Winner of the New Statesman SPERI Prize in Political Economy 2016

Wednesday, 22 October 2014

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 this idea.
  8. Turning to 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 irredeemable.
  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 wealth.
  11. Tony Yates 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".


82 comments:

  1. Had the BBC as state broadcaster decided that explaining the 'liquidity trap' might have been a useful public service in, say, 2009 or 2010, then life would have been easier for all.

    I have just looked at the latest government 10 year borrowing rates, and they remain flat to the floor for all countries except Greece - Krugman may prove right about the politics there after all.

    What percentage of people in the UK know about the history of borrowing rates and how historically low they are?

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  2. Tax cuts plus QE are not functionally equivalent to helicopter-drop "money printing" since they don't create a permanent net increase in the number of currency units in private sector circulation. When central banks conduct QE, the currency units they create are used to buy financial assets, including large volumes of government securities. As a result, cash flows that were going to the former private sector owners of those securities are re-directed to the central bank. So there is generally no need for the CB to "undo" this money printing, since over time it undoes itself, so to speak. As has been made clear by central bank economists talking about exit strategies for QE, the main component of these strategies is to simply let the purchased assets "roll off" the central bank balance sheet as money flows back into the central bank to discharge the security obligations they have purchased.

    A true helicopter drop would consist in a direct, unencumbered emission of central bank currency without an offsetting purchase of securities. For example, a government could decide simply direct the central bank to send everyone in the country a 1000-unit central bank note, redeemable in central bank dollars. People deposit those notes in their bank accounts which the banks mark-up by 1000 units, and the banks then redeem the notes with the CB, which marks up the banks' reserve accounts by 1000 units. End of story. No subsequent repayment of the currency units back to the central bank; no removal of other financial assets from the recipients's balance sheets.

    The fact that people don't understand that QE is a purchase and swap of one kind of financial asset for another is one of the main reasons for the massive confusion in the public discussion of QE, both by those who fear inflation via QE and don't understand why it hasn't materialized, and those who seek inflation via QE and also don't understand why it hasn't materialized.

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    1. How do you know that a helicopter drop involves a permanent increase in money (and equally how do you know QE is temporary)? Surely it all depends on the inflation target. If the inflation target is unchanged, then the CB may have to effectively 'undo' the helicopter drop by taking money out of the system.

      Rather than talking about monetary policy instruments, isn't it more straightforward to talk about objectives: is helicopter money equivalent to raising the inflation target or not?

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    3. It seems to me that whether a government conducts a helicopter drop and whether it changes its inflation target are two separate questions that ought to be kept conceptually distinct. A helicopter drop would be one particular technique of attempted economic stimulus, and whether or not it goes along with a change in the inflation target is a different matter. Since a tax cut is not an injection of helicopter money, and since QE itself is not an injection of helicopter money, then a tax cut combined with QE is not an injection of helicopter money.

      Helicopter money would consist in a direct emission of government or central bank currency into the private sector. If I print a pound note and simply give it to you, that is an importantly different matter than printing a pound note and using it to purchase from you an IOU for the payment of one pound a year or two from now. In the first case, private sector assets are increased by one pound, and private sector liabilities are unaffected. The private sector has one pound more of financial equity. In the second case, the consolidated balance sheet of the private sector is unaffected.

      Even if there is no change in the inflation target, the emission wouldn't necessarily have to be undone, since under some sagging economic circumstances the economy can fully absorb the additional currency units into a higher level of demand and output without any pressure on the price level.

      I'm just trying to get past this idea people have that QE is something like a helicopter drop. It's not just that QE is something the central bank *might* choose to undo in accordance with its inflation target. It's that QE is something that is pre-determined to be "self-undoing" given the very nature of the operation involved. If the central bank later wants to prevent the pre-determined extraction of money that is going to occur as these purchased securities are paid off, it can do so buy continuing to buy securities. But every time it does so it just swaps one form of highly liquid financial assets for another form of only slightly less liquid financial assets. Only the maturity composition, but not the net equity value, of private sector balance sheets is changed in each case.

      If people are interested in trying a helicopter drop, they should consider the real deal. There are a variety of ways in which a government could carry out a direct emission of additional currency units to the private sector which do not involve the simultaneous transfer of an offsetting quantity of financial assets to the central bank. Yes, that government could then subsequently *choose* to offset the emission of money by carrying out some later operation to absorb it. But that is a separate, and not pre-determined, policy choice that can be deferred.

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    4. Bravo, SWL. Very clear. Fiscal & monetary policies tend to be confused very often.

      In your example, what's a combination of fiscal & monetary policy is presented as monetary policy alone. The opposite happens frequently. Why do incrases in M normally generate increases in P? Do a survey and 90% of esconomists (esp neoclassics and monetarists!) will answer: "because if people have more money, they'll spend some of it, and if supply (?) is fixed prices will rise". The trick is "money" here. Monetary policy means more money but not more wealth. Why would a change in wealth composition lead to an increase in consumption? Of course we all believe M-->P, but through other mechanisms.

      Congrats for the post.

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    5. Anonymous 22 October 2014 12:16

      Suppose there is a long run relationship between money and prices. Then the inflation target dictates the extent of money creation in the long run. That means that tax cuts plus QE will be equivalent to helicopter money.

