Winner of the New Statesman SPERI Prize in Political Economy 2016

Wednesday, 27 May 2015

Why helicopter money is a political economy issue

When we have a recession caused by demand deficiency such that interest rates hit their Zero Lower Bound (ZLB), the obvious response from a macroeconomic point of view is fiscal stimulus. Instead governments have become obsessed by their debt and deficits, and so we have austerity instead.

It is important to understand that this deficit obsession is not a worry about the long run sustainability of government finances. We know this for two reasons. First, if it was only a concern about long run sustainability, there would be little need to act on that concern now (when doing so is so costly), rather than waiting a few years for the ZLB problem to be safely behind us. Indeed, governments should be worried that austerity now could actually damage long run sustainability, because of the hysteresis effects examined by DeLong and Summers (pdf, and note that their arguments could equally be applied to the impact of cutting back public investment even if there was no hysteresis). Second, governments seem happy to cut current deficits using measures that actually detract from long run sustainability (because it worsens their intertemporal budget constraint). Privatisation at give-away prices is an obvious example.

This political economy point is important, because it means that ideas such as Miles Kimball’s alternative to tax cuts - which is to give everyone a fixed period loan - will not be considered because it still increases the current budget deficit, even though long run sustainability is potentially unaffected. The political economy problem is that governments are obsessed with the deficit over the next few years.

From a macroeconomic point of view, there is an obvious way around this deficit obsession, and that is to finance any fiscal stimulus using money rather than debt. In a recession creating money does not create an inflation problem, as we have all seen in the last few years with Quantitative Easing (QE). The problem with this textbook solution (often called money financed fiscal stimulus) is that we have ruled it out by creating independent central banks. Governments cannot create money to finance fiscal stimulus. Central banks are creating money - lots of it - but can only use that to buy assets. Whatever political economy problem independent central banks have helped to solve, they have restricted our policy options in what has turned out to be a very serious way.

Helicopter money is the obvious solution to this. But it raises a potential problem. Helicopter money describes a means by which central banks can put money into the system in an effective (reliably demand expanding) way, but that process is not reversible. No one is proposing that a central bank can take money away from every citizen. So what happens, once the recession is over, if the central bank wants to reduce the amount of money in the system?

This, as Eric Lonergan and Cecchetti & Schoenholtz explain, is the only reason why the central bank’s balance sheet matters. If it runs out of assets to sell, its ability to take the money out of the system that it put in with its helicopter is reduced. This problem is not new. It has already occurred with potential losses arising from QE. In the UK, the central bank has dealt with that problem by getting the Treasury to cover these losses, if they arise. There are many things that the central bank could do if it ever runs out of assets to sell as a result of implementing helicopter money, but the most straightforward is to generalise this arrangement. Governments should commit to providing central banks with the assets they need to control inflation.

Making ‘fiscal backing’ of central banks explicit also indicates a contingent liability for governments. Helicopter money creates a contingent liability, and in doing so worsens the expected value of their long run budgetary position. But as we have seen, this is not the major concern for governments. The UK government did not object to QE because it created a contingent liability for them. All that mattered is that it did not raise projected deficits over the next few years.

While Eric Lonergan says central banks need not worry about their balance sheets, Cecchetti & Schoenholtz say that they are right to do so, for political rather than economic reasons. A poor balance sheet, which might make the central bank dependent on the government, compromises its independence. I think this argument is very weak. It imagines that central bank independence is about protecting the public from a government of nightmares that actively wants high inflation. As I argued here, a government that wants high inflation will not let an independent central bank get in its way. It is also ironic that central banks still worry about profligate inflationary governments when our problem is governments that put current fiscal probity above everything else, including the health of the economy. The combination of a government that is obsessed with its current deficit and a central bank that is obsessed with hypothetical future inflation is a dangerous mix. 

53 comments:

  1. If the central bank does the heli's independently it can bypass the budget and fiscal constraint concerns. Independent heli's should have greater impact on spending because people wont expect greater future taxes to pay back the heli's.

