Debating Helicopter Money (while the lunatics continue to run the asylum)

Vox has published an excellent summary account of a debate between Adair Turner and Michael Woodford (skilfully moderated by Lucrezia Reichlin) on helicopter money. My line on helicopter money has been that it is formally equivalent to fiscal expansion coupled with an increase in the central bank’s inflation target (or whatever nominal target it uses), and so adds nothing new to current policy discussions.  I think the Woodford/Turner debate confirms that basic point, but as this may not be obvious from the discussion (it was a debate), let me try to make the argument here.

Two Equivalences and two Red Herrings

Turner calls his proposal ‘Outright Money Financing’ (OMF), so let’s use that term to avoid confusion with other versions of helicopter money. Under OMF, the central bank would decide to permanently print a certain amount of extra money, which the government would spend in a way of its choosing. The alternative that Woodford proposes is that the government spends more money by issuing debt, but the central bank buys that debt by printing more money (Quantitative Easing), gives any interest it receives straight back to the government, and promises to ‘never’ sell the debt. (If it reaches maturity, it uses the proceeds to buy more.) Let’s call this Indirect Money Financing (IMF). If everyone realises what is going on in each case, and policymakers stick to their plans, the two policies have the same impact.  That is the first equivalence, which both Woodford and Turner seem to be happy with.

In both cases, more base money has been permanently created. This will have implications for the inflation or NGDP level that the central bank attempts to achieve. If you believe that in the long run there is a stable relationship between the amount of base money in the economy and the price level, then permanently printing more base money must raise inflation for a time at some point. In other words, the central bank cannot independently control both base money and inflation. This leads to a second equivalence: we can either talk about long run levels of base money or average future levels of inflation: one is implied by the other. [1]

The point of either OMF or IMF is to combine short run fiscal stimulus with raising the long run level of prices. Sometimes advocates of helicopter money suggest that there is no reason for long run prices to be higher. However, as long as there is a link between how fiscal deficits are financed and the long run price level, to keep average inflation constant requires that money financing is temporary, so in that sense it is even closer to current Quantitative Easing. Much of the discussion below is relevant to that case too.

Now the red herrings. First, although Woodford argues in terms of nominal GDP targets rather than inflation targets, the distinction is irrelevant to this debate, if both targets are perfectly credible (see more below). Under both schemes the central bank has some form of nominal target, and its money creation has to be consistent with this. Second, this particular debate has nothing to do with the form of fiscal expansion: under Turner’s proposal the central bank decides the aggregate amount of OMF, but the government directs where the helicopter distributes its money, which could be over schools and hospitals, the population as a whole, or just tax payers.

How can the two proposals differ?

So if the two policies can be formally equivalent, where are the differences? The first point to make is that if the government and central bank were a single entity, there would be no difference at all. Under IMF the government would be selling debt to itself. So any difference has to involve the fact that the central bank is an independent actor.

The promise to raise future inflation to stimulate the economy today suffers from a well known time inconsistency problem. The promise works if it is believed, but when the future comes there is an incentive to go back on the promise. So how likely is it that the central bank will take that incentive? Using the second equivalence noted above, let’s talk about the central bank going back on its promise to make money creation permanent. One argument for OMF is that it may be easier for the central bank to do this if it can just sell some of its government debt. On the other hand, if the only way of taking money out of the system is by persuading the government to raise taxes (or cut spending), that seems less likely. Thus OMT is a commitment device for the central bank not to renege on future inflation targets which sophisticated agents may recognise. This argument seems a little tenuous to me, as it assumes that OMF takes place to such an extent that the central bank in effect loses the ability to raise short term interest rates sufficiently to control inflation. I cannot see any central bank willingly undertaking this amount of OMF.

On the fiscal side, agents may base their assessment of future tax liabilities on the published government debt numbers, and fail to account for the additional future revenue the government will receive from the central bank as it passes the interest on its debt back to the government. Here agents are sophisticated enough to base their spending plans on an assessment of future tax liabilities, but naive about how these liabilities are calculated. Possible I suppose, but then the government just needs to start publishing figures for debt held by the private sector excluding the central bank.

A naive government may feel constrained by its fiscal targets and so feel it is unable to undertake bond financed fiscal stimulus, but may be prepared to contemplate money financed fiscal stimulus. That seems quite plausible, until you note that under the second equivalence above, any switch from bond to money financing that was not reversed should be coupled with a temporary increase in the central bank’s inflation target.  A temporary period of OMF that was later undone would not raise average future inflation, but it would equally do nothing to change long run levels of debt either. In that case surely everyone would just start counting OMF as (soon to be) debt.

Turner argues that OMF would discipline governments more than IMF, because central banks would determine the amount of OMF. This argument also seems strained. For example in the UK, where the government sets the inflation target and we have Quantitative Easing, the problem is that the government is borrowing too little, not too much. Woodford worries that OMF blurs the lines between who take fiscal and monetary policy decisions, which is why he prefers IMF. However if the government decides how OMF is spent, and retains control over aggregate borrowing, it is difficult to see the force of this argument.

