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Friday, January 2, 2015

Helicopter money

Periodically articles appear advocating, or discussing,
helicopter money. Here is a simple guide to this strange sounding concept. I go
in descending order of importance, covering the essential ground in points 1-7,
and dealing with more esoteric matters after that.

  1. Helicopter money is a form of fiscal stimulus. The original Friedman thought
    experiment involved the central bank distributing money by helicopter, but
    the real world counterpart to that is a tax cut of some form.
  2. What makes helicopter money different from a conventional tax cut is that
    helicopter money is paid for by the central bank printing money, rather
    than the government issuing debt.
  3. The central bank printing money is nothing new: Quantitative Easing (QE)
    involves the central bank creating reserves and using them to buy
    financial assets - mainly government debt. As a result, helicopter money
    is actually the combination of two very familiar policies: QE coupled with
    a tax cut. Another way of thinking about it: instead of using money to buy
    assets (QE alone), the central bank gives it away to people. If you think
    intuitively that this would be a better use of the money as a means of
    stimulating the economy, I think you are right.
  4. Is it exactly the same as a conventional tax cut plus QE? A conventional tax
    cut would involve the government creating more debt, which the central
    bank would then buy under QE. With helicopter money no additional
    government debt would be created. But is government debt held by the
    central bank, where the central bank pays back to the Treasury the
    interest it receives on this debt, really government debt in anything more
    than name only? The answer would appear to be yes, because the central
    bank could decide to sell the debt, in which case it would revert back to
    being normal government debt.
  5. However at this point we have to ask what the aim of the central bank is. Suppose
    the central bank has an inflation target. It achieves that target by
    changing interest rates, which it can either control (at the short end) or
    influence (at the long end) by buying or selling assets of various kinds.
    So central bank decisions about buying and selling government debt are
    determined by the need to hit the inflation target. Given this, whether
    money is created by buying government debt (through QE) which finances the
    tax cut or by financing the tax cut directly seems immaterial, because
    decisions about how much money gets created in the long run are determined
    by the need to hit the inflation target.
  6. There is a general principle here that should always be born in mind when
    thinking about helicopter money. The central bank cannot independently
    control inflation and control money creation - the two are linked in the
    long run (although the short run may be much more unpredictable). Now it could be that advocates of helicopter money really want higher inflation targets, but do not want to be explicit about this, just as they may not want to call helicopter money a fiscal stimulus. The problem with this is that central bankers do understand the macroeconomics, so there seems little point trying to be deceptive. If helicopter money does not mean higher inflation targets, then this policy is just fiscal stimulus plus QE. (I elaborate on
    this point here,and discuss but largely discount possible differences here.
    A less technical discussion is here.)
  7. Saying that helicopter money is 'just' fiscal stimulus plus QE is not meant to be
    dismissive. Mark Blyth and Eric Lonergan make the quite legitimate point that our institutional separation between monetary and fiscal policy may not be appropriate to a world where the liquidity trap may be a frequent problem. Many years ago I suggested in a FT piece that the central bank might be given a limited ability to temporarily
    change a small number of fiscal instruments to enhance its control over
    the economy. The more recent proposal outlined by Jonathan Portes and myself has some similarities with thisidea.
  8. Turningto the tax cut, would this work in stimulating consumption? A familiar
    objection to a bond financed tax cut is Ricardian Equivalence: people just
    save the tax cut because they know taxes will increase in the future to
    pay the interest on the new debt. Now we know that for very good reasons
    Ricardian Equivalence does not hold in the real world, so we are entering
    the territory of angels and pins here, and as a result you may want to stop reading
    now. If not, the question is: if Ricardian Equivalence did hold, would a
    tax cut financed by printing money be subject to the same problem? Here we
    come to the issue of whether central bank money is 'irredeemable'. The next point explains.
  9. Ricardian Equivalence works because, to avoid having to reduce future consumption
    when taxes rise to pay the interest on the government debt created by the
    original tax cut, consumers are forced to invest all of the tax cut. If a
    £100 tax cut implies taxes are higher by £5 each subsequent year to pay a
    5% interest rate, then if the rate of interest consumers can receive is
    also 5%, to generate an extra £5 each year to pay those higher taxes they
    have to invest all £100 of the tax cut. Now suppose the tax cut is
    financed by printing money. There is now no interest to pay. So if
    the central bank never wanted to undo its money creation, there is no
    reason why private agents who hold this money should not regard it as
    wealth and at some point spend it. This is what is meant by money being
  10. However we need to recall that the central bank may have an inflation target. For
    that reason, it may want to undo its money creation. If people expect that
    to happen, they will not regard their money holding as wealth. The logic
    of Ricardian Equivalence does apply. (The central bank may not be able to
    reduce money by raising taxes, but it can sell its government debt
    instead. Now the government has to pay interest on its debt, so taxes will
    rise.) This is why Willem Buiter stresses
    that it is expected future money, not current money, that is regarded as
  11. TonyYates has a recent post on this. He argues that if the central bank assumes money is irredeemable, and starts printing a lot of it, people may stop wanting to use it. If
    they do that, it will no longer be seen as wealth. This is real angels and
    pins stuff that can come from taking microfoundations too seriously. Just
    ask yourself what you would do if you received a cheque in the post from
    the central bank. As Nick Rowe points out in this post,
    we can cut through all this by noting the link between money creation and
    inflation targets. The money required to sustain an inflation target will
    not be redeemed, so it can be regarded as wealth.
  12. Suppose central banks do stick to their inflation targets, but are having trouble
    achieving them because inflation is too low and we are in a liquidity
    trap. Without helicopter money, the inflation target will be undershot. That is the context of the current discussion. Might agents save the tax cut, because they will anticipate higher prices and recognise that they will need the additional money as a medium of exchange? As I discuss here, this is not a problem because the increase in prices will reduce real
    interest rates, which will stimulate the economy that way. As Willem Buiter says, "there always exists a combined monetary and fiscal policy action that boosts private demand".

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