Negative rates, helicopter money and the Bank of England

Yesterday Mark Carney said he was against negative interest rates and helicopter money, but in reality he implemented a way of doing a version of both. Let me explain.

When negative interest rates are discussed, we normally think about savers, and the fact that they could avoid being charged to deposit money in a bank by hoarding cash. But borrowers would have no problem with negative rates: borrow £1000, and just pay back £990. The bank they borrowed from would have, unless there were negative rates on savings or they were getting a subsidy to lend.

Helicopter money is normally thought of as the central bank sending a cheque to every citizen. But the key point for economists is not the way the money is distributed, but the fact that it is created by the central bank and given away in return for nothing. (QE involves creating money to buy assets.) Who the money goes to is of course important, but it is not really the defining characteristic of the measure.

We normally think about monetary policy as changing the interest rate. If rates are cut, that benefits borrowers but is bad for savers. But suppose the central bank gave money to private banks, on condition that this money was passed on in the form of lower rates to borrowers. If it did this, but did not change the interest rate, that would be helping borrowers but not hitting savers. The Bank introduced such a scheme yesterday, called the Term Funding Scheme (TFS). What is more, this subsidy for borrowers is financed by creating money. Eric Lonergan argues that the ECB is doing something similar, and if there is any insight in this post I owe it to him (but if there isn’t it is my fault not his!).

So if you think the Bank has ruled out negative rates, you are half wrong. In principle the Bank can expand TFS to make borrowing as cheap as it likes, which could even mean negative interest rates for borrowers. If you think the Bank has ruled out helicopter money, you are half wrong. It is creating money to give away with nothing in return, but just giving the money to one particular group: borrowers.

Now if you are a saver you might say why cannot I rather than borrowers benefit from this money give away. But the Bank could argue that without TFS it would have to reduce the interest rate by even more than it has, which would make savers a lot worse off. So compared to that outcome, you are better off. Whether you find that convincing when you can always hold cash depends on the cost of holding cash.

So why did Mark Carney say that helicopter money was a flight of fancy, when he was in fact doing something quite similar? It is a good question to ask him. I suspect the real answer is that TFS looks like the kind of thing a central bank does, but giving money to every citizen looks like fiscal policy. But what it does mean is that in terms of the basic macroeconomics, the Bank of England is now doing helicopter money. But if you are neither a borrower or a saver and feel aggrieved you are not getting anything, you know who to complain to.

Money and Debt

For economists

As regular readers will know, my advocacy of helicopter money (HM) does not depend on it being different from, or better (at stimulating demand) than, fiscal policy. [1] So, for example, when Fergus Cumming from the Bank of England said that if after HM the government recapitalised a central bank this “reduces the initial stimulus to a vanilla, bond-financed fiscal transfer”, then that sounds just fine to me. Except, of course, to note that HM is not just like fiscal policy because (a) HM may be quicker to implement than conventional fiscal policy, and speed matters (b) HM can bypasses both genuine debt fears and deficit deceit (c) with HM there is no chance of monetary offset.

Much the same is true for this Vox article by Claudio Borio et al. They argue that if interest is paid on all bank reserves, then HM is “is equivalent to debt-financing from the perspective of the consolidated public sector balance sheet”. Maybe, but why should that be a problem? It is only a problem if you set up a straw man which is that HM has to be more effective than a bond financed helicopter drop.

The reason some people think it is not a straw man is that, if you set up a model where Ricardian Equivalence holds and you have an inflation targeting central bank, a bond financed lump sum tax cut would have no impact. Then you would indeed want HM to do something more. And perhaps it could, if it led agents to change their views about monetary policy. While such academic discussions may be fun, I also agree with Eric Lonergan that “theoretical games being played by some economists, which masquerade as policy insights, are confusing at best.” A good (enough) proportion of agents will spend HM - at least as many as spend a tax cut - for perfectly sound theoretical reasons. [2]

The Bario et al article does raise an interesting question. When the central bank pays interest on all reserves, what is the difference between money and bond financing? Reserves would seem to be equivalent to a form of variable interest debt that can be redeemed for cash at any time. It is exactly the same question raised in a paper by Corsetti and Dedola, an early version of which I discussed here. The answer their model uses is that the central bank would never default on reserves, whereas debt default is always an option.