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    6. Mainly Macro

      "is helicopter money equivalent to raising the inflation target or not? "

      The benefit of heli's is that they will have a greater impact on gdp for any given quantity of money expansion compared to QE. Therefore the central bank wont need to expand the money supply as much in order to stimulate. The massive expansion in the monetary base may be the reason why it is lowering its inflation target due to some risks they may perceive so heli drops may result in a higher inflation target.

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    7. Great post and really clear argumentation.

      While the logic here is indisputable, I always start to wonder how applicable all this is in practice. As the reasoning requires representative agents to follow how they should value money and all the expectations. Add all the other complexity and this sort of analysis seems mainly academically (very) interesting.

      I guess no one sane argues that keeping inflation target on hold and mailing (better than tax cut) everybody enough cash would not be inflationary? Mind the concrete steps too.

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    8. Quite right Anonymous - I can think of no reasonable definition of a helicopter drop which could include tax cuts plus QE. The whole point of a helicopter drop is that the central bank has no assets covering the base money expansion. I would have thought the economic effect of that will then depend entirely on the credibility of the inflation target. If the inflation target is fully credible, then the market can be expected to treat the helicopter drop just like a bond-funded tax cut, because the commitment to create bonds as needed to absorb excess base money is so solid that the government might as well have gifted the central bank marketable gilts as the helicopter drop is deployed. In which case there is no point doing it.

      I wish these Keynesian professors would spend more time trying to find ways to fix the real economy rather than endless magic solutions where the undeclared backstop is the wealth of savers in nominal assets, disproportionately including the smallest savers with the weakest voice.

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    9. I thought this was a spoof post from some Primary School hackers!!!

      For instance, Point 2. The Central Bank has a Balance Sheet. It can't create a liability without having an asset to balance it out. If it "prints money" and throws it out of a helicopter, someone on the ground would have to be throwing an asset back into the helicopter. It would have to be a swap.

      Only the Treasury (the sovereign fiat currency issuer) can drop new financial assets out of a helicopter. The Treasury does not have a Balance sheet; that's the pure beauty of being a sovereign FIAT currency ISSUER. It could do it with Pound coins from its own Mint. It would more likely drop IOUs and tell you to go to your nearest Commercial Bank and convert them into crispy new notes with a picture of our Queen on them! The Central Bank will supply as many of the latter notes as are needed, no limits. Or rather, the Treasury has a bottomless pit of them which it allows its Central Bank to give physical form to in various sizes and colours.

      Meanwhile, the Treasury will have sent the Central Bank an amount of "RESERVES" to match the value of the IOUs pound for pound exactly. If you turn up at your Bank and turn your IOU into CASH, the Central Bank will deduct the equivalent "RESERVES" from your Banks Reserve Account at the BoE.

      You might run round to your kids Bank and deposit the CASH you just got, into your kids DEPOSIT account. Your kids Bank could deposit the CASH you just gave it into its account at the BoE. The BoE would shred the cash and replace it in your Banks account with "RESERVES". At the end of the day, the Central Bank will be shifting “RESERVES” between all its Commercial Banks, as they make their individual Balance Sheets; balance.

      By the way. The government does not have to issue debt (Gilts) to match its spending, it chooses to do this. It's a throw back to when we were on the Gold Standard. Why would the Treasury want to borrow back its own currency, that it had previously created, that is, SPENT INTO EXISTENCE and pay interest on it; when it could just create (spend) new money?

      Remember. The Treasury will eventually get all its SPENDING back as taxes; 100%. The fact that we little people keep hanging on to loads of it, that is, SAVING it, means the Treasury has the exact same amount of taxes it hasn't got back yet. It calls this the National Debt, but it is really National Savings.

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    10. @ Tim Young, who said: "I would have thought the economic effect of that will then depend entirely on the credibility of the inflation target. If the inflation target is fully credible, then the market can be expected to treat the helicopter drop just like a bond-funded tax cut, because the commitment to create bonds as needed to absorb excess base money is so solid that the government might as well have gifted the central bank marketable gilts as the helicopter drop is deployed. In which case there is no point doing it."

      That might be true for some of those select and mysterious textbook macroeconomic agents who constitute "the market" - whatever that is exactly - and whose behavior is crucial to the expectations-obsessed, trickle down textbook operations macroeconomists are always thinking about. For them, you need a credible inflation target or else something analogous to Ricardian equivalence is at work.

      But for the majority of actual people in the real world, I think, this level of theoretical calculation is irrelevant. If you send a household or small business a free 1000 pounds, they treat it like a free 1000 pounds. They don't think "Oh I must be careful unless the government or the central bank promises an X % inflation rate, else they will surely tax this back somehow!"

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    11. @ the other Anonymous 23 October 2014 01:27

      From the Anonymous 22 October 2014 10:12:

      You say:

      "The Central Bank has a Balance Sheet. It can't create a liability without having an asset to balance it out. If it "prints money" and throws it out of a helicopter, someone on the ground would have to be throwing an asset back into the helicopter. It would have to be a swap."