    If the central bank is issuing financial assets to its constituent then these should be recognized as equity not a liability eliminating central bank balance sheet concerns.

    If your worried about accountability make the central bank leaders publicly elected. No one is worried about central bank accountability when it conducts OMO's, QE or rate targeting but people are concerned when the central bank interacts with the people for some weird reason.

    Reducing money in the system would create deflation. Don't understand the concern with reversing heli money. Historically the money supply is always growing. If temporary contractions in money are required following heli's these can be done through security issuance by the central bank. Other permanent means of effectively permanently contracting money also exist but permanent contractions of money are unprecedented and unnecessary.

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    1. ".. because people won't expect greater future taxes to pay back the heli's. "

      Maybe people will expect future taxes, especially if the government is expected to bail out the central bank.

      There's a danger that a "prudent" government could decide to tax the helicopter money out of existence - cranking up tax rates until all the helicopter money is in the government's accounts.

      Instead of central-bank monetary funding of government spending, we would get central-bank monetary funding of government hoarding.

      How does the central bank ban the government from doing this?

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    2. Why would the government need to bail out the central bank? The central bank owes money to no-one. An accounting trick can fix the balance sheet problem.

      You hit the nail on the head of the problem with the current QE. Because it is assumed to be temporary then the government can point to a 90% of GDP debt and say that austerity is necessary.

      If the debt were officially written off then the government would have no such excuse and would have to face responsibility for its poor running of the economy.

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    3. I think we should put to rest the Ricardian "people will expect greater future taxes" argument. Just ask yourself who decides on his spending with this kind of considerations.
      Actually, people who could logically expect higher future taxes (the very rich - marginal rates are historically lows) are so not liquidity-constrained that money is just a means of keeping score. Why would they take account of possible future taxes to decide to spend?

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    4. Cyrille Viossat, there is a psychological and neurological question to be considered: what drives the rich to become rich?

      Many of the rich started off very poor and having money meant you ate; if your money reduced in any way you ate less or less well. This creates a linkage in the brain that generates Dopamine (the 'a reward is now coming to you' hormonal neurotransmitter) when these people feel they are making money, and Cortisol (the stress hormonal neurotransmitter) when their money is reduced. The landowning rich may never escape the feeling of being poor, even though they are sitting on assets worth millions; they just happen to generate little or no income.

      In any case, they learn that if they make more money they can expect more rewards. For them money is less a means of keeping score, more it is the buzz they get from that dopamine that keeps them seeking more and more wealth, and they want to avoid the Cortisol low they get if anyone or anything reduces their money. They are not acting logically but since dopamine works on the same brain circuitry as cocaine they are just addicted. So, the rich will fight anything that they imagine will reduce their wealth. It is the only thing they know that keeps that hungry feeling quiet in them. No matter how rich they become, they will not be content or happy they have enough.

      Because of all that, they will spend now to avoid future taxes, which is why so many rich people financially support the right wing parties as they are seen as the tax cutters. Even though they are spending money, they see it as bringing or protecting more in the future so they get a buzz from that too.

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    5. CMA,

      I agree with your “security issuance by the central bank.” I think SW-L actually suggested that (if I understand him correctly) but his language was a bit obscure.

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  2. It is not necessary to reverse the helicopter money. Instead of removing central bank money from the economy, the bank could raise interest rates and thus reduce the amount of private sector debt; removing private money from the economy instead.

    The ratio of private money to central bank money is extremely high and reducing it does no harm.

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    1. This is what I was thinking. The central bank could raise rates off the ZLB to fight inflation. As with QE, it could keep assets on it balance sheet indefinitely or sell some eventually if it wants to. There's no rush.

      Of course if I was in charge, I would push forward with Keynes's "euthanasia of the rentier" and keep interest rates near zero. As Piketty has shown, historically the rentiers still get their 5 percent somehow no matter the official rate and so we'd need more rules and regulations to push the unofficial rate down to zero also.

