Policy response

Policy response

Tax rebates for corporates & households, targeted lending & QE, dual rates, yield capping in the Eurozone – there is lots that both monetary and fiscal authorities can and should do.

There is a compelling case for both fiscal and monetary policy coordination, and post-interest rate monetary policy.

Evidence suggests that the current crisis is likely temporary. Other than direct resources to support the response of health services, what the broader economy needs is temporary cash flow support perhaps for as long as three to four months. It is also clear that simply lowering policy rates is both insufficient and in most jurisdictions irrelevant.

1) There should be coordinated fiscal policy – outlined below – and, contrary to a lot of commentary, there is a great deal that central banks can also do, both in supporting the fiscal effort, but also independently. This may need to vary by jurisdiction.

2) It should be obvious that given the further collapse in government bond yields there is huge fiscal space for developed economy authorities to act. Central banks can make this clear by explicitly outlining the scope of the fiscal space. In the US, the Fed should go further and offer to buy all the bonds issued by the treasury to finance the stimulus. The Fed can add credibility to any package by requesting a fiscal response.

3) US fiscal authorities already have the UK model as a template. But support should be targeted at ensuring that corporates are able to pay all liabilities – trade creditors, and lenders – and pay their employees. Tax rebates to corporates and households make a lot of sense. For example, corporates could reclaim the last two years of taxes in the next three months as temporary cash flow support. This is very easy to reverse when the economy normalises by subsequently raising the corporate tax rate. Households should receive checks in the post, a la Sahm rule. An equal distribution to all adult citizens is an obvious option.

4) The UK has provided a smart model of monetary & fiscal coordination for other countries to copy. In particular, the Treasury providing credit guarantees for banks lending to SMEs and the Bank of England providing loans at base rate, contingent on banks extending new loans to SMEs. The only disappointment in the UK package is that the bank did not cut the interest rate on the TFS scheme below Base Rate. We don’t know what terms the Bank of England is requiring are passed on to corporates, but this is critical.

5) The ECB should do something similar, and hopefully more. Specifically, they should announce a new TLTRO programme, in similar size to previous programmes, providing banks with loans at fixed negative interest rates, contingent on them rolling over loans with SME – and reducing the interest rates commensurately. The interest rate on reserves in the Eurozone should be left unchanged, it is pointless to target lower money market rates. Dual rates should be an active policy, with the TLTRO rate cut independently and below IOR.

6) The ECB should set up a scheme for individual perpetual TLTROs, to be used if the inflation rate in the Eurozone, which is already below target, starts to fall. This would effectively set up a mechanism for the ECB to make cash transfers to households. This could be introduced if the unemployment rate starts to rise significantly.

7) In the Eurozone, there should be a coordinated fiscal stimulus, with sovereign guarantees for small business lending. The fiscal rules should be suspended.

8) The ECB should also cap bond yields, like the Bank of Japan has done. Italy’s bonds behave like risk assets. What would be totally unacceptable is for a sovereign run to occur in the current environment. The ECB should make clear that this would not be tolerated, and reassert the European solidarity which was lost in the Eurocrisis.

9) The US authorities need to wake up to what the Europeans are doing. Fed looks way behind the curve and out of ideas. It should be launching a TFS/TLTRO scheme, and if this is illegal under the Federal Reserve Act, actively pursuing fiscal and monetary coordination.