Sunday, August 20, 2017
Photo of Adair Turner

Can we design rules and institutional responsibilities that ensure that monetary finance is used prudently?

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Demystifying Monetary Finance

LONDON – Eight years after the 2008 crisis governments and central banks – despite a plethora of policies and approaches – have failed to stimulate enough demand to produce sustained and strong growth. In Japan, so-called Abenomics promised 2% inflation by 2015; instead, the Bank of Japan (BOJ) expects it to be close to zero in 2016, with GDP growth below 1%. Eurozone growth halved in the second quarter of 2016 and is dangerously dependent on external export demand. Even the US recovery seems tepid.

Discussions of “helicopter money” – the direct injection of cash into the hands of consumers, or the permanent monetization of government debt – have, as a result, become more widespread. In principle, the case for such monetary finance is clear.

If the government cuts taxes, increases public expenditure, or distributes money directly to households, and if the central bank creates permanent new money to finance this stimulus, citizens’ nominal wealth will increase; and, unlike with debt-financed deficits, they will not face increased future taxes to pay off the debt incurred on their behalf. Some increase in aggregate nominal demand will inevitably occur, with the degree of stimulus broadly proportional to the amount of new money created.

But the debate about monetary finance is burdened by deep fears and unnecessary confusions. Some worry that helicopter money is bound to produce hyperinflation; others argue that, in terms of increasing demand and inflation, it would be no more effective than current policies. Both cannot be right.

One argument that it might be ineffective stems from the specter of a future “inflation tax.” In an economy at full employment and full potential output, a money-financed stimulus could produce only faster price growth, because no increase in real output would be possible. Any increase in private-sector nominal net worth would be offset by future inflation.

All of that is obviously true – and irrelevant. As I argue at greater length in a recent paper, no “inflation tax” can arise without increased inflation, which will result only if there is increased nominal demand. The idea that a future “inflation tax” can stymie the ability of money finance to stimulate aggregate nominal demand is a logical absurdity.

Accounts of how helicopter money works often implicitly assume a simple world in which all money is created by the monetary authority. But in the real world commercial banks can create new private deposit money and hold only a small fraction of those deposits as reserves at the central bank. In this world, another form of future tax becomes relevant.

To see why, it’s important to note that monetary finance is fundamentally different from debt finance only if the money created by the central bank is permanently non-interest bearing. Effective monetary finance therefore requires central banks to impose mandatory non-interest-bearing reserve requirements.

Doing so is entirely compatible with raising policy interest rates when appropriate, because the central bank can pay zero interest on mandatory reserves, while paying the policy interest rate on additional reserves. But if commercial banks are forced to hold non-interest-bearing reserves even when market interest rates have risen from zero, this imposes a tax on bank credit intermediation – a tax that is mathematically equivalent to the future tax burden that would result from a debt-financed stimulus. A recent paper by Claudio Borio, Piti Disyatat, and Anna Zabai argues that, as a result, monetary financing cannot be more stimulative than debt financing.

But while the math is clear, the conclusion does not follow. The future tax can arise only if and when interest rates and inflation have risen, and when banks are creating new credit and deposit money, multiplying the stimulative effect of the initial money-financed tax cut or expenditure. There is undoubtedly a future tax, but one that central banks must impose to ensure that the stimulus is no greater than originally intended.

The arguments that monetary finance would be ineffective are thus unconvincing. If correct, they would logically imply that no amount of monetary finance, however large, would ever stimulate nominal demand. But common sense, logic, and history tell us that if governments and central banks create and spend money on a massive scale, hyperinflation inevitably results. The only risk with helicopter money, indeed, is not too little impact, but too much.

Two questions should determine whether monetary finance is a desirable policy option. The first is whether we need more nominal demand. The strong global consensus nowadays is that we do. It is possible to disagree, arguing that zero inflation would be better than 2%, and that growth is depressed not by inadequate nominal demand but by supply-side factors. But, if so, we should not seek to stimulate nominal demand by any means; we should reject not only monetary finance but also negative interest rates, quantitative easing, and debt-financed fiscal stimulus. If insufficient nominal demand is a problem – with increased inflation desirable and faster real growth possible – monetary finance should an option.

But it may not be a desirable option if – and this is the second question – the political risks of monetary finance are just too great. For the serious argument against monetary finance lies not in the technicalities of future implicit taxes, but in the danger that if we break the taboo and treat monetary finance as an acceptable option, politicians will be tempted to draw again and again from the well of monetary finance.

Fear of that outcome is so great that it seems to motivate some economists to search for technical reasons why monetary finance would be ineffective. But that unconvincing exercise simply diverts attention from the crucial question: can we design rules and institutional responsibilities that ensure that monetary finance is used prudently? If we cannot, we may be stuck with ineffective tools and disappointing economic performance for many years to come.