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    2. Ari,

      Private sector debts won’t come down in a hurry just because interest rates are raised: the average mortgagor doesn’t have tens of thousands to spare to pay of a big chunk of their mortgage. Second, what’s the problem with debts? One of the main problems is the interest people have to pay. If you raise interest rates, that problem is exacerbated.

      Third, interest rate adjustments are distortionary: they change loan based economic activity but not non loan based activity.

      All in all, interest rate hikes are not a brilliant solution, though I wouldn’t rule them out as an emergency measure.

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  3. I wonder if someone will do a analysis of how much has been lost be having an independent central bank since the late 1990s in the UK, given the restriction it has placed on appropriate stimulus since 2008, and given that a little inflation in the 2000s would not have wiped off as much output as the crash and failed recovery has?

    Perhaps an ugly, media-catching figure of lost money would put pressure on the BoE to act more responsibly.

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  4. I guess if the timing is right, the central bank buys assets at relatively low prices (just after the crash) and sells them at high prices (once the economy has recovered). So balance sheet problems shouldn't occur. There might be a problem if QE is undertaken sort of too late and the financial economy has already recovered while the real economy has not. This requires a finance sector that is significantly unhinged from the real economy, but some countries are getting there or are already there, for example, the UK.

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  5. The BoE has instrument independence to meet an inflation target set by treasury and approved by parliament. Assuming this is indeed de facto independence and was intended to prevent politicians using monetary policy to engineer economic cycles that favoured sectional electoral interests over the general economic good, what then happens if very low interest rates become entrenched as Kalescki predicted http://www.interfluidity.com/v2/3451.html
    Monetary policy would collapse into fiscal policy and governments would once again be free to manipulate economic growth for electoral advantage by imposing fiscal repression and then relaxing it towards the end of the fixed term parliament. Why then would they ever allow a helicopter style proposal to get off the ground. At least before the Bank of England Act 1998 the public knew who to hold accountable. We should repeal the act and throw Milton Friedman out of a helicopter.

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  6. When CB-held bonds are redeemed by the issuer, who gets this redeemed money? Does this convert all such CB purchasing into helicoptered money?

    In the US, I assume they will offset the huge sums (Treasury's obligation to redeem is erased at the same time the FED's asset is erased) - turning the positions into helicoptered money, but lagged by the maturity period of the instruments redeemed.

    It is a little nuts. But the US Treasury can't "sell" direct to the FED, so the traders gain on both sides of the bond's purchase and sale to the QEing CB (note: the freshly created CB money simply replaces the money the initial buyers just gave to Treasury) while the govt's financial positions wait to be converted, by offset, to being helicopter money 5 years later.

    JF

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  7. Running out of assets to sell does not prevent a Central Bank from taking cash out of the system. It can simply create and sell its own debt instruments. Bills issued by the National Bank of Poland are a contemporary example.

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  8. Your 31 Dec 14 post "on the stupidity of demand deficit stagnation" brings to mind the institutional framework of the less-than-benevolent CCP - yet economic growth in China continues to slow. Granted China has supply side excesses, but so did the US and southern Europe. Today China has high and rising debt, low and falling interest rates and a dot-com stock market - are these indications of a successful macro policy?

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    1. The trouble with the CPC is that many of the current economic experts are now western trained. Maybe SWL has taught some of them. If the worst happens in China many of them will have dusty unopened copies of Marx close at hand which they can fall back on. China can always run much closer to full capacity if they want because they don't need to use economic policy to control the population. They have the PLA for that.

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  9. There will be no helicopter money.

    SWL's thesis is that the Government/BoE knows the economy is demand constrained but cannot sanction a fiscal expansion because it must pay lip service to the mad household finance model of a sovereign nation.

    It's worse than this, they don't think the economy is demand constrained.

    Institutional continuity will prevent the BoE from doing this anyway.