      But that's not true. All business enterprises have a balance sheet, but it is by no means the case that the assets and liabilities on that balance sheet must "balance". Obviously, most businesses seek to have assets substantially in excess of their liabilities. Rather, what must balance are the assets, conventionally on one side of the sheet, and the sum of liabilities plus equity, conventionally on the other side. And they always do balance because equity is, by definition, equal to assets minus liabilities.

      What you might be thinking is that, as a matter of national accounting, every financial asset that exists anywhere in the economy must be balanced by a financial liability that exists somewhere else in the economy. But all that means is that if the central bank emits and gives away a pile of free money - which officially counts as a "liability" of the central bank - the rest of the economy has accumulated assets exactly equal in value to the liability.

      Also, unlike actual private sector business enterprises, the central bank is the issuer of the nation's base form of money, and there is no functional reason why the central bank needs to have positive equity on its balance sheet. It could operate perfectly well in a state of perpetual negative equity. Indeed, the very concept of financial "equity" makes little real economic sense when applied to the central bank. The understanding of the central bank as a banking business enterprise with a "balance sheet" is a communications strategy central banks have hit upon to present a certain face to the public that gives the latter a somewhat misleading grasp of what it is that central banks do. The positive equity of the bank's so-called "balance sheet" has become incorporate into the public perception of sound money and sound central bank practice. But this is a really a misconception, and is more a matter of preserving a certain mystique and navigating confusing political waters than conducting sound policy.

      There are some economists who claim that the state of the central bank's balance sheet is a key contributing determinant of the price level, and have even proposed mathematical formulas that attempt to quantify exactly how much of a determinant, and so is important to economic policy. But like most such reductive quantitative accounts of the price level, which have all come to naught in recent years, I doubt there is much actual empirical confirmation for these theories.

      But certainly, there must be some level at which central bank emissions of money greatly in excess of its absorption of money begins to become dangerously inflationary. Central banks preserve the mystique of the balance sheet, I believe, because they worry that if lots of people understood how central banks actually function, and what their operational requirements are and are not, they would start demanding helicopter drops all of the time, and that could be a political mess that is hard to clean up.

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    12. Perhaps it would be better if the Central Bank were renamed something like the "Central Monetary Authority", rather than perpetuating the myth that it is a bank like any other

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  3. This is a very good explanation

    http://bilbo.economicoutlook.net/blog/?p=22149

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  4. A favorite helicopter drop method is to issue debit cards by real person social security number. Presumably the Fed could establish its own consumer bank sub to fund these and manage operations or fund prepaid cards at other banks.

    The size of the accounts could be on the order of the output gap per capita less multipliers.

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  5. I want to know more about this helicopter: does it really drop off money, like Santa Clause on Christmas eve? When? Where? Who got the money? Were there any regrets? Does it count as earned income?

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    1. Johnny! don't panic and keep this to yourself. Santa has been doing a "sleigh drop", in November. A bit like a helicopter drop but much much faster. Santa had the contract, with DWP, to deliver "Winter Fuel Payments" directly into old peoples Bank Accounts. These are 100% proof fiscal stimulus.

      Unfortunately, Santa tried to up his rates, cos he told DWP he was delivering "out of season". DWP told him to stick his red nose where the sun don't shine. It appears that BACS (Bankers Automated Clearing Services) got the contract. BACS claimed its keyboards, could shift the payments even faster than Rudolf on laxatives. All the best ;-)

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  6. People initially hold $100 of government bank notes, backed by various assets worth 100 oz of silver. $1 is worth 1 oz. Then the government prints another $100 and gives them away. Now $1=0.5 oz. There is no stimulus any way you look at it. If prices are sticky then wealth gets transferred around a bit, but the crops didn't grow any faster and no new wealth is created.

    On the other hand, suppose the extra $100 was issued in exchange for 100 oz worth of assets. Now there's twice as much money, and twice as much backing, so $1=1 oz. If this money was not wanted, that is, if the economy was already flooded with cash, then it would reflux to the issuer and nothing else would happen. But if the economy had been cash-starved, then the additional $100 would lubricate trade, and new wealth would be created. That's how the Keynesian myth of stimulus got started. People saw a few cases where money was introduced into a cash-starved economy and business was revived, and they were fooled into thinking that a helicopter drop would have done the same thing.

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    1. There is no backing now though that I can see. If the fed purchases gov bonds when expanding money it is buying claims on the money it prints. That's not a backing.

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    2. The fed's bonds serve as backing for the dollars it issues. The fed might have issues $100 in exchange for a $100 bond in the first place, so the fed can just as well sell that bond for the dollars it previously issued, and retire the dollars received. If the fed had no backing, it would have no assets with which to buy back the dollars it issued.

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    3. The fed can temporarily contract through issuance of securities. There is no precedent of a permanent contraction in fed history or of any central bank that Im aware of.

      Historically simply holding the MB constant would result in deflation. No need to contract. What will permanent contraction achieve anyway in real terms? Lower prices and lower NGDP.

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    4. Central banks don't do permanent contractions because people have use for the money, and that use grows over time. As long as that's the case, CB's will issue more money, not less. But if you think that CB assets do not back CB money, you'd have a hard time explaining why CB's hold assets anyway, or why it is that when CB's lose their assets, their currency loses its value.

      A constant monetary base, along with constant CB assets, would result in zero inflation or deflation.

