Monday, September 26, 2016
brad delong

It is time for central banks to assume responsibility and implement “helicopter money,” putting cash directly into the hands of people who will spend it.

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Rescue Helicopters for Stranded Economies

BERKELEY – For countries where nominal interest rates are at or near zero, fiscal stimulus should be a no-brainer. As long as the interest rate at which a government borrows is less than the sum of inflation, labor-force growth, and labor-productivity growth, the amortization cost of extra liabilities will be negative. Meanwhile, the upside of extra spending could be significant. The Keynesian fiscal multiplier for large industrial economies or for coordinated expansions is believed to be roughly two – meaning that an extra dollar of fiscal expansion would boost real GDP by about two dollars.

Some point to the risk that, once the economy recovers and interest rates rise, governments will fail to make the appropriate adjustments to fiscal policy. But this argument is specious. Governments that wish to pursue bad policies will do so no matter what decisions are made today. And to the extent that this risk exists at all, it is offset by the very tangible economic benefits of stimulus: improved labor-force skills, higher business investment, faster business-model development, and new, useful infrastructure.

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Aversion to fiscal expansion reflects raw ideology, not pragmatic considerations. Few competent economists have failed to conclude that the United States, Germany, and the United Kingdom have large enough fiscal multipliers, strong enough spillovers of infrastructure, investment, and other demand-boosting programs, and sufficient financial space to make substantially more expansionary policies optimal.

The question is not whether, but how much, fiscal stimulus is appropriate. Answering that should be a simple, technocratic cost-benefit calculation. And yet, in most countries that would benefit from fiscal stimulus, nothing is being done.

Faced with this, my former teacher and long-time colleague Barry Eichengreen has become positively alarmed: “The world economy is visibly sinking, and the policymakers who are supposed to be its stewards are tying themselves in knots.”

Germany’s experience with hyperinflation in the 1920s and its subsequent embrace of “ordoliberalism,” in which the government avoids interfering in the economy, has “rendered Germans allergic to macroeconomics,” Eichengreen writes. Similarly, in the US, deep-rooted suspicion of federal government power – especially in the South, where it was used to abolish slavery and enforce civil rights – has resulted in hostility to countercyclical macroeconomic policy.

“Ideological and political prejudices deeply rooted in history will have to be overcome to end the current stagnation,” Eichengreen concludes. “If an extended period of depressed growth following a crisis isn’t the right moment to challenge them, then when is?”

Sadly, this debate is no longer an intellectual discussion – if it ever was. As a result, a flanking move might be required. It is time for central banks to assume responsibility and implement “helicopter money,” putting cash directly into the hands of people who will spend it.

Proponents of austerity in Germany, the US, and the UK are suspicious of central banks for the same ideological reasons they are averse to deficit-spending legislatures. But their objections to central banks are far weaker. That is because, as David Glasner, an economist at the Federal Trade Commission, has pointed out, attempts to erect an automatic monetary system – whether based on the gold standard, Milton Friedman’s k-percent rule, or the Stanford University economist John Taylor’s “rules-based monetary policy” – have all crashed and burned spectacularly.

History has refuted the University of Chicago economist Henry Simons’s call for “rules rather than authorities” in monetary policy. The design task in monetary policy is not to construct rules but, instead, to establish authorities with sensible objectives, values, and technocratic competence.

The actions of central banks have always been “fiscal policy” in a very real sense, simply because their interventions alter the present value of future government principal and interest payments. But when it comes to promoting economic recovery, central banks can certainly do more. They have immense regulatory powers to require that the banks under their supervision hold capital, lend to classes of borrowers that have historically faced discrimination, and serve the communities in which they are embedded. And they have clever lawyers.

Helicopter money could take many forms. Its exact shape will depend on the legal structure of a given central bank, and on the extent to which its administrators are willing to take actions that go beyond their traditional authority (with the implicit or explicit promise that the rest of the government will turn a blind eye).

Success in rebooting the economy will depend on ensuring that the extra cash goes into the hands of those who are constrained in their spending by low incomes and a lack of collateral assets. And, as with governments engaged in fiscal stimulus, the key to a positive outcome will be to rule out even a smidgeon of fear that repayment obligations will become onerous in any way.

 

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Photo of Michael Heise

Distributing largesse financed by the central bank would have dangerous systemic consequences in the long run, because it would create perverse incentives for everyone involved.