I think this all kind of misses the point. Base or high powered money (cash or reserves) is not the same as government debt, no matter however many times MMT followers claim the opposite. (For a simple account of why the tax argument is nonsense, see Eric Lonergan here.) Civil servants can frighten the life out of finance ministers by saying that they may no longer be able to finance the deficit or roll over debt because the market might stop buying, but they cannot do the same by saying no one will accept the money their central bank creates. [3] Money is not the government’s or central bank’s liability. (For a clear exposition, see another piece by Eric, or this by Buiter.) Money is not an obligation to make future payments. Money is valuable because, as Eric describes here, it is an established network.

Bario et al seem to want to claim that because central banks nowadays control interest rates by using the interest they pay on reserves, this somehow creates an obligation. Reserves are like variable rate, instant access debt that banks get for nothing.

I think we can see the problem with this line of argument by asking what happens if obligations are broken. If the government breaks its obligation to service or repay its debt we have default, which has extremely serious consequences. If the central bank decides on a different method to control short term interest rates because paying interest on reserves is too much like a transfer to banks, no one but the banks will notice.

So reducing the macroeconomics of helicopter money to fiscal policy is not an argument against it. Furthermore money created by the central bank is not the same as government debt, even if interest is paid on reserves.

[1] They would also know - unlike Jörg Bibow - that I do not think there is any kind of contest between fiscal policy and HM, because the fiscal authority moves first.

[2] The two main reasons some people will spend a tax cut is if they are borrowing constrained, or if they think there is a non-zero probability that the tax cut will be paid for by reducing government spending. An additional reason for spending HM is that it might be permanent if it avoids the central bank undershooting its inflation target.

[3] If the finance minister knows some macroeconomics they would of course realise that not being frightened by the second means you should not be frightened by the first. But that does not negate the conceptual difference.           

Postscript (8/6/16): This by Biagio Bossone provides a very good complement to my analysis, looking a why HM is not 'permanent' and discussing interest on reserves

Helicopter money and fiscal policy

Both John Kay and Joerg Bibow think additional government spending on public investment is a good idea, and that helicopter money (HM) is either a distraction (Bibow) or fiscal policy by subterfuge (Kay). They are right about public investment, but wrong about HM.

We can have endless debates about whether HM is more monetary or fiscal. While attempts to distinguish between the two can sometime clarify important points (as here from Eric Lonergan) it is ultimately pointless. HM is what it is. Arguments that attempt to use definitions to then conclude that central banks should not do HM because its fiscal are equally pointless. Any HM distribution mechanism needs to be set up in agreement with governments, and existing monetary policy has fiscal consequences which governments have no control over.

Here is where Kay and Bibow are right. At this moment in time, even if a global recession is not about to happen, public investment should increase in the US, UK and Eurozone. There is absolutely no reason why that cannot be financed by issuing government debt. Furthermore, in the event of a new recession, increasing ‘shovel ready’ public investment is an excellent countercyclical tool. Indeed there would be a good case for bringing forward public investment even if monetary policy was capable of dealing with the recession on its own, because you would be investing when labour is cheap and interest rates are low.

Where Bibow is wrong is that the existence of HM in the central bank’s armory in no way compromises the points above. HM does not stop the government doing what it wants with fiscal policy. Monetary policy adapts to whatever fiscal policy plans the government has, and it can do this because it can move faster than governments.

This goes part of the way to answering Kay, but he also suggests that HM is somehow a way of getting politicians to do fiscal stimulus by calling it something else. This seems to ignore why fiscal stimulus ended. In 2010 both Osborne and Merkel argued we had to reduce government borrowing immediately because the markets demanded it.

HM is fiscal stimulus without any immediate increase in government borrowing. It therefore avoids the constraint that Osborne and Merkel said prevented further fiscal stimulus. To put it another way, they did not say that increasing government spending or cutting taxes were bad in itself, but just that they were extremely unwise because they had to be financed by adding to government debt. HM is not financed by increasing government debt.