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    5. If people's "use" for money grows over time that should be enough to maintain the money supply without the central bank buying assets. The central bank can hold assets Im not against that either but its not essential or necesary.

      What instances are you reffereing to where CB's lost assets?

      A constant MB and CB assets would result in deflation if productivity grows.

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    6. 1. You assume the correctness of the quantity theory, which is the point in dispute. The backing theory (aka the real bills doctrine) gives a satisfactory explanation of the value of so-called fiat money, and it must be addressed before you jump to the wrong conclusion, i.e., that the quantity theory is right.
      2. Peoples' use for money is why it remains in circulation instead of refluxing to the issuing bank in exchange for the issuing bank's bonds, but use does not explain why money has value. Backing does. The same is true of stocks and bonds and every other financial security.
      3. If, for example, people wanted to hold 30% less money, then the central bank must be able to buy it back at par. Without assets, the CB could not do so.
      4. Examples include historical cases of runs on the central bank, e.g. Thailand 1997, Bank of England 1797.

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    7. Money is used because it is the most efficient medium of exchange while being a store of value and unit of account. If it fulfills these functions people use it because they are much better off than bartering. This is money's true backing. If people expect money to continue to perform these functions they will use it.

      A physical backing of say gold on fed balance sheet will provide reassurance that money can be exchanged for this gold by fed if it cant be exchanged for goods and services from private sector. If fed maintains efficient monetary system then it is guaranteeing ppl can exchange money for goods and services. In both cases you are placing your trust in fed. If you cant trust fed to maintain efficient monetary system then why do you trust the fed to give you gold even if it has it on balance sheet?

      How is a gov bond backing? It is simply a claim on money. It's a derivative of the money the fed creates. You could get the same backing by the fed holding MB on its own balance sheet.

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    8. Consider this T account:

      ASSETS............................................LIABILITIES
      1) 100 oz silver deposited......................$100 paper FRN's
      2) +bond worth $200..............................+$200 FRN's
      3) -bond worth $200...............................-$200 FRN's

      In line 1, 100 oz of silver is deposited and 100 federal reserve notes are issued in exchange. $1=1 oz.
      In line 2, the fed issues another $200 of FRN's in exchange for a bond worth $200. The bond could just as well have been worth 200 oz. The mere denomination of the bond in dollars instead of ounces is trivial.
      In line 3, the fed sells the $200 bond back to the public, getting its $200 bond in return. This could not have been done if the fed had just given the $200 away. The $200 of FRN's were created in exchange for the bond in the first place, and they can be retired in exchange for that same bond. The importance you attach to the fact that the bond is denominated in dollars is unjustified. By analogy, GM could issue new shares of stock and use them to buy call options on GM stock. The calls are just a claim on GM stock, but nobody could claim that the calls do not back GM shares, or that GM shares would lose value because of this transaction.

      If the quantity theory that you espouse were correct, then money-issuance would be a free lunch, and issuers of rival moneys would issue competing moneys until the demand for the original money fell to zero.

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    9. Mike Sproul said: "A constant monetary base, along with constant CB assets, would result in zero inflation or deflation."

      Why can't the monetary base be zero and demand deposits be used as MOA and MOE as long as the commercial banks are solvent and there is 1 to 1 convertibility to currency if people changed their minds?

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    10. Fed Up:

      That would work. You don't even need any government issued money. Private banks could issue their own notes and checkable deposits, and make them convertible (or inconvertible) into anything they want.

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    11. Mike Sproul, everyone seems to obsess over the monetary base. If the commercial banks are solvent and there is 1 to 1 convertibility to currency, isn't it currency plus demand deposits that matters?

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    12. Fed up:
      Welcome to my world! Here's an analogy: GM issues shares of stock, which are valued according to GM's assets and liabilities. Next, Merrill Lynch issues some call options on GM stock. The issuance of those calls does not affect the value of GM stock, but the value of GM stock does affect the value of ML's calls. If ML went broke, then those calls would lose their value because they are no longer backed by ML's assets, but GM stock would be unaffected.

      (GM shares are like base money issued by the central bank, ML's calls are like checkable deposits issued by private banks.)

      So no, it's not currency plus demand deposits that matter. What matters is money issued by the Fed, and the aggregate assets and liabilities of the fed. Demand deposits, being nothing but call options on fed money, have no effect on money's value.

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    13. "So no, it's not currency plus demand deposits that matter. What matters is money issued by the Fed, and the aggregate assets and liabilities of the fed. Demand deposits, being nothing but call options on fed money, have no effect on money's value."

      I don't agree with that. Notice I said 1 to 1 convertibility. Let's say demand deposits go up. Next, people demand all currency. The fed won't break 1 to 1 convertibility if the commercial banks are solvent (the assets perform). They will increase the stock of currency (liability). I'm assuming the Bureau of Printing and Engraving complies.

      Let's say something goes wrong with the call options. GM won't increase the stock of GM stock (liability). GM does not guarantee any fixed conversion rate.

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    14. Fed up:

      It's private banks that peg their checkable dollars to the FRN's issued by the fed. The fed does not peg FRN's to the bank's checkable dollars.
      "demand deposits go up"---Do you mean more checkable dollars are issued, or that they rise in value relative to FRN's?

