What would happen if the ECB immediately and directly ran a helicopter drop of money to the periphery? I don’t find that an easy question to answer. Here is one recent report:
But the indicator [interest rate spreads] has since risen again and reached a record of 3.7 percentage points in January, indicating companies in southern Europe were paying significantly higher interest rates than northern rivals.
“Market segmentation remains, divergence in bank lending rates persists and, as a result, immediate growth prospects in the periphery are bleak,” said Huw Pill, European economist at Goldman Sachs, who was previously a senior monetary policy official at the ECB in Frankfurt.
Would the new helicopter drop money be kept in periphery banks and lent out to stimulate business investment? Or does the new money flee say Portugal because Portuguese banks are not safe enough, Portuguese loans are not lucrative and safe enough, and Portuguese mattresses are too cumbersome?
The former scenario implies that monetary policy should be potent. The latter scenario implies that the helicopter drop will be for naught and the fiscal policy multiplier also will be low, on the upside at the very least (fiscal cuts still might cause a lot of damage on the downside). I call this the liquidity leak, rather than the liquidity trap.
So which scenario is it?
Does it matter who gets the helicopter drop? Perhaps a granny gets the money first and sticks it in the local bank. Alternatively, a financial manager in Lisbon would transfer that same euro rather seamlessly to his second account in Frankfurt. Under this differential scenario, changes in the distribution of wealth also have nominal and eventually real effects.
Is the flow of marginal deposits the problem or the flow of marginal loans? Or both?
Ryan Avent suggests allowing banks to swap their risky commercial loans for safer assets. Other ideas propose running QE on packages of small to mid-sized loans or accepting those loans as collateral at the ECB. Of course these assets are difficult to price and also moral hazard problems would loom. If the ECB is not “overpaying” for the small loans, they won’t be encouraged. If the ECB is overpaying, there are plenty of Sicilian businessmen who have friends at the local bank. The mere lending isn’t enough, the projects also need to be good ones, because in these cases we are talking about tackling issues in the real economy. Can a long-distance ECB collateral support operation spur good, growth-inducing projects? It is easy to see why the Germans might be skeptical.
In some regards these problems will look like liquidity traps, because monetary policy will not always work. But in the periphery lending rates are high (albeit with restricted credit), and standard liquidity trap models will not in general apply. Again, I call it the liquidity leak.
Liquidity trap approaches will encourage you to think in terms of raising expectations of inflation (which is indeed the correct question in many settings), but here the geographic distribution of credit and economic activity is instead the crux of the matter. Our current macroeconomic tools are not well-suited for integration with spatial economics, I am sorry to say.
Addendum: On some related issues, read Scott Sumner.