Helicopter Drops of Money Are Not the Answer

Among major news outlets with a print component, I am happy to say I have had occasion to praise negative interest rate reporting in the Wall Street Journal and in the Globe and Mail:

Unfortunately, Negative Interest Rate Reporting is Still in the Dark Ages at the Economist

The subtitle for the cover story for the February 20-26, 2016 Economist states their overall take quite clearly: 

“The World Economy: Out of ammo? Central bankers are running down their arsenal. But other options exist to stimulate the economy”

To give a further sense of that take on things, here are some key passages from that article:

One fear above all stalks the markets: that the rich world’s weapon against economic weakness no longer works. Ever since the crisis of 2007-08, the task of stimulating demand has fallen to central bankers. … 

… Despite central banks’ efforts, recoveries are still weak and inflation is low. Faith in monetary policy is wavering.

In this article, negative interest rates are dismissed with this one sentence:

Negative interest rates in Europe and Japan make investors worry about bank earnings, sending share prices lower.

(On negative interest rates and bank earnings, see my posts “How to Handle Worries about the Effect of Negative Interest Rates on Bank Profits with Two-Tiered Interest-on-Reserves Policies” and “If a Central Bank Cuts All of Its Interest Rates, Including the Paper Currency Interest Rate, Negative Interest Rates are a Much Fiercer Animal.”) 

The one other appearance of the word “negative” is in simply remarking

Borrowing has never been cheaper. Yields on more than $7 trillion of government bonds worldwide are now negative.

The Economist is wrong to dismiss negative interest rates. Indeed, I think the Economist will be unlikely to continue to dismiss negative interest rates as a powerful policy tool once one of their reporters takes the time to interview me, as they may sometime soon.

In the related article in the same issue, “Fighting the next recession: Unfamiliar ways forward–Policymakers in rich economies need to consider some radical approaches to tackling the next downturn,”the Economist says several negative things about negative rates without a change in paper currency policy, ignores the now well-heralded possibility of a negative paper currency interest rate (see how to deftly achieve a negative paper currency interest rate at the links in “How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide”) and has this to say about negative interest rates with the alternative paper currency of abolishing paper currency:  

Since the existence of cash is a limit on how low interest rates can go, Andy Haldane, the chief economist of the Bank of England, and Ken Rogoff of Harvard University have proposed abolishing it altogether. But even if such radicalism were to prove feasible in a few countries, its effects might be limited. Savers would find alternative stores of value, such as precious metals or foreign banknotes, or pass on the cost of having money in the bank to others by making payments early.

The Economist, like John Cochrane (1, 2), is totally wrong about this. As my brother Chris and I point out in “However Low Interest Rates Might Go, the IRS Will Never Act Like a Bank,” it is almost impossible for anything but an unlimited opportunity to lend to the government at a zero interest rate to create a zero lower bound either or both because 

  1. most possible assets have a fluctuating price and therefore cannot provide a safe return, nor is there anything to prevent the price being big up high enough to generate a negative expected return, and  
  2. all other opportunities to earn a zero interest rate in a negative interest rate environment would be exhausted long before investors had found a home for all of the assets they wanted a safe zero interest rate for.

And as for foreign assets, as I discuss in “Could the UK Be the First Country to Adopt Electronic Money?” the desire to purchase foreign assets when domestic assets are earning a negative return is part of the transmission mechanism, since it induces capital flows that in turn generate additional net exports. This is a feature of negative interest rate policy, not a bug. And in any case, it is not a concern for the world as a whole, to the extent the world as a whole turns to negative interest rates. 

The Economist Turns to Fiscal Policy

Instead of monetary policy, the Economist looks in important measure to some form of fiscal policy to provide economic stimulus, writing

The good news is that more can be done to jolt economies from their low-growth, low-inflation torpor (see Briefing). Plenty of policies are left, and all can pack a punch. The bad news is that central banks will need help from governments. Until now, central bankers have had to do the heavy lifting because politicians have been shamefully reluctant to share the burden. At least some of them have failed to grasp the need to have fiscal and monetary policy operating in concert. Indeed, many governments actively worked against monetary stimulus by embracing austerity. 

I am not so positive about fiscal policy. In “Narayana Kocherlakota Advocates Negative Rates and Criticizes the Conduct of US Fiscal Policy,” conscious of the power of deep negative interest rates to stimulate the economy, I write:

I tend to think that monetary policy should be used to stabilize the economy, not fiscal policy. Once monetary policy does its job, if the medium-run natural rate of interest is still low, then we should undertake more government investment. (See “The Medium-Run Natural Interest Rate and the Short-Run Natural Interest Rate.”) And we should undertake crucial government investments even if interest rates are high after the economy recovers. But it is just too hard to time government investment effectively in order to stabilize the economy.

Monetary policy has a lag of 6 to 12 months in its effects. Even so, it is much nimbler than government investment. Private investment and imports and exports can’t turn on a dime; hence the 6 to 12 month delay in the effect of monetary policy. But government investment typical takes even longer than that to turn around.

Using monetary policy as it should be used, aggregate demand is no longer scarce. Monetary policy can provide all the firepower needed.

Why Helicopter Drops Big Enough to Make People Think that the Government Will Go Bankrupt Unless There is Massive Inflation are Not the Answer

The Economist has a long list of policy prescriptions, among which using deep negative interest rates (combined with an appropriate paper currency policy) is conspicuously missing. But among all of the policy prescriptions, a helicopter drop of money takes pride of place as the first to get a full paragraph treatment:

The time has come for politicians to join the fight alongside central bankers. The most radical policy ideas fuse fiscal and monetary policy. One such option is to finance public spending (or tax cuts) directly by printing money—known as a “helicopter drop”. Unlike QE, a helicopter drop bypasses banks and financial markets, and puts freshly printed cash straight into people’s pockets. The sheer recklessness of this would, in theory, encourage people to spend the windfall, not save it.