      If something goes wrong with the call options, that's on ML, not on GM. ML pegs the calls to GM stock, GM does not peg GM stock to the calls. However in this case, since GM owns some calls, the calls partially back GM shares, and a fall in the value of the calls would cause GM shares to drop.

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    15. "It's private banks that peg their checkable dollars to the FRN's issued by the fed. The fed does not peg FRN's to the bank's checkable dollars.
      "demand deposits go up"---Do you mean more checkable dollars are issued, or that they rise in value relative to FRN's?"

      Let me try it this way.

      There is $500 billion in currency and $2 trillion in demand deposits. Over time, that becomes $1 trillion in currency and $6 trillion in demand deposits. During these times the commercial banks are solvent (the assets perform). Suddenly, every entity redeems their demand deposits for currency. There is $7 trillion in currency and no demand deposits.

      As long as the commercial banks are solvent (the assets perform), the fed will allow the redemption. The fed does not come along and say well that will create too much currency leading to too much price inflation so we (the fed) won't allow the fixed conversion.

      "ML pegs the calls to GM stock, GM does not peg GM stock to the calls."

      I think that sounds right.

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    16. OK, so the public demands $7T in currency from the banks, which take $6T of bonds to the fed, which issues another $6T in currency. It used to be that private banks had $6T of assets backing $6T of liabilities, while for the fed it was $1T backing $1T. After the conversion, private banks have 0 backing 0, while the fed has $7T backing $7T. On backing theory principles this does not affect the value of checkable deposits or FRN's.

      Have I lost the thread of your argument? What's the importance of this swapping of assets and liabilities?

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    17. From just above about the $7 trillion in currency and "It's private banks that peg their checkable dollars to the FRN's issued by the fed. The fed does not peg FRN's to the bank's checkable dollars."

      The fed had to increase currency. What should that be called?

      It appears to me that the commercial banks do not worry about pegging demand deposits to currency. They just make mostly loans and try to stay solvent. If the demand deposits from loans produce price inflation, the fed raises the fed funds rate. It never stops or denies the 1 to 1 conversion so demand deposits fall in value against currency.

      "So no, it's not currency plus demand deposits that matter. What matters is money issued by the Fed, and the aggregate assets and liabilities of the fed. Demand deposits, being nothing but call options on fed money, have no effect on money's value."

      By "money's value", I assume you mean against goods and services (price inflation). With solvent commercial banks and 1 to 1 convertibility between currency and demand deposits, currency plus demand deposits can fall in value against goods and services. Since they are "money", it appears as rising prices.

      Delete
    18. "The fed had to increase currency. What should that be called?"

      It should be called passively issuing money, in the way that a mint passively issues coins to people who bring in silver bullion.

      "commercial banks do not worry about pegging demand deposits to currency."

      We must be talking about different things. Every checking account dollar is pegged to the green paper dollar.

      "With solvent commercial banks and 1 to 1 convertibility between currency and demand deposits, currency plus demand deposits can fall in value against goods and services."

      Only if FRN's have less backing. If both FRN's and checkable deposits are adequately backed, there can be no inflation even if the quantity of money (however defined) rises.

      Delete
    19. "We must be talking about different things. Every checking account dollar is pegged to the green paper dollar."

      Demand deposits are pegged to currency. I mean this. The commercial banks can create demand deposits by making loans and staying solvent. They don't worry about the fed saying we won't increase currency and/or central bank reserves because you (the commercial bank) made too many demand deposits along with making the loans. If the commercial banks are creating too much debt, they raise the fed funds rate and hope other interest rates go up to slow down or stop debt production. That last sentence is mostly.

      "So no, it's not currency plus demand deposits that matter. What matters is money issued by the Fed, and the aggregate assets and liabilities of the fed. Demand deposits, being nothing but call options on fed money, have no effect on money's value."

      "Only if FRN's have less backing. If both FRN's and checkable deposits are adequately backed, there can be no inflation even if the quantity of money (however defined) rises."

      Those two seem different to me. I'm mostly but not entirely agreeing with the second quote.

      Assume demand deposits and currency are pegged 1 to 1 thru the commercial banks, the fed sets the capital requirement at 10%, and the reserve requirement at 10%.

      I start a new bank by saving $10,000 in currency. There is $10,000 less in currency circulating. The equity of the new bank is $10,000, and the $10,000 asset of currency can be used to meet the reserve requirement. Someone gets a mortgage (loan) for $100,000. The $10,000 in currency can be used to meet the 10% reserve requirement, and the $10,000 in equity can be used to meet the 10% capital requirement. It is interest only with a 0% interest. That is unrealistic but will illustrate my point. This bank will hold the loan on its balance sheet (not sell it).

      The borrower spends the $100,000 in demand deposits on the house. Now there is $100,000 more in demand deposits circulating along with $10,000 less in currency circulating for a difference of $90,000. With 0% interest and interest only (no principal payments), the $90,000 in demand deposits stay in circulation. That can be price inflationary even though the demand deposits are backed by the loan/bond part because of the terms of the loan (mortgage).

      Delete
  7. The basic problem with helicopter money drops is that Friedman was more naive than Greenspan who believed fraud was impossible in a market so no one would buy vapor.

    In Friedman's case, he failed to imagine and economy like that of Qatar which is a great example of massive helicopter drops on 100,000 people by the rest of the world.

