THE Federal Reserve Bank of Kansas City's annual conference in Jackson Hole, Wyoming, is the big event of the year for central bankers. But defining monetary policy is far harder than it used to be. In recent years central bankers have lurched ever closer to the realm of fiscal policy, mainly by buying government debt with freshly printed money. They can justify such “quantitative easing” (QE) on monetary grounds since they have already lowered short-term interest rates to, or close to, zero. But they also worry it is a slippery slope from QE to monetising government deficits and thence, inevitably, to inflation. When Phillip Swagel, then an official with the US Treasury, was asked why he attended the conference in 2008, he shrugged: “Fiscal policy, monetary policy—what's the difference?”

For central bankers this is an unsettling thought. Their mistrust of fiscal policy was nicely captured in a paper presented at this year's Jackson Hole conference by Eric Leeper of Indiana University*. As central bankers have become more independent, they have increasingly based their policies on rigorous economic analysis. By contrast fiscal policy is deeply politicised, with haphazard methods and few, if any, defined goals.

Much as central bankers would like to ignore fiscal policy, they cannot. “Fiscal alchemy can undermine monetary science,” says Mr Leeper. A wise monetary policy aims to keep prices stable, prudent fiscal policy to stabilise government debt. This division of labour works as long as the public believes that, after running a big deficit, the government will raise taxes or cut spending enough to keep debt under control. But, he argues, if the debt is so large that the government cannot credibly commit to these actions, the public assumes the central bank will inflate away the debt by printing money. Inflation expectations soar and the central bank loses control of prices.

Mr Leeper's warning resonates with central bankers, many of whom are calling for fiscal austerity even as they keep their own feet to the floor. Yet it is an odd thing to worry about now. Debt may be rising, yet underlying and expected inflation rates are falling in America and Europe, just as they did in Japan after its crisis. Fiscal austerity robs policymakers of a potent antidote to a deflationary slump: simultaneous fiscal and monetary expansion.

By itself, QE works mainly through two channels. First, when the central bank buys government bonds the extra demand raises bond prices and lowers their yields. Lower long-term interest rates stimulate activity elsewhere in the economy. Second, when banks sell their bonds to the central bank they get reserves (ie, deposits at the central bank) in return. They have an incentive to swap those low-yielding reserves for something with better returns, like shares or corporate debt. This lowers private-borrowing costs and raises asset values, boosting wealth and spending.

There is a catch, however. Supplying trillions of dollars of reserves and driving interest rates to zero cannot force banks to lend or companies and households to borrow. Five years of quantitative easing by the Bank of Japan in the early 2000s had barely any effect on inflation and unemployment (see left-hand chart). Since late 2008 the Federal Reserve has bought $1.75 trillion of Treasuries and mortgage-related debt, bringing long-term interest rates down sharply. Yet sales of homes remain moribund, bank credit has contracted and the recovery is feeble.

This does not mean QE was useless, only that formidable headwinds have blunted its effect. Carmen Reinhart of the University of Maryland and her husband, Vincent Reinhart of the American Enterprise Institute, presented evidence** at Jackson Hole that in the wake of financial crises, deleveraging is a powerful drag on recovery. They found that the ratio of private credit to GDP rises by a median of 38 percentage points in the decade prior to a crisis, and drops by an equal amount in the decade after. Per-capita GDP growth is 0.6 percentage points lower after a crisis.

Ben and the art of helicopter maintenance

If QE cannot spur private demand on its own, combining it with looser fiscal policy may help. If the private sector will not spend, the government can do it instead, borrowing to cut taxes, send cheques to households, build infrastructure or even extinguish underwater mortgages. QE prevents all that borrowing from driving up long-term interest rates. This is the “helicopter drop” of money made famous by Milton Friedman and notorious by Mr Bernanke in a 2002 speech when he was still a Fed governor.

The combination has worked before. To fight the second world war, America's federal government increased its debt from 44% of GDP to 106%. Starting in 1942 the Fed agreed to buy as much debt as necessary to keep short- and long-term interest rates below prescribed ceilings (see right-hand chart). The stimulus of mobilisation produced an immediate, and powerful, impact: unemployment fell from around 15% to 2%, and from 1940 to 1945 GDP grew by 12% a year. But there was a cost. Wage and price controls were used to contain inflation, which surged when controls came off. The Fed chafed under the yoke of the Treasury, winning its freedom only after a long battle in 1951.

Could the mechanics of wartime finance be recreated without the inflation or the loss of central-bank autonomy? Mr Leeper says the answer may be to create fiscal institutions that mimic the rigour and autonomy of central banks, as Sweden, Chile, Hungary and New Zealand have done to varying degrees. No easy task, to be sure, judging by how euro-area countries flouted the fiscal targets in their Stability and Growth Pact. But if a fiscal authority helped governments credibly commit to a target debt-to-GDP ratio by a certain date, it could then combine stimulus today with austerity later. Perhaps then central bankers could join hands with their fiscal counterparts without trepidation.

* “Monetary Science, Fiscal Alchemy” by Eric Leeper

** “After the Fall” by Carmen Reinhart and Vincent Reinhart