a policy measure. The analysis regards practical examples of how helicopter money could be implemented advised by its advocates, the analytical models that study the macroeconomic effects that it could potentially generate, and ultimately the literature against it. Finally, the scope of the thesis is to offer a depiction of the change in approaches operated by the central banks in the last decade, and an examination of the recently most talked-about alternative policy and why it would be extremely difficult, if not impossible to implement it in the Eurozone. 2 CHAPTER 1 UNCONVENTIONAL MONETARY POLICIES 1.1 Conventional scenario of short-term rate setting The role of central banks has historically been fundamental in implementing all the necessary monetary policies finalized at influencing and adjusting the monetary transmission mechanism, in a systematic and foreseeable manner, aimed at pursuing a specific target. In the last twelve years their importance in setting rules to stabilize the macroeconomic and financial sector has been more evident as recessions and intricate scenarios forced central banks to step forward and intervene to restore equilibrium. Macroeconomic literature has vastly discussed to what extent central banks can have an impact on macroeconomic aggregates. For example, monetarists such as Friedman believed in the “neutrality of money”: monetary policy only affects nominal variables and not real variables such as unemployment, GDP, investments etc. A similar view belonged to the neo-classical thread that believed that prices are determined solely by the level of money, and as the latter fluctuates, prices are the only elements of the market that are affected. Neo-Keynesian theory, instead, used Keynes’ idea regarding the “reserve of value” function referred to money, to conclude that there is a domino effect from the monetary market that affects the interest rates, and in turn has an influence on aggregate demand. This strand of literature, though, is not to be considered alternative to the neo-classical one, as the two can be considered as complementary. The mandate of central banks is nowadays oriented not only towards price stability (i.e. inflation target), but also in setting requirements in terms of reserves1, monitoring, supervising2 and rules that can directly affect the market. 1 As an example, after the economic crisis that busted in 2007, the European Commission and the European Parliament published the n. 575/2013 o “CRR - Capital Requirement Regulation” and the2013/36/UE o “CRD 4 - Capital Requirements Directive” aimed at setting two requirements in terms of reserves. The first one is the Liquidity Coverage Ratio, that forces banks at having an adequate level of unencumbered high-quality liquid assets (HQLA) that can potentially be converted in cash to face a 30 days period of stress scenario. The second is the Net Stable Funding Ratio (NSFR), used to reduce a potential long-term funding risk. To fulfill this requirement, banks need to hold on to a specific amount of stable funds. 2 In the Euro system, national central banks are, amongst other things, the supervising authorities responsible for the pursuing of the “sound and prudent management of the financial intermediaries” (Banca d’Italia, Our Role). 3 Price stability is the main objective pursued, even if in different manners, by the four major central banks, namely the Federal Reserve, the European Central Bank (ECB), the Bank of England and the Bank of Japan. When the economy faces periods of trouble, so when the inflation is distant to the target - both in cases of high inflation or deflation -, central banks act in order to keep the price level anchored to the predetermined target, in order to fulfill price stability.