    The helicopter drops of cash are managed by the King who does not consume a lot of it, being wiser than Friedman, but instead imports goods and laborers to build stuff that will be used to generate income in coming centuries by enticing consumers to be imported to be served by imported workers providing services using the capital assets the King is effectively importing.

    The King is importing everything because the helicopter drop on Qatar means that distributing the cash to the 100,000 Qatari in helicopter drops means they do not want to work, so the helicopter drop by the world results in only imports of everything.

    Since Milton Friedman provided "authority" to Reaganomics which is better call free lunch pillage and plunder economics, government policy has been to drive up consumption by all sorts of helicopter drops like tax cuts to put more money in your pockets and Fed easy money policy and promoting financial deregulation so the shadow banks can spur consumption by helicopter drops on the middle class falling behind so they can spend far more than they can afford on imported goods. Friedman and Reagan thought that showering cash on the Persian Gulf dictatorships was a good way to increase consumption, while doing everything possible to cut wage incomes.

    We need to go back to the FDR policy that the focus is on jobs that build assets that will by their productivity will pay for themselves - debt is backed by productive assets created by real labor, not some ponzi scheme of price inflation.

    The Fed could simply buy new tax backed construction bonds at really great terms - buying water and sewer bonds with 50 year terms, for example. Water and sewer systems in the US in lots of cities are over a century old, so a 50 year term, repaying 2% per year at 0% interest would certainly have lots of water districts scrambling to rebuild problem plumbing. California would certainly jump on that to move, recycle, and store its scarce water. And those projects require lots of labor, a $1 of wage labor for every $1 borrowed in direct labor.

    ReplyDelete
  8. I have a dumb question. When the central bank creates reserves (or say pays interest on reserves) does that show up on its balance sheet? Would a helicopter drop show up on its balance sheet?

    ReplyDelete
    Replies
    1. Peter:
      Yes to both, on the liability side of the central bank's balance sheet.

      Delete
    2. Be careful with the phrase "bank creates reserves". The process is loans create deposits which create the need for reserves. Reserves at the central bank, are commercial banks' assets. If the DWP transfers a state pension payment directly to your "current account" say, then your Bank has a liability to you, it's your money. Your Bank does not have an asset to fund it (balance it out), until the Treasury makes a "reserves" deposit in your Bank's "current account" at the Central Bank.

      Have a look at https://www.youtube.com/watch?v=kAgNJNvDcu8&index=10&list=PLslyOrpjJ0z0rOnnJcr18eKSM9QlHvOyn

      Also the rest of the videos in this play-list. Particularly the one "Money Creation in the Modern Economy".

      Delete
    3. Would someone please advise me why my computer will not let me post on this site other than as "anonymous". I do have industrial grade security on my machine, it may be that, don't know?

      Delete
  9. "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. "

    Helicopter money is a policy tool or instrument. If heli's are performed by central bank independantly through issuance of emoney then it is monetary policy. If performed with cooperation of government then its fiscal.

    ReplyDelete
  10. Friedman might have coined the term "helicopter money" but Irving Fisher called it Santa Claus money long before -- see section 14 here http://en.wikisource.org/wiki/Stabilizing_the_Dollar/Chapter_2

    ReplyDelete
  11. The Fed just moves money from a savings account to a checking account. The Fed buys interest bearing securities (treasuries) in exchange for non interest bearing securities (reserves). It would be the same thing as your bank moving money from your savings account to your checking account. At the end of the day you still have the same financial wealth (savings+checking). When the Fed does it at the macro level the publics net financial wealth does not change. This is why QE has had no effect on the economy or inflation. If anything the public has less interest income which can be deflationary. Which is exactly what we are seeing. Only fiscal policy can change the net financial wealth of the public and stimulate the economy.

    ReplyDelete
  12. Is there a shred of evidence to support Ricardian equivalence? I.e. has anyone actually asked or surveyed households to find out whether they keep an eye on the money supply, etc. I find the whole idea unrealistic. I.e. I agree with Stiglitz who said "Ricardian equivalence is taught in every graduate school in the country. It is also sheer nonsense."

    ReplyDelete
    Replies
    1. Why does it have to be all or nothing. As a occasional visitor to Japan, I am sure that some Japanese are holding back spending a bit because they expect higher taxes in the future.

      Delete
    2. Ralph, there is no Ricardian Equivalence and there never has been, it is a neo-liberal myth perpetrated by legacy mainstream economists to please legacy political party politicians.

      Tim, the Japanese are holding back because they are expecting prices to drop in the future. Nothing to do with taxes other than they think that sales taxes may reduce back to where they were, when Abe works out that he f***ed up raising them with Abenomics.

      Delete
    3. Tim,
      From my limited knowledge of Japan, the Japanese might well be right to expect tax increases: that’s because of the influence of the political right which as in the West, doesn’t like to see money being showered on Main Street. But that’s different from possibility that Simon referred to above, namely that given a helicopter drop, the private sector will assume the drop will be reversed at some stage. I just don’t think the average small firm or household would recognise a helicopter drop if it stared them in the face.


      Delete
  13. Buiter is correct when he says "there always exists a combined monetary and fiscal policy action that boosts private demand".