    Offering helicopter money to the BoE is like giving a mobile phone to man with a wet blanket and a fire. He will look at the mobile phone and say how do I send smoke signals with this, then throw the mobile phone on the fire.

    Thats it fartig

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  10. "Why helicopter money is a political economy issue"

    It isn't.
    Leave off.

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  11. The obvious solution is for the central bank to buy bonds directly from the treasury.

    The "drop" is then distributed from cash in the treasury account at the bank. And the bank has the asset to sell as necessary.

    The entire idea is so far fetched relative to usual institutional arrangements that this would be a relatively realistic operational arrangement in that context.

    It is absolutely inconceivable that a central bank would do a "helicopter drop" absent coordination with the treasury function.

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    1. JKH,

      Good points. The only “matter arising” from that is: who’s in the driving seat – CB or Treasury? If your answer is CB, then you’re advocating the system suggested by Positive Money, Richard Werner and the NEF in their submission to Vickers.

      If your answer is “Treasury”, then you’re saying the country’s finance minister / politicians should have access to the printing press. I don’t view the latter with quite the same horror as some do, but I certainly prefer making access difficult. So I prefer the former “CB in the driving seat” option. Although any old committee of economists would do (as pointed out in the above Vickers submission). It doesn’t necessarily have to be CB based.

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    2. Ralph,

      I don't have a good answer to that question.

      But my instinct is that it should be Treasury.

      It's a sort of institutional strategy variation on the banking system rescue of 2008, where Treasury took the lead on solvency, but the Fed steered the full liquidity facilitation alongside. On the original TARP, Paulson was in the lead and Bernanke was in the room.

      Real time "money financing" of deficits is a fiscal operation - a different liquidity channel for what in fact is a deficit strategy. It's a deficit strategy because there is no guarantee that there won't be a future interest expense in respect of the money that is created. Interesting bearing reserves are a special kind of bond in that sense.

      And whatever the competence of politicians, they need to be involved at some level in deficit strategies.

      “Money financing” is an alternative to bond financing. The choice of strategy should be driven top down. Better to formulate and implement strategy by coming in through the front door – rather than the basement window.

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    3. JKH,

      “And whatever the competence of politicians, they need to be involved at some level in deficit strategies.”

      The authors of the above Vickers submission wouldn’t agree with that, and I think they are right. Under their system, politicians have no say WHATEVER in the SIZE of a stimulus package. That’s left to a committee of economists. In contrast, politicians retain control over the obviously political stuff like what proportion of GDP is allocated to public spending.

      And in fact that split of responsibilities already exists in the US and UK: that is, the central bank has the ultimate say on the amount of stimulus in that it can override stimulus decisions by politicians by adjusting interest rates, QE, etc. Indeed market monetarists have a name for that ultimate power of central banks: they call it “monetary offset”.

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  12. The last "dangerous mix" line is what we'll get in the US if Republicans win the White House. That and a couple wars.

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  13. One more note: Austerity, in the US at least, is such a fraud. It has nothing to do with fiscal probity. It's about srhredding the safety net. Moreover, it's about sticking to the poors aka dark skinned people. The right rides here on paranoia, racism, and resentment. The Ryan budget was a fiscal charade.

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  14. If the government pays everyone a "living wage" as suggested by Tony Atkinson, the central bank could have a role in setting the level of the living wage from a macroeconomic perspective. This seems politically plausible to me. The living wage (funded by Teasury) would also serve as a macroeconomic tool. Just my suggestion.

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  15. "The UK government did not object to QE because it created a contingent liability for them. All that mattered is that it did not raise projected deficits over the next few years."

    So what's the difference if the central bank buys bonds directly from the government?

    It's a contingent liability only if bonds held by the central bank are not counted as part of total debt. They get "counted" if they are sold or if they are matured and rolled over in QE exit.

    If they are, the liability is already accounted for.

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  16. And if the central bank does helicopter drops without buying bonds from the government, it blasts a negative equity hole in its balance sheet.