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The Case Against Helicopter Money

MUNICH – Despite years of expansionary monetary policy, the European Central Bank has failed to push inflation back up to its target of “below but close to 2%.” The latest measures – a zero interest rate on the ECB’s main refinancing operations, an increase in monthly asset purchases from €60 billion ($67 billion) to €80 billion, and an even lower deposit rate of -0.40% – are unlikely to change this. That is why some economists are urging the ECB to go even further, with so-called “helicopter drops” – that is, financing private consumption by printing money.

The idea of helicopter money dates back to the monetarism debates of the 1960s. A central bank, it was argued, never runs out of options for stimulating aggregate demand and stoking inflation, provided it is willing to resort to radical measures. But what was once a theoretical notion now seems to be a concrete possibility.

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In practice, helicopter drops would arrive in the form of lump-sum payments to households or consumption vouchers for everybody, funded exclusively by central banks. Governments or commercial banks distributing the money would be credited with a deposit or be given cash, but no claim would be created on the left-hand side of the central bank’s balance sheet.

This type of single accounting would reduce the central bank’s equity capital, unless it realized (sold) valuation reserves on its balance sheet. Proponents defend this approach by claiming that central banks are subject to special accounting rules that could be adjusted as needed.

The proponents of helicopter drops today include some eminent figures, including former US Federal Reserve Chair Ben Bernanke and Adair Turner, former head of the United Kingdom’s Financial Services Authority. And while ECB President Mario Draghi has highlighted the technical, legal, and accounting obstacles that stand in the way of helicopter drops by his institution, he has not ruled them out.

The question now is: Is such an extreme step really justified?

The answer is no. While helicopter drops are a viable policy option if deflation is spiraling downward, as it was in the late 1920s and early 1930s, that is not the case today – neither in the eurozone nor in the global economy.

True, demand growth is subdued, reflecting the lingering fallout from the global financial crisis that erupted in 2008. Banks, firms, and households are still cleaning up their balance sheets and working off the heaps of debt they amassed during the credit boom that preceded the bust. But they have already made significant progress, meaning that the drag on growth is set to diminish.

Consumers today are not holding back on spending because they expect goods and services to become cheaper, as one would expect during a period of deflation. Instead, they are gradually increasing their spending, taking advantage of restored income growth and large gains in purchasing power caused by collapsing oil and commodity prices. As a result, most advanced economies are once again producing at close to capacity.

Data on corporate profits also contradict the view that we are mired in deflation. Price stability has not put profit margins under pressure. On the contrary, in many advanced economies, profits are high – even reaching record levels – owing partly to lower input costs.

In this environment, distributing largesse financed by the central bank would have dangerous systemic consequences in the long run, because it would create perverse incentives for everyone involved. Policymakers would be tempted to resort to helicopter money whenever growth was not as strong as they would like, instead of implementing difficult structural reforms that address the underlying causes of weak economic performance.

All of this would raise expectations among financial-market actors that central banks and governments would always step in to smooth out credit bubbles and mitigate their consequences, even if that meant accumulating more debt. These actors’ risk perception would thus be distorted, and the role of risk premiums would be diminished.

Add to that the impact of the depletion of valuation reserves and the risk of negative equity –developments that could undermine the credibility of central banks and thus of currencies – and it seems clear that helicopter drops should, at least for now, remain firmly in the realm of academic debate.

 

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Adverse global conditions, however troubling, should not lead central bankers to neglect the risks of untested policies – above all the “helicopter drops” that many are now proposing.

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Money from Heaven?

TOKYO – The world economy is struggling. The single currency is fettering, not freeing, the eurozone; Japan is smarting from the slowdown of America’s normalization of monetary policy; and emerging markets worldwide are suffering the consequences of China’s economic mismanagement. But adverse global conditions, however troubling, should not lead central bankers to neglect the risks of untested policies – above all the “helicopter drops” that many are now proposing.

Conceived in 1969 by Milton Friedman as part of a thought experiment – not an actual proposal – helicopter drops got their name from the fantastic vision of fresh money being scattered from a helicopter whirring overheard. But the point of helicopter drops – or what former US Fed Chair Ben Bernanke recently called a “money-financed fiscal program” (MFFP) – is simply to distribute newly printed cash directly to consumers, such as through tax rebates.

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Over the last half-century, central bankers have repeatedly ruled out the use of MFFP. But in the current environment of persistently weak aggregate demand, below-target inflation, and slow or no output growth, economists worldwide have been desperately seeking deus ex machina – a search that, for some, has led to the heliport.

