It is time for unorthodox policy – one far more effective than Milton Friedman’s helicopter drops of money – because it is reversible. Indeed it is akin to ‘stabilising speculation’ by central banks.
The world’s main central banks should collectively buy mainstream securities (not the obscure assets as initially proposed under TARP). This is the best way to put liquidity into the pockets of consumers and companies. But these securities must be targeted to relieve the critical credit blockages impeding recovery. Many of the assets discussed below are now at the lowest real prices seen in decades. The influx of cash and credit will stabilise global activity, eventually increasing the real value of most of these assets. In due course, the central banks will be able to sell back the assets to the private sector. Assuming the stimulus works, this operation will be profitable for the central banks – a important difference when comparing this to fiscal measures that raise national debts.
The financial accelerator
A key part of the economic logic behind this unconventional monetary policy is provided by what economists call the financial accelerator, well explained by Bernanke (1983), building on Irving Fisher’s 1933 theory of debt deflation.