    The central bank balance sheet is set up to reflect the essential nature of the bank's operations, including the element of "independence".

    The purpose of accounting is to keep track of stuff. That balance sheet hole may arouse some curiosity.

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    1. issuing financial assets (money) to your own constituent (people) means you are issuing equity not liabilities

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    2. Existing and announced QE exit plans disprove that

      QED by reality

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    3. How did you go from issuing money to ppl recognized as equity to QE exit plan? I dont get the connection.

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    4. The context was that the central book could do helicopter drops by purchasing bonds directly from Treasury, crediting Treasury’s account with the central bank, and distributing “the drop” from that account. That way, the central bank has the bonds to sell along the lines of the “contingent liability” referenced in the post.

      From a balance sheet perspective, that situation is no different than QE. The central bank holds bonds offset by bank reserves in both arrangements. And the nature of the “contingent liability” is the same in both circumstances.

      In other words, the “contingent liability” aspect is not unique to helicopter drops (when HDs include direct bond purchases).

      When the government runs deficits, the private sector accumulates financial assets. That holds whether those assets are bonds or money. And it’s a government liability in both cases because there is no guarantee that the central bank won’t have to pay interest on reserves created in the money case, sometime in the future. That’s a contingent fiscal cost. And if monetary policy is successful in its long term goal, interest rates will rise and there will be a future fiscal cost.

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    5. Yes in the case of conventional heli's thats true. It is also possible for the central bank to conduct the heli's without purchasing bonds and recording the newly created money as equity instead of liab on its BS. This will eliminate the BS problem.

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    6. no that's not possible - that's fantasy accounting

      HDs without assets create negative equity for the CB balance sheet

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    7. A financial asset may be recorded as equity or liab. If it is issued to the constituent then equity is a more accurate recognition. The BS of the central bank is largely fiction.

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    8. as I said, deficits increase the income/saving/wealth/equity of the private sector holders of the financial claims created by deficits - money or bonds

      and it doesn't matter if its money or bonds, the only difference being the liquidity characteristic of the claim

      that is not the same thing at all as central bank equity

      its a liability to the government/CB and an asset to the private sector

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    9. Money is asset to the private sector. Like any other financial asset it may be equity or liability from point of issuer. Since its issued to constituent and there is no specific liability such as capital and interest payments M is better recognized as equity.

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    10. U, what about zero interest bonds? How close does the interest rate be to zero to create 'money'?

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  17. If helicopter money is (by definition) permanent, then why doesn't it (eventually) cause a permanent increase in the price level, and thus (eventually) cause a (temporary) increase in the inflation rate?

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    1. 1) I'm not sure "permanence" has meaning in the context of cash payment from CB financed by base money. Analogy with tax cuts not perfect. We simply don't know future demand for reserves, and reversal may entail tax on banks (higher reserve requirements). 2) if supply endogenous, future inflation lower and no need to raise taxes, 3) constant reserves multiplier likely positive, so no need to reverse.

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    2. Nick. It may, which is why central banks has to have the means to reverse the helicopter drop. Maybe it could avoid this by forcing banks to hold reserves as Eric suggests, but it should also be able to ask the government to do it for them by giving them the assets to shrink the money supply (because required reserves may be a rather inefficient tax).

      If you think about what is going on here, HM it is a tax cut which is eventually financed by borrowing (when the government recapitalizes the CB), but temporarily by creating money. What's the point? Simply to get around the governments reluctance to increase in deficit in the short term. That is really what the point of the post is.

      You may say - why will governments be happy to increase deficits later but not now? Again political economy: they dislike deficits, but they dislike inflation even more, so they will never say no to the CB.