    I’d take that further and abolish the distinction between monetary and fiscal policy: that is, I’d just have the state create new base money and spend it (and/or cut taxes) when stimulus is needed. That’s what Positive Money advocates and what most MMTers advocate far as I can see.

    ReplyDelete
    Replies
    1. Dont you see it as a conflict of interest for the state to print and spend as it sees fit?

      Delete
    2. Where's the "conflict"? If you're suggesting that having "monetary or fiscal action" necessarily means expanding the public sector, it doesn't. M/F action can take the form of expanding the PRIVATE SECTOR (if that's what the government of the day chooses to do) just as it can involve expanding the PUBLIC SECTOR.

      In fact Positive Money (and others) advocate a system under which a committee of independent economists decide on the SIZE OF the monetary/fiscal boost, while the exact WAY TO implement the boost (e.g. public versus private sector) is quite rightly left to the electorate and politicians. I fully back that system.

      Delete
    3. If you have an independent committee then you are making a distinction between monetary and fiscal it seems. Instead of giving to private sector like now the CB gives it to gov.

      Hopefully the politicians are accountable. Hopefully the committee isnt undermined like the congress was with its money creation powers.

      Delete
  14. The Ricardian Equivalence is 19th-century nonsense. The idea that if a government runs a deficit taxpayers save for future tax increases runs contrary to all evidence in first-world nations over the past 70 years.

    First one can apply the Churchillian Equivalence: the best case against democracy is spending 5 minutes with the average person talking about the issues. In other words, most people never heard of the Ricardian Equivalence. The only people who abide by the lame hypothesis are a tiny minority of neoclassical economists (who should've figured out, by experience, the idea is tripe.)

    Second, there's significant evidence government spending has a multiplier effect, especially in a slump. Not only does the borrowed money create equivalent GDP, the resultant economic activity creates economic spin off producing more GDP than what was spent. In short, one person's spending is another person's income, whether it's people or democratic government spending the money. Since the rich make most of the income they pay most of the taxes and most of the government spending. So government investments in social capital and physical infrastructure redistribute wealth, level the playing field, and better allocate scarce resources creating a stronger economy with higher GDP growth.

    Third, debt burden is measured in debt/GDP. So as the economy grows, the debt burden shrinks. In the post-war Keynesian era (1945-1980,) governments paid down most of their debts. Not by running surpluses equivalent to all the money they borrowed funding the world war effort that put debt/GDP over 100%, but with strong GDP growth created with strong government spending. The idea a fixed amount of borrowed money has to be paid back with a fixed amount of tax increases is based on ignorance which Ricardo could be forgiven for, but certainly not present day economists two centuries later.

    New Keynesians are about as Keynesian as neoliberals are liberal.

    The reason economics failed to launch as a science is because too many economists have flaky models based on ridiculous assumptions. If the future of civilization didn't hang in the balance, it would be no big deal. But the world is burning while little men and sociopathic oligarchs play games with the global economy.

    ReplyDelete
  15. If economists had any brains, they would be asking why trickle-down helicopter money has failed to work, not sing its praises. Neoclassical economics is like religion. Some people believe in the most absurd, irrational ideas. Other people use those ideas to gain wealth and power.

    ReplyDelete
    Replies
    1. I'm not that sure helicopter money (in the way SWL describes it here) has ever been tried (not in a controlled form anyway).

      Delete
    2. Those last two sentences are really the story of everything, ever. How the world works, distilled.

      Delete
  16. Yes, this is all fine, but what about the energy costs of the helicopters?

    ReplyDelete
  17. "... but the real world counterpart to [helicopter money] is a tax cut of some form."

    really? but tax cuts benefit most those who pay more of the tax in question. I thought a key idea was that helicopters reach everybody equally.

    ReplyDelete
    Replies
    1. Or even better, the helicopters reach those with the highest MPC?

      Delete
  18. Moniker: Hugh of the north

    Ralph: Agreed! (which shows how backward this blog is :-p just kidding ; but I think I may have to stop reading this one). To the people posting as anonymous, please add a name within your post!

    ReplyDelete
  19. Though it is not helicopter money, the model below enables to achieve inflation target under liquidity trap, without increasing government debt.

    The model works well relatively in the early stage after the burst of bubble.

    https://sites.google.com/site/newmonetarypolicy/

    ReplyDelete
  20. Interesting that instead of saying - QE did not do much for the real economy, lets do fiscal stimulus, you are advocating the same voodoo so that the central bank gets some of the credit from a fiscal stimulus. This Fed worship has to stop at some point so we can have a constructive conversation to get us out of this malaise instead of producing higher inequality through high unsustainable asset prices.

    ReplyDelete
  21. Helicopter Money is just the central bank running the printing presses and giving away the money. This is exactly the scenario the "group of 17" warned about. However, in this case it WILL lead directly to inflation. This is not like QE - which was the Fed buying up assets and giving banks the money - a supply side stimulus. The problem being that at the ZLB the money just sits in the bank because nobody out in the world needs to borrow it (insufficient demand). If the helicopter money is given to the poors then it will be spent and it will stimulate the economy.

    ReplyDelete
    Replies
    1. But in case you do HM when demand is severaly depressed and much below the economy's potential output, it will increase production and employment, not prices.

