Helicopter Money: missing the point

I am tired of reading discussions of helicopter money (HM) that have the following structure:

1. HM is like a money financed fiscal stimulus
2. HM would threaten central bank independence
3. So HM is a bad idea

(Admittedly here (3) is only implicit.) What these discussions never seem to ask, even when discussing (2), is why we have independent central banks (ICB) in the first place. And what they never seem to note, even in establishing (1), is that ICBs deny the possibility of a money financed fiscal stimulus (MFFS).

ICBs exist to avoid problems when politicians do macro stabilisation. But creating an ICB means that a MFFS is no longer possible. It could only happen through ICB/government cooperation, which would negate independence. But proponents of ICBs say this is no problem, because macro stabilisation can be done entirely by using changes in interest rates, so a MFFS is never going to be needed.

Then we hit the Zero Lower Bound. Unconventional monetary policy (e.g. QE) is a far more uncertain and unreliable stabilisation tool than fiscal policy. Which means ICBs cannot do the job there are required to do, and their existence prevents a MMFS.

To then say no problem, governments can do a bond financed fiscal expansion is to completely forget why ICBs were favoured in the first place. Politicians are not good at macroeconomic stabilisation. If you had any doubt about that, global austerity should be all the proof you need.

So demonstrating (1) does not, I repeat not, imply that ICBs do not need to do HM. Implying that it does is a bit like saying governments could set interest rates, so why do we need ICBs. Most macroeconomists would never dream of doing that, so why are they happy to use this argument with HM?

Which brings us to (2). Now (2) is never in my experience examined with the same rigour as (1): it seems almost that just mentioning ‘fiscal dominance’ is enough to frighten the horses. The only circumstances I can see where (2) would be true is if, following HM and a subsequent upswing, the central bank finds that it runs out of assets to sell in order to keep rates high and prevent inflation exceeding its target. One obvious solution is for the government to recapitalise the central bank.

Does that compromise central bank independence? The Bank of England does not think so. It got the government to agree to make good any losses from QE. Have people worried that this compromises the independence of the Bank of England Of course not: no one can seriously imagine a UK government ever reneging on this commitment. So why would HM be any different?

Let me put it another way. Imagine the set of all governments that would refuse a request from an ICB for recapitalisation during a boom when inflation was rising: - governments of central bank nightmares. Now imagine the set of all governments that, in a boom with inflation rising, would happily take away the independence of the central bank to prevent it raising rates. I would suggest the two sets are identical. In other words, HM does not seem to compromise independence at all.

So please, no more elaborate demonstrations that HM is equivalent to a MFFS, as if that is an argument against HM, without even noting that ICBs prevent a MFFS. No more vague references to HM threatening independence, without being precise about why that is. And please some recognition that the whole point of ICBs is not to have to rely on governments to do macro stabilisation.

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.

Can governments offset helicopter money

Nick Rowe makes a couple of simple points around my post yesterday. Let me start with the issue of whether helicopter money (HM) is ‘permanent’ or not. (Alas I cannot match Nick’s admirable brevity.)

Permanent or temporary?

Think about a really simple world, where the ratio of money to prices is always the same in the long run. In this world we have a short run recession accompanied by deflation, and nominal interest rates have hit the buffer of zero (or wherever). The inflation target is 2%, and the central bank will never let inflation go above 2%. However because interest rates have hit zero, it cannot do the reverse and prevent deflation by conventional means.

If in this world the monetary authority gives away some new money (helicopter money, or HM) to stimulate the economy, is that new money permanent or temporary? Let’s think about what happens without HM. Prices fall or stall for a while, and only when the recession ends does inflation go back to 2%. Now compare this to what would happen if the central bank does HM, and this was successful at raising inflation much more quickly to 2%. That means that the price level will in the long run be permanently higher than if the central bank had done nothing. As a result, at least some of the additional money created to end the recession quickly will be created permanently relative to the no money creation case.

So to the extent HM works, and stops deflation, it involves permanently creating some money. That permanent money creation does not mean that inflation has to be above target, but rather it stops inflation being below target.

