Abhijit Banerjee (AB) has raised a few eyebrows by recommending "printing money" to fight the poverty impact of Covid-19 mitigation measures. Some have rightly expressed concerns that the intervening processes such as economic governance or economic consequences such as inflation may make this cure worse than the disease.
Resolving this debate requires clarity about what "printing money" really means. It is a metaphor referring to the expansion of aggregate liquidity—the size of financial assets that can be used to meet obligations—by the Bangladesh Bank (BB). Aggregate liquidity is measured by the stock of reserve and broad money. Reserve money consists of net foreign currency denominated assets held by the BB and its financial claims on the government and the deposit money banks (DMBs). It is also called "high powered money" because of its potential to multiply through credit creation by the DMBs. Broad money (M2) comprises of the net foreign currency denominated assets of the banking system and its financial claims on the public and private sectors.
A key objective of policy interventions currently is to flatten the poverty and joblessness curves resulting from different forms and degrees of social distancing we are currently practicing for containing the spread of the virus. The design of the policy response to the economic challenges is separate from the strategy used to finance the response in a world of fungible money.
AB has recommended "printing money" as a strategy for financing income transfers to the poor and the vulnerable. Whether or not income transfer to the poor is desirable is at the end of the day a social choice. There is hardly any debate about the desirability of such a choice not just on equity-cum-human rights considerations but also as an essential complement to the virus mitigation efforts. Given that, the question is how to finance it?
What are the options?
The Prime Minister has rightly envisaged reallocation of unspent allocations in the revised development budget to fighting Covid-19. There is room for at best Tk80-90 thousand crores assuming no slips between the expression of intent and its realization. There may be savings from the revised non-development budget as well. There is no possibility of additional revenue. A large revenue shortfall to the extent of 4.5 percent of GDP relative to the target is projected by many. This combined with the proposed increases in Covid-19 related public expenditures, which currently is not nearly as high as the latest 3.9 percent of GDP support package estimates suggest, is likely to drive the fiscal deficit upwards. Scaling up income support to the extent needed based on any reasonable estimate of the numbers needing such support would make it much higher. Expenditure austerity, wherever possible, will cushion the pressure, not eliminate it. Yet the policy response to help the poor cannot be downsized to fit a predetermined deficit ratio.
Additional foreign financing windows have opened. The government has already approached the multi-lateral financial institutions for budget and balance of payment support. While all these institutions are processing funding requests on a fast track, it will take a few months for the money to flow into the BB and the Treasury accounts. Even after they do come in, the size of the expansion in deficit needed to protect lives and livelihoods is likely to exceed the external financing available. There are therefore questions of timing and adequacy of external financing.
The need for policy response is immediate. It cannot wait. So, what can be done to meet the inadequacy and the still protracted timing of external financing? Non-bank borrowing is not promising because of the reduction in private saving due to fall in individual disposable incomes and business profits. The room for bank borrowing is limited for several reasons. The government has already exceeded the original budget target. Liquidity in the banking system is under pressure because of reduced deposit growth, decline in reflows on account of a quasi-moratorium on interest and amortization payments, and the requirement to channel bulk of the concessional loan support to large and small businesses from the banks' own funds.
This logically leaves recourse to the proverbial "lender of the last resort"—the central bank. BB has the ability to create money in the form of currency or a credit to an account held at the BB. BB has increased regulatory forbearance, expanded refinancing schemes and used the repo market more actively in recent months to boost liquidity.
BB lowered the cash reserve ratio (CRR) by 1.5 percentage points and reduced the repo rate by 50 basis points. The CRR reduction has released about Tk 18-20 thousand crores. The liquidity provided through these means are significant, but not adequate to fund the subsidized loans to business enterprises. BB has therefore extended the existing refinancing schemes and added new ones which together constitute about 1.3 percent of GDP. If banks respond to these, reserve money will increase. When domestic credit expands as a result, broad money will also increase—same as "printing money"! These measures have widely been applauded, albeit with suggestions to pay more attention to the details so that they become operational, irrespective of concerns about the governance of the financial support package.
Now, AB has advocated similar "printing money" option to finance large income transfers to the poor—old and new—for as long as their livelihood ecosystem remains locked down. The exact mechanism for expanding money supply in this case will have to be different. Banks will have a role in facilitating the transfer, if it is made in cash. The funds will have to come from the government. BB can credit the government account for the amount of additional transfers for the duration of the program. That credit would not be repayable. It can be captured by a reduction in BB's capital or by a permanent annotation on the asset side of the BB balance sheet. This will increase reserve money. When the government transfers the fund to the poor in cash or kind, broad money will increase. There is no reason to applaud this any less than we do for money supply increases induced by the support to businesses.
The preference for one over the other in the list of policy priorities has to depend on which one is considered more pressing in managing the Covid-19 situation. The concern about governance cuts across different policy responses. It is not the case that non-monetization of income transfer induced increases in fiscal deficit will make the transfer programs more efficient and corruption free. Yes, external financing brings with it certain transparency and accountability requirements. As the IMF Managing Director Kristalina Georgieva advised "keep your receipts". However, when external financing takes longer than the needs warrant and is inadequate, we cannot let governance concerns stop some programs because of the monetary effects, but not others which have similar monetary effects.
Whether or not monetary expansion will be inflationary depends on what happens to total liquidity in the economy and international commodity prices, going forward.
Total liquidity depends not just on the increase in the supply of money but also on the demand for money. The precautionary demand for cash has increased recently resulting in increase in the cash-deposit ratio. This reduces the money multiplier. The demand for credit coming from trade, production and investment is now quarantined. BB has not shifted from the stance of not allowing the taka to depreciate in line with supply-demand balance in the foreign exchange market. Its interventions to defend the taka-USD rate drains taka liquidity. It is therefore not obvious that there will be too much liquidity due to monetization of deficit.
Almost all commodity prices declined sharply in the international markets during the past three months. Mitigation measures disrupted transport, causing an unprecedented decline in demand for oil. Weaker economic growth globally will continue to weaken overall commodity demand. Crude oil prices are expected to average $35/bbl this year and $42/bbl in 2021, according to the World Bank's April 2020 Commodity Market Outlook. Non-energy prices are also expected to fall in 2020. Food prices are expected to be broadly stable.
Inflationary pressure cannot accelerate if liquidity growth remains modest and international commodity prices keep falling. Even if there is some inflation, it can be viewed as a general consumption "tax" to help protect lives and livelihoods. The poor and the vulnerable will still be better off if the income transfers do in fact materialize.
The fact that monetary policy is driven by fiscal considerations may be perceived as undermining BB's operational autonomy. However, the autonomy issue should not be a concern in the current situation if the reliance on monetization is linked to the duration of the emergency measures related to the health crisis and the availability of alternative financing.
Monetization of fiscal deficit is a powerful tool that policymakers should use only in emergency situations. That emergency is currently with us. Governance concerns in the implementation of deficit financed policy interventions are legit, but not relevant to the choice of the deficit financing instrument. However, as citizens we must always insist on "keeping the receipts" irrespective of how the deficit is financed.