Many argue that these concerns about debt are manufactured, and that in reality politicians on the right pushing austerity are using these concerns as a means of achieving a smaller state: what I call here deficit deceit. HM, particularly in its democratic form, calls their bluff. If we can avoid making the recession worse by maintaining public spending, financed in part by creating money while the recession persists, how can they object to that? Politicians who wanted to use deficit deceit will not like it, but that is their problem, not ours.

There is a related point in favour of HM that both Kay and Bibow miss. Independent central banks are a means of delegating macroeconomic stabilisation. Yet that delegation is crucially incomplete, because of the lower bound for nominal interest rates. While economists have generally understood that governments can in this situation come to the rescue, politicians either didn’t get the memo, or have proved that they are indeed not to be trusted with the task. HM is a much better instrument than Quantitative Easing, so why deny central banks the instrument they require to do the job they have been asked to do.

Helicopters are easy to fly

The debate over helicopter money seems to have got past the ‘shock, horror, people’s faith in the monetary system would collapse’ phase, and past the ‘it wouldn’t work because people wouldn’t spend the money’ phase, to the ‘what happens next’ phase. And to be fair to the critics, many proponents of helicopter money have not been clear on this issue.

The point was put very clearly yesterday in an FT Alphaville piece by Gerard MacDonell. Once the recession is over, there is likely to be too much money in the economy from the central bank’s point of view (which means, money has to be withdrawn to maintain the inflation target). We cannot say how much, but equally it would be wrong to ignore the problem. So what happens next?

I think I have been clear (at least recently) on this point. First, helicopter money as I see it is not a way to get inflation overshooting by the back door. The idea that the increase in money is ‘permanent’ is meaningless, as Eric Lonergan says. Overshooting may be a good idea, but there is no need to be devious about it. Second, the obvious way to ensure the central bank still achieves its inflation and other objectives is to recapitalise the bank if necessary. The central bank could enforce very high reserve ratios on commercial banks, but is that a desirable thing to do?

In my view helicopter money would be accompanied by a commitment by the government to recapitalise the central bank if that was needed. Yes, commitments can be broken, but only by the kind of government that would happily revoke central bank independence anyway.

The answer to what happens next is therefore easy. When it becomes clear after the recession that there is now too much money in the economy, the central bank takes it out. In other words, monetary policy acts as normal. If the central bank runs out of assets to do this, it gets recapitalised. Recapitalisation means more government debt. So we can end up in a position which is exactly equivalent to one where the distribution of money had been financed by an increase in debt in the first place: a conventional fiscal expansion.

In this world, helicopter money is (a particular type of) fiscal expansion by the back door. As Narayana Kocherlakota points out, this back door method has no purely macroeconomic advantages over the real thing. But the reason why we need a back door is obvious right now. Economists need to get real about these political constraints. Obsession with debt is not just based on ignorance, but it serves an ideological purpose which is not going to go away.

Yet even if governments were not obsessed with current levels of debt (and that is all they are obsessed by), go back to the textbooks on why monetary policy is prefered to fiscal policy as a stabilisation tool. One of the reasons you will find is that monetary policy is quick to invoke, with no institutional (aka democratic) hurdles to pass. Those who argue that helicopter money is just like fiscal policy seem to ignore this. There is also the (obvious) point that helicopter money allows what I call the consensus assignment to work (by expanding the meaning of monetary policy a little beyond interest rate changes), rather than leaving it with the rather large Achilles Heel of the zero lower bound.

Helicopter money is just another way of doing textbook demand management. What it does is move around current institutional boundaries a bit, to reflect real institutional and political constraints. There is nothing magical about the current institutional boundaries. Perhaps if you think (as Brad DeLong does) about the profits the central bank makes as a social credit that gets automatically distributed to people rather than given to an intermediary (the government), you might feel easier about it.       

Is mainstream academic macroeconomics eclectic?

For economists, and those interested in macroeconomics as a discipline

Eric Lonergan has a short little post that is well worth reading. Not because it is particularly deep or profound, but because it makes an important point in a clear and simple way that cuts through a lot of the nonsense written on macroeconomics nowadays. The big models/schools of thought are not right or wrong, they are just more or less applicable to different situations. You need New Keynesian models in recessions, but Real Business Cycle models may describe some inflation free booms. You need Minsky in a financial crisis, and in order to prevent the next one. As Dani Rodrik says, there are many models, and the key questions are about their applicability.