But there is absolutely no reason to limit HM to the amount by which money will be permanently higher, because that will almost certainly be insufficient to end deflation. Money will need to overshoot its permanent long run level in the short term. [1] There is nothing wrong in temporarily creating additional money to get us out of a recession. The only issue of any interest in all this is whether unwinding any temporary money creation requires the central bank or the fiscal authorities to do anything unusual (see below)

Will the temporary money be spent?

But if you just give people additional money temporarily, will that mean it is just saved? This is a variant of the Ricardian Equivalence issue, and the real world answer is the same: all the evidence is that quite a lot of it will be spent. I would argue there are two main reasons for this: some people are credit constrained (and HM is like a bank manager that says yes), and others do not know how the money will be payed back (it could be through lower public spending).

What about governments: will they try to offset conventional (cheque in the post) HM by raising taxes, or not increase spending as a result of ‘democratic helicopter money’ (see my last post)? We need to go back to why we need HM in the first place. We need HM because governments are not undertaking the fiscal expansion through borrowing that they should do in a recession where interest rates hit their lower bound. To know how governments will respond to HM, we need to know why they will not undertake this fiscal expansion.

The real fear of too much government debt

Suppose governments have convinced themselves that any additional spending paid for by borrowing is ruled out by worries over the amount of government borrowing. Their fears about borrowing are genuine, and this fear is acting like a constraint stopping them from doing what they otherwise would like to do. So what happens if the central bank does conventional HM, or says to the government you can spend more (or cut taxes) without having to borrow in the short term. Central banks are removing the constraint that governments have (almost certainly) imagined. There is therefore no reason why governments should either try and offset conventional HM, or not spend the democratic variety.

But if HM is temporary, borrowing will have to increase at some point. It is easy to get lost in the institutional detail of the many ways this can happen, so let’s just pick one. Once the recession is over, the central bank worries that there is too much money in the system, and they do not have enough financial assets to mop it all up. They ask the government to recapitalise the central bank, which just means that the government gives the central bank some financial assets in the form of government debt. That means more government borrowing.

Will the government worry about this, and therefore try to reduce its borrowing to offset HM? I would suggest the government will almost certainly not do this. The reason is that governments have convinced themselves that the problem is not the long run position of the government’s finances, but the level of debt and the deficit right now. How do I know this? Because if the problem was the long run position of the government’s finances, they would spend now to end the recession quickly, and then cut the deficit once we were away from the interest rate lower bound. That is the obvious optimal intertemporal policy mix. The fact that they do not do this suggests some imagined short run constraint.

You can also look at what governments undertaking austerity do. They are quite happy to cut deficits through privatisation, which almost surely increases future deficits. They embark on all kinds of fiscal tricks that simply shift revenues into the short term, or shifts spending into the long term. In other words, fiscal plans operate under a short term deficit constraint, and democratic HM relaxes that constraint.

Using a fear of debt as a cover for shrinking the state

Suppose governments do not really believe that their own borrowing has to be reduced right now, but are using public anxiety over public debt (with phrases like the government has maxed out its credit card) as a pretext to cut public spending. Short term borrowing is not really a constraint, but governments just pretend it is to achieve the goal of a smaller state. Such a government would almost certainly use any democratic HM to cut taxes, so the distinction between conventional and democratic HM is not central. Would this government use HM as an excuse to cut spending by yet more, thereby offsetting the benefits of HM?

The great advantage a central bank has is speed. It takes time to put new fiscal plans into effect, but money can be created overnight. So if the government plans to cut spending by more as a result of HM, the central bank can just offset the demand impact of those additional spending cuts with yet more HM. If you think such a game cannot go on forever you are right, but it does not have to. Once the recession is over, monetary policy can offset the impact of spending cuts on demand using interest rates in the normal way.

