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Long-despised, risky economic doctrine now a hot idea

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Billionaire Ray Dalio (left) and monetary policy maven Stanley Fischer (right) foresee central bankers taking a more junior role, and collaborating with governments

Hong Kong

IT'S like a design competition. Hardly anyone thinks central banks can fix a stalling world economy with their current tools. So some of the biggest names in finance are trying to invent new ones.

The proposals so far - including recent entries by billionaire Ray Dalio and monetary policy maven Stanley Fischer - have one thing in common: They foresee the once all-powerful central bankers taking a more junior role, and collaborating with governments.

That type of stimulus used to be taboo, in part because it risks eroding the independence from politics that monetary policymakers prize - and US President Donald Trump is already threatening. History is littered with cautionary tales in which blurring the lines between central bank and Treasury coffers led to runaway inflation.

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But right now, deflation is the big threat. An emerging consensus says the next downturn may need to be fought with direct and permanent injections of cash - often called "helicopter money" - and that central banks cannot deliver it alone.

The monetary policymakers can encourage private actors to spend or invest, by making it cheaper to borrow. By historical standards, though, interest rates are near rock-bottom already and the credit cards of households and businesses are pretty maxed out. In the low-rates era, it has mostly been governments doing the borrowing.

What is resurfacing is "the old idea of monetary policy sometimes pushing on a string'' Lawrence Summers, a former US Treasury secretary and now Harvard University professor, told Bloomberg Television recently. "We've got to think much harder, for economic stabilisation, about mechanisms that involve spurring demand directly.''

That is code for involving fiscal policy. Via their budgets, governments do not have to push the string - they can open the taps, spending directly into the economy or boosting the purchasing power of consumers or companies by cutting taxes.

The new thinking says that central banks can get in on this act too - an idea, known in the jargon as fiscal-monetary cooperation, that economists are now trying to flesh out. It could solve problems, and maybe create some new ones, on both sides.

Governments have been criticised - often by those overseeing monetary policy - for being slow to deliver fiscal support, which typically needs approval by hundreds of lawmakers who may worry about adding to national debts. Central banks can act faster.

The banks would get their hands on some powerful new instruments. But they would likely have to accept that independence from politicians - jealously guarded, especially in the age of Mr Trump's frequent attacks on the Federal Reserve and its chairman Jerome Powell - has limits.

Where to draw those boundaries is the preoccupation of a recent paper published by BlackRock Inc and co-written by Mr Fischer, the Fed's former vice-chair. It argues that monetary stimulus has run out of road as a way to boost economies, while fiscal policy has not been "pulling its weight".

One solution is to combine them - for example, by letting central banks create money to finance government budget deficits. The challenge, say the BlackRock authors, is to encase such "historically unusual'' measures in explicit rules so that central bankers retain their independence, and can apply the brakes if government spending gets out of control.

Their proposal involves an emergency fiscal fund that central banks could activate when inflation is dangerously below-target and there is no room to cut rates. The money-tap would shut off automatically once prices are back on track.

The details differ, but plenty of others have reached similar conclusions about what central bankers could do next - provided they have government authorisation.

"When you have the next downturn, QE (quantitative easing) isn't going to be as effective, interest rates aren't going to be effective,'' Mr Dalio, founder of Bridgewater Associates LP, the world's biggest hedge fund, told Bloomberg TV. "Then you need fiscal policies and debt monetisation,'' he said. "We're going to enter a new realm.''

Modern Monetary Theory (MMT), a school that says government spending and taxes are better tools to steer the economy than interest rates, has also been gaining support. MMT is relaxed about monetary financing of budget deficits, and does not see it as much different from selling bonds.

Along with the lack of monetary ammunition, one reason behind the big rethink may be deepening inequality, especially after 2008's financial crisis.

As central banks shifted from setting rates to seemingly propping up financial assets, they became more vulnerable to the charges that their policies helped the rich most, and went beyond their remits.

A new book by financial commentator Frances Coppola, titled The Case For People's Quantitative Easing, calls for newly minted central-bank money to be funnelled straight into the bank accounts of households or small businesses. That kind of stimulus will deliver more growth and better distribution, she argues - as well as addressing challenges such as ageing populations and automation. BLOOMBERG