The Economist discusses a helicopter drop further in the related article “Fighting the next recession: Unfamiliar ways forward–Policymakers in rich economies need to consider some radical approaches to tackling the next downturn”:

One way to raise expectations of inflation and boost aggregate demand is for a central bank and its finance ministry to collude in printing money to pay for public spending (or tax cuts). Such shenanigans are not possible in the euro zone, where the ECB is forbidden by treaty from buying government bonds directly. Elsewhere they might work as follows: the government announces a tax rebate and issues bonds to finance it, but instead of selling them to private investors swaps them for a deposit with the central bank. The central bank proceeds to cancel the bonds, and the government withdraws the money it has on deposit and gives it to citizens. “Helicopter money” of this sort—named in honour of a parable told by Milton Friedman, a famous economist—is as close as you can get to raining cash from a clear blue sky like manna from heaven, untouched by banks and financial markets.

Such largesse is, in effect, fiscal policy financed by money instead of bonds. It is conceivable that a bond-financed fiscal tax cut might in fact be cheaper to finance: although cash has a zero yield, medium-term bonds in Japan and in much of Europe have negative yields. But the unaccustomed drama—indeed, the apparent recklessness—of helicopter money could increase the expected inflation rate, encouraging taxpayers to spend rather than save. It is not something to rush into, or to try prophylactically; but in the midst of a global financial crisis, or a deep recession, it would have much to recommend it. If it were co-ordinated by a group of rich countries, all the better.

A related idea is to cancel a portion of the sovereign bonds purchased by central banks, ostensibly cutting public debt at a stroke. It would have the drawback, as would helicopter money, of leaving the central bank technically bankrupt, since its liabilities (money) would exceed its assets (bonds). But since most central banks are backed by national treasuries, this ought not to matter much. A bigger worry is that it is hard to know in advance what effect monetisation would have. Bond markets could panic about an inflationary surge, driving yields through the roof. Or they might just shrug the whole thing off. After all, the central bank could issue fresh bonds to soak up the excess money if things eventually got out of hand.

The Economist points clearly to the one case in which a massive helicopter drop might be called for: if it became necessary to have the government give away so much money that people would be convinced there was no way the government could ever sell enough bonds to soak that money up. But this is clearly a drastic measure. Convincing the markets that the government will surely go bankrupt and have to explicitly default on its debt unless their is massive inflation is a counsel of desperation. By contrast, despite all of the hyperventilating reporting, once it is coupled with an appropriate paper currency policy, negative interest rate policy is, in its main effects, simply conventional monetary policy continued into the negative region. (See my National Institute Economic Review paper “Negative Interest Rate Policy as Conventional Monetary Policy” and “If a Central Bank Cuts All of Its Interest Rates, Including the Paper Currency Interest Rate, Negative Interest Rates are a Much Fiercer Animal.”)

Why Helicopter Drops the Government Can Afford are Not the Answer

What about helicopter drops that won’t lead to government bankruptcy or runaway inflation? Here the Economist also provides a clue to why such helicopter drops are an inferior policy. Printing money and sending it to people is equivalent to printing money to buy Treasury bills and then selling those Treasury bills to raise funds to send to people. Written as an equation:

printing money and sending it to people = 

printing money to buy Treasury bills

+ selling Treasury bills to get funds that are sent to people

This is an interest equation, because each of the terms in the equation has a name. Here is the same equation, with the usual policy names attached:

helicopter drop = standard open market operation + tax rebate

This equation takes some of the mystique out of helicopter drops. Let’s see what it means. First, this equation is consistent with the discussion above. If the aim is to create doubts about the government’s ability to pay its debts without massive inflation, then the easiest way to sell enough Treasury bills to get funds for a big enough tax rebate to do so is by printing money and having the central bank buy those Treasury bills. 

On the other hand, if the size of the tax rebates is an amount the government could borrow enough for even without central bank financing, then adding standard open market operation of printing money to buy Treasury bills may or may not add much. If printing money to buy 3-month Treasury bills stimulates the economy, then the central bank can simply do this as what everyone considers totally standard monetary policy, without the tax rebate. If at any point printing money to buy 3-month Treasury bills ceases to do much of anything, then the extra stimulus beyond that totally standard monetary policy action is the effect of a tax rebate. 

National Lines of Credit Strictly Dominate Tax Rebates

To the extent a helicopter drop has the same effect as a tax rebate because (a) the amount at issue is affordable and (b) open market purchases of Treasury bills have little stimulative effect, the question then is how attractive tax rebates are. The answer is: not attractive at all. I have argued at length that tax rebates are strictly inferior a policy I call “National Lines of Credit.” I introduced this policy in a working paper heralded by a blog post of the same name:

Here is the abstract for that paper:

Abstract: In ranking fiscal stimulus programs, it is useful to focus on the ratio of extra aggregate demand to extra national debt that results. This note argues that (because of repayment after the end of a recession) “national lines of credit”–that is, government-issued credit cards with countercyclical credit limits and favorable interest rates—would generate a higher ratio of extra aggregate demand to extra national debt than tax rebates. Because it involves government loans that are anticipated in advance to involve some losses and therefore involve a fiscal cost even after efforts to minimize losses, such a policy lies between traditional monetary policy and traditional fiscal policy.

Here are some other blog posts (with the most important at the top) on “National Lines of Credit” (which in the US context I also call “Federal Lines of Credit”):

Most Important Posts about National Lines of Credit

Less Important Posts in relation to National Lines of Credit