In this situation, both the central bank and government are happy. The central bank, by using HM in potentially unlimited amounts, can end the recession quickly. The government that wants to use the deficit as a cover for cutting public spending has succeeded in doing so, perhaps by more than they had thought possible. That might upset you because you do not want a smaller state and resent voters being tricked into allowing it to happen, but I personally would prefer that to a prolonged recession every time. [2]

[1] Macroeconomists sometimes say that in a recession the public’s demand for money increases, or there is an excess demand for money. To a non-economist, of course, that just sounds silly.

[2] Remember that HM does not stop a benevolent government doing the right thing and enacting a fiscal stimulus. It is a fall back to stop a malevolent government crashing the economy in pursuit of an ideological goal.  

Ben Bernanke and Democratic Helicopter Money

“The fact that no responsible government would ever literally drop money from the sky should not prevent us from exploring the logic of Friedman’s thought experiment, which was designed to show—in admittedly extreme terms—why governments should never have to give in to deflation.”

The quote above is from a post by Ben Bernanke (who, in case anyone does not know, used to be in charge of US monetary policy). I put it up front because it expresses a macroeconomic truth that no one should ever forget: persistent recessions and deflation are never inevitable, and always represent the failure of policy makers to do the right thing.

There are many useful points in his post, but I just want to talk about one: Bernanke is in fact not talking about helicopter money in its traditional sense, but what I have called elsewhere ‘democratic helicopter money’.

When most people talk about HM, they imagine some scheme whereby the central bank sends ‘everyone’ a cheque in the post, or transmits some money to each individual some other way. It is what economists would call a reverse lump sum tax, or reverse poll tax: the amount you get is independent of your income. That makes it different from a normal tax cut.

In practice the central bank could only really do this with the cooperation of governments. It would not want to take the decision about what everyone means on its own. (Do we include children or not. How do we find everyone?) But once those details had been sorted out, a system would be in place that the central bank could operate whenever it needed to.

Bernanke suggests an alternative. The central bank sets aside a sum of newly created money, and the fiscal authorities then spend it as they wish. They could decide to use all the money to build bridges or schools rather than give it to individuals. There might be two reasons for doing HM this way. First, for some reason the fiscal authorities are reluctant to spend if they have to fund it by creating more debt, so it may allow them to get around this (normally self-imposed) ‘constraint’. Second, a money financed fiscal expansion could be more expansionary than a bond financed fiscal expansion. Lets leave the second advantage to one side, as the first is sufficient in a world obsessed by government debt.

I have talked about something similar in the past (first here, but later here and here), which I have called democratic helicopter money. This label also seems appropriate for Bernanke’s scheme, because the elected government decides on the form of fiscal expansion. The difference between what I had discussed earlier under this label and Bernanke’s suggestion is that in my scheme the fiscal authorities and the central bank talk to each other before deciding on how much money to create and what it will be spent on (although the initiative always comes from the central bank, and would only happen in a recession where interest rates were at their lower bound). The reason I think talking would be preferable is simply that it helps the central bank decide how much money it needs to create. [1]

Imagine, for example, you had a fiscal authority in one country that wanted to spend the money on ‘shovel ready’ public investment projects, and an authority in another country that wanted to spend it on some temporary tax cuts for the rich. The impact of the two different stimulus policies on demand and output are very different. If the two economies were in similar conjunctural positions, then the central bank with the tax cutting fiscal authorities would want to create a lot more money than would be required in the other economy.

In some countries it is easier for central banks to talk to the fiscal authorities than in others. When it is difficult, Bernanke’s scheme may appear attractive, but it leaves the central bank somewhat in the dark about how much money it needs to create. The big advantage of the more popular conception of HM (a cheque in the post) is that the impact of any money creation is much clearer. (As it is important to end recessions quickly, waiting to see what happens is not helpful advice.)

When central banks and governments do happily talk to each other (as in the UK, for example) then my version of democratic HM becomes an option. Arguments that this makes the central bank less independent are spurious in my view. The central bank initiates the discussion, in clearly defined circumstances. They simply ask what the government would spend any newly created money on. This question should be accompanied by the central bank’s current view on what the multipliers for various fiscal options are. The government then makes a choice, and the central bank then decides how much money to create.

