My starting point is with what the pandemic is in terms of
macroeconomy. It is a huge and unanticipated wealth shock. We do not have to
discuss the huge part, I believe. The unanticipated part is more controversial:
if you would ask epidemiologists, they would (and did) say that what we are
experiencing is a clear possibility. However, the macroeconomic consequences
were completely and utterly unappreciated. I view it from my perspective of
somebody creating macroeconomic stress-testing scenarios for living: not only
is the current outcome way out of the range of outcomes consider by regulators
such as Fed, EBA or PRA – even though they were not trying, with latest CCAR
being twice worse than the great recession - but I am fairly confident that if
I would propose drop of GDP by 10-20% over 2 quarters I would be laughed at.
Given that, I think that this outcome was clearly not in
subjective distribution of those creating and pricing financial assets or just
any contracts, on either side of the deals. This means that the shock creates ex-ante
relative winners and losers: in
financial markets bond holders are relative winners, for most part, with the
residual-claim holders (=shareholders) suffering (almost) all the losses and
bond holders not bearing (almost) any of the shock; in rent contracts, say
between shop renter and shopping mall, the shop renter bears (almost) all the
costs of not having any business, while shopping mall renting the space out is
protected by the contract. Of course, with defaults on contracts the bond
holders and those renting out will suffer as well, but this is only in the
extreme outcomes and in any case their loss is much smaller compared to the
stock holders and shop renters. Given the generally unanticipated nature of the
shock, this distribution seems unfair, and indeed, governments around the world
try to address this in some form.
Ideally, there would be a renegotiation of the contracts,
with bond holders and shopping malls taking a hit. Of course, we know from the
contract literature that this is hard, so will not likely occur on massive
scale. However, I realized that the same thing could be partly achieved by
central banks, or at least in theory it could. Take the debt contract. Debt
contracts are almost always written in nominal terms, so decreasing the real
value of money via unexpected inflation shifts some of the real loss to bond
holders, at least those who have long-term contracts. So the central bank could
bypass the problem of contract-renegotiation by announcing it will increase the
price level by say 5% or 10%. In practice this might be easier said than done,
but there is always helicopter money, after all: by giving everybody 5% of new
money supply now, we decrease the value of those holing the fixed-nominal-value
side of the contracts by 5%, distributing the costs of the shocks more widely,
evenly and I would say fairly.
I think the strongest case for this is at levels of whole countries,
say indebted country like Italy. In the old pre-euro days, in response to this
shock Italy would experience a bout of inflation. This would re-distribute from
the bond holders (and deposit holders) to the other people, alleviating some of
the unfairness in the distribution of impact of this widely unanticipated shock
by shifting it from tax-payers to creditors of the state. Of course, Italy does
not have the option anymore, and doing this via default or deposit tax is not
the same as it affects only one part of the link (e.g. hits bond holders, but
not their creditors, making them insolvent). And of course, leaving the euro
has such a large associated costs that it outweighs the associated benefits, so
there is no such option for Italy. Before someone concludes that this shows
that having common currency is bad, it is worth pointing out that this shock is
extreme in that it was not part of our prior distribution, plus one could (or
should?) do this at euro-zone, so this is not related to common currency
per-se.
P.S.: Of course this is all closely related to price level
or NGDP targeting.