      Delete
    2. Very true. Although, getting some inflation would be beneficial overall because that would reduce the debt burden of households too.

      Delete
    3. Sure. My point is that HM, properly designed, would not create unnecessary inflation. Having said that, I agree that raising it eg from 0% to 2% in the Eurozone is precisely what the ECB is currently (and unsuccessfully) trying to achieve.

      Delete
  22. If any policy - helicopter drops, QE, whatever, increases the rate of growth in the future by just 1%, doesn't the wealth from that extra growth wipe away any conceivable problem ?

    So what if there is inflation; you have an exta 1% real growth/year, you can inflate as much as you want

    ReplyDelete
  23. If developed nations began to implement helicopter drop policies, would the rest of the world react by dropping all pretense of respecting the intellectual property rights of said nations?

    Would we actually see the building of the faux Apple stores and a lot more in China? Would this mark the beginning of the end of globalization (to be replaced by bi-lateral trade agreements).

    Would this in turn mark the beginning of the end of trade imbalances as systems would be in place to discourage large trade imbalances going forward? And large trade imbalances may no longer be needed as the world now has more than enough currency set aside in the way of foreign currency reserves.

    ReplyDelete
  24. [cannot comment with google account; let my name be Perlasca]

    This is the type of article which, to me, raises more questions than it answers.

    What it does is to equate its subject, helicopter money with something else, then lamenting whether that something else is indeed the same as helicopter money, then jumping onto an apparently unrelated subject without answering the former question, then adding a bit of esoteric theorising of the type one can ‘prove’ anything and its opposite with, before concluding… errr, in fact, not concluding anything.

    More concretely: points 1-4 are on the whole comprehensible, although they still leave me puzzled in three respects:
    1. It begins with stating heli money is fiscal stimulus, while most people would regard it as a monetary stimulus.
    2. Helicopter money targets everyone, while a tax cut only the active (tax paying) part of the population. Seems like quite some difference.
    3. Question of understanding: what would classical helicopter money do to the central bank’s balance sheet? The liabilities side would surely increase by the distributed amount with no corresponding increase on the assets side, so presumably it would lead to a (paper) loss for the central bank. That would have to be replenished by the state budget in order to preserve the central bank’s equity. Or not?

    Point 5 I simply can’t get my head around. Having read points 1-4, one assumes it will explain why the prima facie reasoning in point 4 (“would appear to be yes”) is wrong after all. Instead of this, it embarks on a new line of thought with apparently no relevance to the question in point 4; and stunningly the post never returns to answer that question.

    Point 6 elaborates on the notion put forward in point 5 by postulating a close link between M0 and inflation, which I thought is a highly discussed topic and a notion many central banks don’t actually sign up to. So it’s a bit strange it’s posted as evidence here.

    Points 8-9 are a shining example why the reputation of economics as a science has suffered so gravely. It starts with a notion (Ricardian Equivalence) so counterintuitive one would need massive historical evidence and huge amounts of empirical data for it to be taken seriously. The entire reasoning that follows then remains in the realm of arbitrary, pseudo-logical speculation which at no point touches anything with a connection to reality (evidence, data - that sort of stuff).

    The rest… seriously suggesting people will consider not spending their money due to anticipating a reversal of central bank balance sheet expansion… no comment.




    ReplyDelete
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  27. What if debt actually increases the value of money?

    See: Debt gives value to money

    ReplyDelete
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  29. The central bank could issue a credit card to every taxpayer with a credit limit of say $100K and modest interest rate (eg 2%pa) which a taxpayer could draw on at any time and repay in full or partially provided that if taxable income is say $100k or more, the tax office would collect 5% of income to repay any outstanding balance at each financial year. So the credit card would be a contingent loan similar to the student loan for higher education in Australia.

    If I am desperately poor without a job, this would be a great help. I could draw on the credit card to enrol in training or education while the economy is weak. Alternatively if I see an opportunity to invest, I could use the credit card to fund my investment. In any event, the availability of this credit card facilit would foster overall optimism in the economy!

    Just my suggestion.

    ReplyDelete
  30. The credit card limit could be reduced or increased by the central bank having regard to the state of the economy. Same for the interest rate on tags credit facility or the taxable income threshold for automatic repayments. All these parameters could be adjusted by the central bank with ease. No need for the government to identify "shovel ready" projects.

    ReplyDelete
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  32. The real problem with QE + helicopter money is that there is no influx continuum. QE is monopoly money without a real tangible value. Helicopter influx of money is a one-time deal. Borrowing to pay debt is a vicious cycle, no matter what you want to call it.

    ReplyDelete
  33. As a non-economist I find this post very confusing. Firstly you state the helicopter money is a fiscal stimulus. Surely, since it effects money supply it is a monetary stimulus. Can you explain why money creation is a fiscal stimulus, particularly when given into the hands of the general population.

    Secondly you say a real world equivalent is a tax cut. I don't understand why this is equivalent since a tax cut doesn't affect money supply, where as helicopter money does.

    ReplyDelete
  34. Why would issuing newly minted currency and giving it to people who will spend it in the economy involve "raising the inflation target"? The target has been above actual (CPI) inflation for a long time, so wouldn't it just be a policy action in the direction of the existing target?

    ReplyDelete

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