While democratic HM is not talked about much among economists (Bernanke excepted), I think there are good political economy reasons why it may be the form of HM that is eventually tried. As I have said, conventional HM of the cheque in the post kind almost certainly requires the involvement of government. Once governments realise what is going on, they may naturally think why set up something new when they could decide how the money is spent themselves in a more traditional manner. Democratic HM is essentially a method of doing a money financed fiscal expansion in a world of independent central banks.

Which brings me back to the quote at the head of this post. The straight macroeconomics of most versions of HM is clear: all the discussion is about institutional and distributional details. If it is beyond us to manage to set in place any of them before the next recession that would be a huge indictment of our collective imagination, and is probably a testament to the power of imaginary fears and taboos created in very different circumstances.

[1] A sequential set-up of the kind Bernanke suggests is also more vulnerable to cheating: the government uses the money to finance something they were going to do anyway, and in effect largely offsets the money creation by reducing its own borrowing. 

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.       

Two related confusions about helicopter money

Confusions about helicopter money is something of a generic title (although Martin Sandbu is thankfully not confused). Because a discussion of helicopter money (HM) cannot normally be found in the textbooks (which have only just caught up with central bank independence), the scope for misunderstanding is huge. Here I want to talk about two related confusions. The first is about whether HM would lead to an increase or decrease in nominal interest rates, as discussed in a recent interchange between Tony Yates and Paul Krugman. The second is whether HM is in competition with the use of fiscal policy to get us out of recessions.  

On HM money and nominal interest rates, there is of course the standard and very basic point that in a market you cannot control both quantity and price, still less move them in opposing directions. So if we want to think about a market for money, you cannot raise the supply of money and raise its price - the nominal interest rate - at the same time.

But this observation ignores what else is going on when you have HM. HM is a large fiscal expansion. Please none of this ‘but if Ricardian Equivalence (RE) holds’: we are talking real world policy here not doing thought experiments, and we have all the evidence we need that RE does not hold (for reasons that are not difficult to understand). Let's also not fall into the trap of doing IS-LM. We are in a world of inflation targeting, and anything that raises demand (as a fiscal expansion will) will tend to raise inflation, and so the monetary authorities will tend to raise nominal interest rates. Any temptation to say ‘yes but in the short run’ becomes dubious because of expectations effects. 

So it is really quite simple. Either the nominal interest rate lower bound constraint continues to bite, which means helicopter money will leave nominal interest rates unchanged (but the economy better off), or there is no constraint (or that constraint is removed), in which case rates will rise (sooner) with HM.

The second confusion is that helicopter money in some way precludes undertaking countercyclical fiscal policy. It does not. Right now, for example, governments could and should announce large increases in public sector investment (where I am using investment in the economist’s sense to include investment in human capital, rather than in a national accounts sense). This would negate any immediate need for HM. Monetary policy adapts to fiscal policy.

When people ask me which we should have, helicopters or fiscal expansion, I'm tempted to say I would love to have the choice! If I did have that choice, right now I would take additional public investment over a helicopter drop, because the micro case for investment is in many cases (and countries) very strong, interest rates are low and investment improves the supply as well as the demand side. In any future severe recession where the interest rate lower bound was likely to be hit [1] I would also advise bringing forward public investment. However I do not see this as a competition (countercyclical fiscal action vs HM) for two reasons.

First, one lesson of the Great Recession is that we cannot rely on governments to do the right thing with fiscal actions, so HM is an insurance policy in that sense. If governments do spend more or tax less as we approach the ZLB, that insurance policy may not be needed. [2] Second, even if governments do the right thing, either lack of good projects [3] or information delays may mean they do not do enough, and so the very quick action that central banks could take with HM could be a useful complement. To put it another way, helicopter money is best seen as an alternative to QE rather than as an alternative to fiscal action.

[1] Because of implementation lags, a fiscal response to an impending deep recession should not wait until nominal interest rates actually hit their lower bound. If that fiscal response involves investment, used in an economists rather than national accounts sense, then there is no great loss if the deep recession does not happen, because it is wise to invest when real interest rates and wages are relatively low.

