Until now, monetary policy has essentially worked by lowering interest rates to stimulate demand and the appetite for risk. But a cursory glance at capital markets tell us that this isn’t an option today. A third of all government bonds globally – and two-thirds in Europe – have negative yields. Even in the US, which still enjoys moderate growth, long-dated Treasury yields are at or near record lows and could easily head towards zero in a recession. Traditional monetary policy has also had a number of unpleasant side effects, from boasting inequality to normalizing low-to-negative rates, with adverse consequences for savers and banks’ profitability. Fiscal policy will play a major role in any future downturn, but will not be enough on its own. While there are powerful forces at play that will contribute to keeping interest rates low, this could change with large fiscal stimulus when debt is already at record levels and rising. Moreover, historically, fiscal policy has not been flexible enough to be deployed quickly when needed.
To be feasible, a policy of going direct should have the following elements. First, a clear definition of the circumstances that call for such unusual policy co-ordination.
Second, an explicit expansion objective that fiscal and financial specialists are jointly held accountable for achieving.
Third, a mechanism that enables the prompt deployment of productive fiscal policy measures, without the negative money related approach on inequality. Could advance money offer something here?
Finally, and critically, a clear exit strategy.