If we take that as given, the question I want to ask is whether current mainstream academic macroeconomics is also eclectic. (My original title for this post was can DSGE models be eclectic, but that got sidetracked into definitional issues, but from the way I tend to define things it is the same question.) My answer is yes and no.

Let’s take the five ‘schools’ that Eric talks about. We clearly already have three: New Keynesian, Classical, and Rational Expectations. (Rational Expectations is not normally thought of in the same terms, but I understand why Eric wanted to single it out.) There is currently a huge research programme which aims to incorporate the financial sector, and (sometimes) the potential for financial crises, into DSGE analysis, so soon we may have Minsky too. Indeed the variety of models that academic macro currently uses is far wider than this.

Does this mean academic macroeconomics is fragmented into lots of cliques, some big and some small? Not really, in the following important sense. I think that any of this huge range of models could be presented at an academic seminar, and the audience would have some idea of what was going on, and be able raise issues and make criticisms about the model on its own terms. This is because these models (unlike those of 40+ years ago) use a common language. The idea that the academic ranking of economists like Lucas should reflect events like the financial crisis seems misconceived from this point of view.

It means that the range of assumptions that models (DSGE models if you like) can make is huge. There is nothing formally that says every model must contain perfectly competitive labour markets where the simple marginal product theory of distribution holds, or even where there is no involuntary unemployment, as some heterodox economists sometimes assert. Most of the time individuals in these models are optimising, but I know of papers in the top journals that incorporate some non-optimising agents into DSGE models. So there is no reason in principle why behavioural economics could not be incorporated. If too many academic models do appear otherwise, I think this reflects the sociology of macroeconomics and the history of macroeconomic thought more than anything (see below).

It also means that the range of issues that models (DSGE models) can address is also huge. To take just one example: the idea that the financial crisis was caused by growing inequality which led to too much borrowing by less wealthy individuals. This is the theme of a 2013 paper by Michael Kumhof and colleagues. Yet the model they use to address this issue is a standard DSGE model with some twists. There is nothing fundamentally non-mainstream about it.

So why is the popular perception so different? Why do people talk about schools of thought? I think there are two reasons. First, while the above is true in the realm of academic understanding and discourse, it does not carry over into policy. When it comes to policy, we get to learn which models academic think are applicable to particular policy problems, and here divisions can be sharp. Second, there are plenty of people outside academia who have a public voice about economics (and generally a policy orientation), and they often do see themselves as school followers.

In terms of working practice rather than the hot end of macro policy decisions, most academic macroeconomists would regard themselves as eclectic in terms of the kind of work they are prepared to spend an hour or two seeing presented. But this view, and the common language that mainstream academics use, leads me to the No part of the answer to my original question. The common theme of the work I have talked about so far is that it is microfounded. Models are built up from individual behaviour.

You may have noted that I have so far missed out one of Eric’s schools: Marxian theory. What Eric want to point out here is clear in his first sentence. “Although economists are notorious for modelling individuals as self-interested, most macroeconomists ignore the likelihood that groups also act in their self-interest.” Here I think we do have to say that mainstream macro is not eclectic. Microfoundations is all about grounding macro behaviour in the aggregate of individual behaviour.

I have many posts where I argue that this non-eclecticism in terms of excluding non-microfounded work is deeply problematic. Not so much for an inability to handle Marxian theory (I plead agnosticism on that), but in excluding the investigation of other parts of the real macroeconomic world. (Start here, or type microfoundations into this blog’s search box and work backwards in time.) But for me at least this as a methodological point, rather than anything associated with any school of thought. Attempts to link the two, which I think many people including myself have been guilty of, just confuses.

The confusion goes right back, as I will argue in a forthcoming paper, to the New Classical Counter Revolution of the 1970s and 1980s. That revolution, like most revolutions, was not eclectic! It was primarily a revolution about methodology, about arguing that all models should be microfounded, and in terms of mainstream macro it was completely successful. It also tried to link this to a revolution about policy, about overthrowing Keynesian economics, and this ultimately failed. But perhaps as a result, methodology and policy get confused. Mainstream academic macro is very eclectic in the range of policy questions it can address, and conclusions it can arrive at, but in terms of methodology it is quite the opposite.