[2] In the proposals put forward in Portes and Wren-Lewis (2015), the central bank would directly tell the government the probability of the lower bound being hit.

[3] I think the argument that the amount of public investment cannot be adjusted to match macro conditions is often overstated. We are not talking HS2 here (the proposal to build a high speed train line between London and Birmingham and beyond), but improving flood defences, repairing roads and schools etc.

Central bankers and their irrational fear

Mervyn King said

“Central banks are often accused of being obsessed with inflation. This is untrue. If they are obsessed with anything, it is with fiscal policy.”

As an academic turned central banker, King knew of what he spoke. The fear is sometimes called fiscal dominance: that they will be forced to monetise government debt in such a way that means inflation rises out of control.

I believe this fear is a key factor behind central banks’ reluctance to think seriously about helicopter money. Creating money is no longer a taboo: with Quantitative Easing huge amounts of money have been created. But this money has bought financial assets, which can subsequently be sold to mop up the money that has been created. Under helicopter money the central bank creates money to give it away. If that money needs to be mopped up after a recession is over in order to control inflation, the central bank might run out of assets to do so. A good name for this is ‘policy insolvency’. [1]

There is a simple way to deal with this problem. [2] The government commits to always providing the central bank with the assets they need to control inflation. If, after some doses of helicopter money, the central bank needs and gets refinanced in this way, then helicopter money becomes like a form of bond financed fiscal stimulus, but where the bond finance is delayed. In my view that delay may be crucial in overcoming the deficit fetishism that has proved so politically successful over the last five years, as well as giving central banks a much more effective unconventional monetary instrument than QE. [3] But central banks do not want to go there, partly because they worry about the possibility of a government that would renege on that commitment.

The fear is irrational for two reasons. First, central banks already face the possibility that they may make sufficient losses on QE that they may require refinancing by the government. The Bank of England has requested and been given a commitment to cover those losses. There is no conceptual difference between this and underwriting a helicopter drop except probabilities.

The second reason is more basic. In today’s world, where in the major economies it is now well understood that interest rates need to rise in a boom to control inflation, it is hard to imagine a government that would make its central bank impotent by refusing to provide it with assets. If such a government ever existed, it would have long before ended central bank independence because it wanted to stop it increasing interest rates with the assets it already had. Under the government of central bank nightmares, the central bank would lose its independence before it could complain that the government was reneging on an earlier commitment to underwrite helicopter money.

The fear of fiscal dominance is itself not irrational, although it seems increasingly unlikely it would happen in a modern democracy. What is irrational is thinking that allowing helicopter money in a recession would make fiscal dominance more likely to happen. [4]

I have also argued that this irrational fear has already been costly. I have described how the widespread adoption of austerity at the beginning of the recovery represents the failure to politicians to follow basic macro. Here central banks become a policy intermediary between academia and politicians: they have the knowledge of how costly austerity can be when rates are zero. But what politicians heard from senior central bankers was not these costs, but encouragement to pursue austerity. An irrational fear of budget deficits may be one explanation for central banks being economical with the truth.

Central banks overcame one big psychological barrier when they undertook Quantitative Easing. That was the first, and perhaps the more important, stage in ending their primitive fear of fiscal dominance. They now need to complete the process, so we can start having rational discussions about alternatives to QE.

[1] A central bank cannot actually become insolvent, as this post explains.

[2] No one to my knowledge has ever proposed giving the central bank the legal power to collect a poll tax.

[3] A key feature of deficit fetishism is a concern about deficits in the short term. Politicians seem happy to take measures that cut deficits in the short term even if debt becomes higher in the longer term. Indeed the analysis presented by DeLong and Summers argues that hysteresis forces would not have to be that large before austerity would raise long run debt to GDP levels. We also know that deficit fetishism is specific to increases in debt caused by recessions: over the longer run if anything deficit bias implies rising rather than falling levels of government debt. So any form of fiscal stimulus that avoided an increase in debt in the short run but not in the long run would avoid deficit fetishism. That is what a money financed fiscal stimulus aka helicopter money aka People’s QE could do.

