‘Cold Fusion’ Is Citi's Answer to Fading Central Bank Firepower by Simon Kennedy
The medicine may nevertheless need to be stronger than the traditional prescription. If the world economy enters a downdraft, Steven Englander, global head of G-10 FX strategy at Citigroup Inc., proposes a more revolutionary response, akin to the “helicopter money” once advocated by Milton Friedman.
In what he calls “cold fusion,” politicians would cut taxes and boost spending. Central banks would then cover the resulting increase in borrowing by purchasing more bonds as part of a commitment to permanently expand their balance sheets. The easier fiscal policy would be covered by QE Infinity.
“Politically it is difficult for central banks to outright endorse monetization of government debt, but faced with another slump and armed with ineffective policy tools, we expect that central banks will quickly give the wink and nod to fiscal measures,” Englander said in a report to clients last week.
The upshot would be greater purchasing power would be injected straight into the economy, increasing activity and inflation. Long-term bond yields would rise, yet short-term yields adjusted for inflation would turn negative.
“Increasingly the absence of fiscal policy is viewed as one of the reasons for a less than satisfactory recovery,” said Englander. “With rates at zero, fiscal policy will be needed to offset any negative shock that hits global economies.”
Michala Marcussen, head of global economics at Societe Generale SA in London, agrees.
“In a risk scenario, we believe policy makers, faced with the abyss, would take the next step into unorthodox policy, namely fiscal expansion,” she said. “Clearly not the risk that bond markets have in mind.”