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.