So I think OMF and IMF are pretty well equivalent. As I’m in favour of IMF (fiscal expansion and more future inflation), then this implies I am in favour of OMF.  If my earlier posts have appeared critical, I think that is because some proponents of helicopter money seemed to deny the equivalence to IMF. However, if pretending that helicopter money is monetary rather than fiscal policy could convince some policymakers to change course, maybe the end justifies the means. Unfortunately Eurozone consolidation continues unchecked, the UK government brushes aside advice from the IMF to relax austerity, and the US recovery is dampened as sequester bites. The intellectual case against austerity is overwhelming (beside the Krugman piece I mentioned in my last post, see also Martin Wolf here), more and more academics are suggesting we need higher inflation (to take just five: Mankiw, Rogoff, Krugman, Ball, Crafts), yet only Japan has been moved to change course. The lunatics and asylum jibe is of course unfair, but just how long will it take policymakers to start addressing the problems of today, rather than the half imagined problems of the past.

[1] Some comments on earlier posts have disputed this point. There is not space to discuss this here, as we need to consider not only the detailed mechanics of monetary policy but also the nature of money itself.  Obviously if the long run price level is really independent of how deficits are financed, then much of the discussion here becomes unnecessary.

What do people mean by helicopter money?

Following a speech by one of the front runners to replace Mervyn King as Governor of the Bank of England, there has been renewed talk about helicopter money. Helicopter money involves the central bank printing money, but that in effect is what Quantitative Easing (QE) does, so what is different about helicopter money? There seem to be two rather different things that people might have in mind.

The first difference is where the money goes. QE, in the UK and to some extent in the US, involves the central bank printing money to buy government debt. Helicopter money is like the central bank sending a cheque to everyone in the economy. The second difference is whether the creation of new money is permanent or temporary. QE, if you ask central bankers, is temporary: when the economy picks up and there is the first sign of inflation, QE will be put into reverse (except, just maybe, in the US). Helicopter money is thought to be permanent: the central bank is sending out cheques, not loans.

Let’s take the permanent/temporary issue first. As I have argued before, calls for money creation to be permanent are in effect calls to increase inflation above target at some time for some period. The reason why most people believe QE is temporary is because (with the possible recent exception of the US Fed) central banks are sticking firmly to their inflation targets. There may be very good reasons why central banks should instead allow inflation to exceed those targets as the economy recovers. But if this is the issue, why not just call for higher inflation? Surely it makes sense to be explicit about what is trying to be achieved, particularly as the benefit involved in higher inflation for the real economy comes from increasing inflation expectations. We gave up money targets long ago, and quite rightly so. For the central bank to destroy some proportion of the government debt they now own and just hope this gave them the amount of extra inflation they desire would be like going back to money targets.(1)

The first issue, of where the money being printed is going, is more interesting. It reflects an understandable view that it would be better to print money and give it to consumers who would spend it (helicopter money), rather than using it to buy government debt (QE) which may reduce long term interest rates which may help stimulate the economy. The second route has been tried and has not been that successful, so why not try the first route?

It is useful to think about the circumstances in which the two routes are exactly equivalent. To focus on this, let us assume helicopter money is temporary: the central bank sends out cheques, but the government says it will get the money back in a few years time by raising a poll tax. (This is like the proposal from Miles Kimball.) If consumers are Ricardian, they will save all the amount of the cheque, because only by doing so can they pay the future poll tax without cutting their consumption. How will they save the money? Let us suppose they buy government debt. Then this is exactly the same as QE, except that consumers hold government debt temporarily instead of the central bank. This seems to be what David Miles had in mind in the speech that Stephanie Flanders refers to here, when he says: “If helicopter drops of money are reversed when their impact shows up very largely in prices and not in activity, the economic difference with conventional QE largely evaporates.”

Yet we can now see why in reality the two may not be equivalent, because consumers may not be Ricardian. In particular, some may have been asking their local bank for a loan to buy a car, and the bank had refused because it has become very risk averse since the crisis. For these credit constrained folk, the central bank’s cheque is just like the loan they couldn’t get. So they use the cheque to buy the car, and reduce their future consumption to pay the poll tax later. Instead of buying government debt, they have bought something real, which will increase aggregate demand for sure.

If this is the reason people call for helicopter money, then I have a lot of sympathy but only one problem:  what difference is this from an expansionary fiscal policy combined with further QE? Instead of the central bank sending people cheques, the government can send the cheques using money borrowed by selling debt, and the central bank can buy the debt by printing money (i.e. QE). In this sense, helicopter money is just another name for a fiscal stimulus combined with QE. We have the QE, so why not call for fiscal stimulus rather than helicopter money?

 (1) There may be a case for announcing (in some form) higher future inflation, and then destroying the debt, because that commits the central bank to higher inflation. What does not make sense is to destroy the debt and pretend you are not going to increase inflation at some point.