Among the most prominent advocates of MFFP is Adair Turner, whose latest book, Between Debt and the Devil, provides an insightful thought experiment on the use of helicopter money. Turner and his fellow MFFP advocates seem to believe that placing more money in the hands of the public is practically always welcome. In their view, it is not only a straightforward way instantly to boost real demand; it also seems preferable to debt-financed fiscal stimulus, owing both to political constraints on debt-burdened governments and to MFFP’s more direct – and thus faster – impact on economy-wide spending.

But MFFP could easily produce too much demand. The only guarantee against an inflationary surge in this scenario is the prudence of policymakers.

But their incentive to limit inflation may not be particularly strong. In fact, throughout history, governments have had strong political incentives to monetize the deficit, with the subsequent inflation reducing the debt burden (and effectively confiscating the borrowed savings). That is why inflation is so much more prevalent in history than deflation. Yet no MFFP proposal even recognizes this tendency, much less includes provisions to avoid it.

Of course, central banks are independent from government precisely to ensure that their policies are utterly pragmatic, instead of being shaped by partisan politics. But, in reality, such conduct has been repeatedly absent. Who today still holds up former Fed Chair Alan Greenspan as a paragon of sagacity?

Still, the biggest risk is posed by fiscal authorities, who tend to be more heavily influenced by political considerations. Unfortunately, MFFP, by matching monetary expansion to fiscal expansion, effectively empowers fiscal authorities over monetary authorities.

Turner believes that Japan, in particular, would benefit from helicopter drops. In his view, MFFP is the ideal solution to spur demand, without further augmenting Japan’s already-heavy debt burden. But Japan’s large public-debt burden is dangerous precisely because of its potential to spur inflation, through the monetization of the debt. In this context, introducing MFFP – a policy that is even more likely to destabilize prices – seems dangerous.

Japan has made this mistake before. In 1931, after more than a decade of deep deflation, Finance Minister Korekiyo Takahashi used debt-financed fiscal expansion to bring about a domestic economic revival.

But Takahashi knew when it was time to rein in spending, and in 1934 he attempted to do just that. His focus on reducing military expenditure, however, attracted strong opposition from army officers, who assassinated Takahashi in 1936. His successor allowed the military budget to swell, funded by newly created money. This stimulated rapid inflation, which was brought under control only after the reconstruction following World War II.

Today, Prime Minister Shinzo Abe’s approach to monetary expansion – central to his “Abenomics” program for economic recovery – is producing positive results, especially in the labor market. The job-to-applicant ratio stands at 1.28, its highest level since 1991. The wages of part-time workers are, for the first time in Japan’s history, rising faster than those of full-time employees.

Moreover, prices of food products have started to increase. Japanese companies are generating strong profits (Japanese stocks may even be undervalued). And, although GDP is growing very slowly, and even turning negative from time to time, gross national income continues to rise steadily. It seems clear that, rather than risk triggering inflation, Japan should continue on this promising path.

And, indeed, even Turner has offered an alternative proposal that fits with this scenario. He recommends that Japan continue its current method of monetary easing – which can boost demand, while maintaining some safeguard against inflation – and postpone its forthcoming consumption-tax hike. While fiscal stimulus and monetary expansion do not always have to go hand in hand, under current circumstances in Japan, this proposal makes sense.

 

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The technical case for monetary finance is indisputable. It is the one policy that will always stimulate nominal demand.

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Helicopters on a Leash

PARIS – Faced with a slowing global economy, a number of observers – including former US Federal Reserve Chair Ben Bernanke and Berkeley economist Brad DeLong – have argued that money-financed fiscal expansion should not be excluded from the policy toolkit. But talk of such “helicopter drops” of newly printed money has produced a strong counterattack, including from Michael Heise, the chief economist of Allianz, and Koichi Hamada, the chief economic adviser to Prime Minister Shinzo Abe and one of the architects of Japan’s “Abenomics” economic-recovery program.

I disagree with Heise and Hamada, but they rightly focus on the central issue – the risk that allowing any monetary finance will invite excessive use. The crucial question is whether we can devise rules and responsibilities to guard against that danger. I believe we can and must, and that in some countries the alternative will not be no monetary finance, but monetary finance implemented without discipline.

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As I argued in a recent International Monetary Fund paper, the technical case for monetary finance is indisputable. It is the one policy that will always stimulate nominal demand, even when other policies – such as debt-financed fiscal deficits or negative interest rates – are ineffective. And its impact on nominal demand can in principle be calibrated: A small amount will produce a potentially useful stimulus to either output or the price level, whereas a very large amount will produce excessive inflation.