[4] Why am I confident that a government could not be so obsessed with its debt that it might renege on an underwriting pledge? It is because deficit fetishism is only politically attractive in a recession when individuals are themselves cutting back on their borrowing, and therefore feel the government should do the same. This will not apply when the recovery has taken place and inflation is in danger of exceeding its target.

Haldane on alternatives to QE, and what he missed out

Andrew Haldane, Chief Economist at the Bank of England, gave a typically well researched and thoughtful talk recently. The main subject matter was the problem of the Zero Lower Bound (ZLB): why we may hit it much more often than we would like, and why QE is not a great instrument for dealing with it. To quote:

“QE’s effectiveness as a monetary instrument seems likely to be highly state-contingent, and hence uncertain, at least relative to interest rates. This uncertainty is not just the result of the more limited evidence base on QE than on interest rates. Rather, it is an intrinsic feature of the transmission mechanism of QE.”

In the past I have emphasised the point about lack of evidence simply because it is obvious. But as Haldane’s discussion shows, the problems are more basic than that. Some people argue that we can always get the result we want with enough QE. Yet if the central bank and the public never know how effective any amount of QE will be, then lags make it a poor instrument. It is refreshing to see a senior member of the Bank finally acknowledge its limitations.

Haldane considers two alternative ways of dealing with, or avoiding, the ZLB: a higher inflation target and getting rid of cash so that negative interest rates of whatever size become possible. The first is obviously welfare reducing, but as Eric Lonergan argues the second is likely to be as well. (See also Tony Yates.) But what is really strange about Haldane’s analysis is what is missing from his discussion.

One omission is a discussion of the possibility that targeting something other than inflation might help. The other omission is any discussion of helicopter money. There are some basic contradictions in the Bank of England’s views on helicopter money, but because central bankers tend to talk to each other I suspect they remain concealed. One argument is that helicopter money will somehow reduce confidence in the currency, but then the Bank seems happy to research getting rid of cash and imposing negative rates on money as if this is all about technicalities. [Postscript - meant to link to John Cochrane's discussion, and here is a reply by Miles Kimball.] I should have referenced  Another argument is that helicopter money will threaten the Bank’s independence because it will have to rely on government to (if necessary) recapitalise it, when at the same time the Bank has already obtained an underwriting guarantee for losses on QE. Also strange is the argument that independence will be threatened once the Bank does a 'helicopter drop' because governments will want the money for themselves, as if politicians had not noticed the amount of money being created under QE. After all Jeremy Corbyn's proposal was a response to the reality of QE, not the possibility of helicopter money.

The really ironic argument is that helicopter money is too like fiscal policy, and that there should be democratic control over fiscal policy. This is what central bankers mean when they talk about blurring the lines between monetary and fiscal policy. The argument is ironic because I am sure that if you actually asked most people which they would prefer - being charged to hold money, 4% average inflation, or occasionally getting a cheque from the Bank - the answer would be emphatic. So we rule out helicopter money because its undemocratic, but we rule out a discussion of helicopter money because ordinary people might like the idea.

There is also an element of hypocrisy. It is sometimes argued that helicopter money is unnecessary because it has a very similar impact to conventional fiscal policy. This is true, but it deliberately ignores the fact that governments around the world have gone for fiscal contraction because of worries about the immediate prospects for debt. It is not as if the possibility of helicopter money restricts the abilities of governments in any way. If governments undertake fiscal stimulus in a recession such that helicopter money is no longer necessary, it will not happen.

So it is good that some people at the Bank are thinking about alternatives to QE, which is a lousy instrument with unfortunate, and potentially permanent, distributional consequences. It is a shame that the Bank is not even acknowledging that there is a straightforward and cost free solution to this problem. My last two posts have involved defending central bank independence, but with independence comes a responsibility not to exclude discussion of particular policy options simply because they break some kind of taboo.