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There is no realistic scenario in which such a policy would not go awry.

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The Unavoidable Costs of Helicopter Money

MUNICH – The long-running debate about the advisability of so-called helicopter money has changed shape, as new ideas emerge about the form it could take – and questions arise about whether it is already being dropped on some economies. What hasn’t changed is that embracing helicopter money would be a very bad idea.

According to the conventional view, helicopter money is newly printed cash that the central bank doles out, without booking corresponding assets or claims on its balance sheet. It can come in the form of cash transfers to the public or as the monetization of government debt; in both cases, it is a permanent loss for the central bank.

In practice, helicopter money can look a lot like quantitative easing – purchases by central banks of government securities on secondary markets to inject liquidity into the banking system. The helicopter-money version would be the purchase of zero-interest-rate government bonds that will not be repaid, either because they are perpetual bonds or because they are rolled over every time they mature.

That is arguably what the Bank of Japan is now doing. BOJ Governor Haruhiko Kuroda has said that directly underwriting the budget deficit is not an option. Nonetheless, he has initiated a policy of replacing the government bonds on the BOJ’s balance sheet once they mature, while constantly increasing the volume of government debt on the central bank’s books.

This comes after years of declarations by prominent economists, including Berkeley’s Brad DeLong and former US Federal Reserve Chair Ben Bernanke, that helicopter money offers a way to overcome deflation (with which Japan has struggled for decades). The idea is that, by monetizing the fiscal deficit, the central bank helps the government to finance growth-enhancing investments in, say, infrastructure, while providing the liquidity needed to counter deflationary forces.

If it sounds too good to be true, that’s because it is. As Milton Friedman often said, in economics, there is no such thing as a free lunch.

In fact, there are major downsides to helicopter money. Most important, by enabling the monetization of unlimited amounts of government debt, the policy would undermine the credibility of the authorities’ targets for price stability and a stable financial system. This is not a risk, but a certainty, as historical experience with war finance – including, incidentally, in Japan – demonstrates only too clearly.

In the early 1930s, under Finance Minister Takahashi Korekiyo, Japan implemented money-financed deficit spending, in order to lift the economy out of deflation. But it worked a little too well, generating a powerful wave of inflation. Korekiyo’s subsequent attempts to rein in public deficits by slashing military spending failed. The military rebelled, and Korekiyo was assassinated in 1936.

Germany’s monetary breakdown after World War I also stemmed from the issuance of war bonds to the German public. In the United States, the excessive printing of dollars to finance the Civil War contributed to high inflation. The list goes on.

Some proponents of helicopter money, such as Adair Turner, former head of the United Kingdom’s Financial Services Authority, argue that this danger can be neutralized with clear rules to limit the use of monetary and fiscal stimulus. And, theoretically, they are right. But are such limitations politically realistic?

The truth is that the central bank would struggle to defend its independence once the taboo of monetary financing of government debt was violated. Policymakers would pressure it to continue serving up growth for free, particularly in the run-up to elections.

Even if central banks did retain their independence, it is doubtful that they would be able to steer inflation gradually to, say, 2%, and then keep it there. Dispensing liquidity to spur inflation is much easier than draining it to prevent price growth from spinning out of control.

The problem, which Friedman identified in 1969, is that while helicopter money generates more demand in an economy, it does not create more supply. So the continued provision of helicopter money after an economy has returned to normal capacity utilization – the point at which demand and supply are in equilibrium – will cause inflation to take off.

Developed economies have not reached that point today, because the consequences of the 2008 global financial crisis are still dampening demand. But once deleveraging is complete and the credit cycle turns, inflationary pressure is likely to reappear. And central banks’ efforts to suppress it will carry large costs, in terms of employment and growth, as occurred in the 1980s and 1990s.

But even if supply-side growth were maintained, say, by China, thereby holding down prices of tradable goods, helicopter money would carry major costs, because debt would still be growing faster than nominal GDP. In the long run, that would jeopardize confidence in the central bank, saddled with claims against an over-indebted government, and put the fiat money system at risk. Once investors began to move their assets into more stable currencies, the local currency would depreciate and bond prices would collapse.

All forms of monetary stimulus – from quantitative easing to negative interest rates – carry risks. But helicopter money is particularly dangerous; indeed, there is no realistic scenario in which such a policy would not go awry.

It is time to recognize, once and for all, that governments, not central banks, are responsible for generating long-term employment and growth, by ensuring favorable investment conditions, a high-quality education system, and open, competitive markets. Monetary policymakers should defend this red line – which means keeping the helicopters on the ground.