That is not to deny important complexities in implementing helicopter drops. If money creation finances tax cuts rather than increased public expenditure, the impact will depend on how much consumers decide to spend versus save – a balance that may be unstable over time. And, because money creation by central banks increases commercial banks’ reserves, there is a risk that lending will increase little at first, but then rapidly. But these complexities simply argue for a cautious approach to the scale of monetary finance and the careful use of tools – such as mandatory-reserve requirements – to constrain subsequent knock-on effects.

The only powerful argument against helicopter drops is the one that Heise and Hamada stress – the political risk of overuse. If monetary finance is no longer prohibited, politicians might use it to curry favor with political constituencies or to over-stimulate the economy ahead of an election. Hamada oddly suggests that proponents of monetary finance ignore this risk; but in my own IMF paper, and in Bernanke’s recent blog post, it is a central concern.

History provides many examples of excessive monetary finance, from Weimar Germany to the many emerging economies where governments have pressured central banks to finance large fiscal deficits, with high inflation the inevitable result. So a valid argument can be made that the dangers of excessive monetary finance are so great that it should be prohibited entirely, even if in some circumstances it would be the best policy.

But a valid argument is not necessarily a convincing one. After all, other policies to support demand growth, or a failure to implement any policy, can be equally dangerous. It was deflation, not hyperinflation, that destroyed the Weimar Republic. Hitler’s electoral breakthrough of 1932 was achieved amid rapidly falling prices.

And alternative policies will in some circumstances have adverse side effects. The root cause of today’s problems was excessive private credit growth before 2008. If our only way out is interest rates negative enough to re-stimulate that rapid growth, we are doomed to repeat past mistakes.

Moreover, there is no reason why we cannot construct rules and responsibilities to mitigate the political risk of excessive use. Bernanke, for example, has proposed giving independent central banks the authority to approve a maximum quantity of monetary finance if they believe doing so is necessary to achieve their clearly defined inflation target.

Of course, opponents can counter with a “slippery slope” argument: Only total prohibition is a defensible line against political pressure for ever-laxer rules. And in countries with a recent history of excessive monetary finance – for example, Brazil, which is still struggling to contain inflation amid political pressures for large deficit finance – that argument could be compelling. But if the European Central Bank, the Bank of England, or the Fed could independently approve a maximum quantity of monetary finance, no erosion of their independence would inevitably follow.

The crucial issue is whether political systems can be trusted to establish and maintain appropriate discipline. Hamada cites the example of Japanese Finance Minister Korekiyo Takahashi, who used monetary-financed fiscal expansion to pull Japan’s economy out of recession in the early 1930s. Takahashi rightly sought to tighten policy once adequate output and price growth had returned, but was assassinated by militarists keen to use unconstrained monetary finance to support imperial expansion.

But Hamada’s inference that this illustrates the inherent dangers of monetary finance is not credible. Continued deflation would also have destroyed Japan’s constitutional system, as it did Germany’s. And if Takahashi had stimulated the economy with negative interest rates, and then sought to reverse that policy, he would have met the same end.

Prohibition of monetary finance cannot secure democracy or the rule of law in the face of powerful anti-democratic forces. But disciplined and moderate monetary finance, by combating deflationary dangers, might sometimes help. So, rather than prohibiting it, we should ensure its responsible use. The likely alternative is not no monetary finance, but monetary finance implemented too late and in an undisciplined fashion.

Japan today illustrates that danger. Having eschewed monetary finance for too long, it now has so much public debt (about 250% of GDP) that if that debt were all monetized, excessive inflation would probably result. But there is no credible scenario in which that debt can ever be “repaid” in the normal sense of the word. De facto monetization is the inevitable result, with the Bank of Japan purchasing each month more bonds than the government issues, even while it denies that monetary finance is an acceptable policy option.

If Japan had followed Bernanke’s advice in 2003 and implemented a moderate money-financed stimulus, it would today have a slightly higher price level and a lower debt-to-GDP ratio. Having failed to do that, it should now define clear rules and responsibilities to govern and manage as best as possible the inevitable monetization of some part of its accumulated debts.

The lesson of Japan – but not only Japan – is clear: It is better to recognize the technical case for monetary finance and mitigate the political dangers than to prohibit its use entirely and pile up still greater dangers for the future.