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    3. It is also worth bearing in mind, that post-financial crisis it seems reasonable to expect persistently higher demand for reserves - induced both by regulatory changes and shifts in private sector preferences (bank shareholders will require higher liquidity ratios). As monopoly provider of liquidity, this is a fiscal free lunch. Arguably we have already seen this. Mervyn King argued that the gilts bought by the Bank under QE should not be "cancelled", even in accounting terms, arguing that the increase in reserves was "temporary". What if it is not temporary? After all, 7yrs later and the Bank is still remitting interest payments to the Treasury.

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    4. A final point re the comparison of cash payments from CB and tax cuts. I do think it is reasonable to defend the principle that base money should controlled by CB. Cash transfers are under the control and initiative of the CB subject to an inflation-target. Helicopter money is a broad set of options, in which the CB could be subservient. My point about reserves is recognition that the CB has "tax" raising powers within conventional tools. This may be more relevant to ECB. The ECB, intiguingingly, has the power to compel member states to increase its capital - although I'd be interested to know if anyone knows what form this takes ...

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    5. NR, the economy may well quantity not price expand.

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  18. So if the Inland Revenue allows me to pay my tax bill with £1000 notes that I print-off on my desktop, everyone is happy.
    Excellent.

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    1. It's all printed. All of it. To the penny. There are no existing Govt sector liabilities that were not printed. The question is, whose balance sheet for political reporting purposes.

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  19. Excellent post; but unfortunately not on the agenda for IMF/G20 discussions this fall due to Merkel's and Cameron's insistence on debt brakes and balanced budgets; just tragic!

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  20. Simon - would be very interested to get your thoughts on reserve requirements. I think they are analogous to raising taxes - although the burden initially falls on the banking sector (but eventually would result in a repricing of credit).

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    1. Eric - see my reply to Nick Rowe above.

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  21. No. The obvious monetary response to short term interest rates being at the zlb is to start buying longer and longer trim assets until their ptice level or price level inflation plus unemoyment or NGDP is bank at its target level.

    The obvious fiscsl.policy is to invest in projects that have positive NPV at the lowered borrowing cost as this will raise gdp and lower the debt to gdp ratio.
    For political reasons neither of these obvious policies were imemented.

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  22. In addition to SW-L’s basic justification for helicopter funding of fiscal stimulus, there is another, and I think more fundamental and very simple reason, as follows.

    As distinct from having the state borrow AND spend, the simple act of borrowing is deflationary. Now what in Earth is the point of doing something DEFLATIONARY when the object of the exercise is the opposite, i.e. “reflationary” or stimulatory? That makes as much sense as the fire brigade throwing petrol on a fire before squirting water on it.

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    1. No, Ralph bonds provide more interest income. They are inflationary compared to "printing money."

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  23. As this is far from conventional, might might the UK be seen as simply trying to print its way out of its debts. Perhaps rightly, people would perceive a serious reduction in the value of Sterling and the currency would suffer. Do you think this is a credible danger if such a policy was implemented?

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  24. I came across this by Professor Soll and wondered if you have a view on it's content?

    Greece's National debt is 18% of GDP not 175% so what is Germany's - it's actually 46% of GDP! How can this be.

    Germany omits using the Ipsas standards, similar to those used by leading governments, multi-nationals, banks and investors.
    That means that Greece’s debt situation is better than that of Germany’s!


    So why doesn’t Germany use Ipsas to calculate the Greek debt? For two reasons, according Professor Soll. First, they don’t apply Ipsas in their own House.“A little-known fact is that the Germans also do not use Ipsas and have notably opaque public finance standards,” he writes.

    Second, by steering away from Ipsas, Germany can keep Greece on the leash while conveniently keeping Greek debt off its own books.

    “One reason might be that the Germans have refused to price the debt fairly, or properly report its value, which means in the short run that they extract more austerity from the Greeks than they should, and that they also keep this loan off the budget balance sheets because it would come up as a loss under any legitimate accounting standard,” writes Professor Soll.

    There’s a third reason. Overestimating sovereign debt for Southern European countries stirs anxiety in foreign currency markets, depressing the Euro, and firing up Germany’s export engine.

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