Blog Post

Permanent QE and helicopter money

What’s at stake: As the ECB contemplates its own version of quantitative easing, this review clarifies the conditions under which this policy is believed to matter (beyond the portfolio channel) for inflation and growth. Unlike what was done in the US, the associated monetary base growth needs to be permanent. Within this framework, this review also discusses the pros and cons of helicopter money – i.e. overt money-financed deficits – as compared with permanent QE.

By: Date: January 5, 2015 European Macroeconomics & Governance Tags & Topics

Temporary vs. permanent QE

David Beckworth writes that there are two underappreciated facts about the Fed’s quantitative easing programs.

The first underappreciated fact is that the large expansion of the monetary base under QE is temporary. The Fed has always planned to eventually return its balance sheet and, by implication, the monetary base back to the trend path it was on prior to the QE programs. This point has been communicated directly in several ways. By also explicitly committing to not raise the inflation target, the Fed was implicitly committing to only a temporary expansion of the monetary base.

The second underappreciated fact is that in order for QE to have made a meaningful difference the associated monetary base growth needed to be permanent. This understanding is the standard view in modern macroeconomics (Beckworth has a useful compilation of statements by Woodford, Svensson, and Obstfeld among others). The reasoning behind it is that a permanent expansion of the monetary base implies in the long-run a permanent rise in the price level, which creates an incentive to start spending more in the present when goods are cheaper. Or, from a Wicksellian perspective, it would imply a temporary surge in expected inflation that would lower real interest rates to their market clearing level.

Paul Krugman writes a stripped down version of his 1998 model to make explicit that QE is expected to be effective only to the extent that the expansion in the money base is permanent. Krugman considers an infinite-horizon model in which all the action takes place in period one. There may be shocks to consumer preferences, or fiscal policy, or monetary policy, but they all take place “now”; after period 2 everything stays the same. What this in turn means is that we can take the future price level and level of consumption as given.

From this set-up, we have an Euler equation that lets us read off current consumption from future consumption, current and future price levels, and the interest rate. And we can take future consumption as given.

C = C*(P*/P)/(1+i)

Now suppose that we’re in a New Keynesian world in which prices are temporarily sticky; so P is given. And suppose we’re at the zero lower bound, so i=0. Then there’s only one moving part here: the expected future price level. Anything you do — monetary or fiscal — affects current consumption to the extent, and only to the extent, that it moves the expected future price level. Full stop, end of story. An immediate implication is that the current money supply doesn’t matter. The future money supply matters, because it can affect the future price level, so a permanent increase in M can affect the economy — but that effect works entirely through expectations. What you do now matters only to the extent that people take it as an indication of what you will do in the future.

Helicopter money = money-financed deficits = permanent QE

Simon Wren-Lewis writes that the self-imposed institutional setup of strict separation between monetary and fiscal policy prevents either central banks or governments doing money financed fiscal stimulus alone. Within the existing institutional framework, there is plenty to be done to convince fiscal policy makers that reducing deficits should not be a priority in the short term, or in trying to improve the monetary policy framework so liquidity traps happen less often. Yet it would be better still if we had an institutional framework where money financed fiscal stimulus in a liquidity trap is possible. Adair Turner writes that ‘helicopter money’ – by which we mean overt money finance of increased fiscal deficits – may in some circumstances be the only certain way to stimulate nominal demand.

Mark Blyth and Eric Lonergan write that, in the 1930s, Keynes proposed burying bottles of bank notes in old coal mines; once unearthed (like gold), the cash would create new wealth and spur spending. The conservative economist Milton Friedman also saw the appeal of direct money transfers, which he likened to dropping cash out of a helicopter. Dylan Mattews writes that the idea is most closely associated with former Fed chair Ben Bernanke, who first raised the proposal in the context of Japan’s economic malaise in 1999 and repeated it in 2002 as a Fed board member.

Mike Woodford writes that the same equilibrium can be supported by traditional quantitative easing or by helicopter money. On the one hand (traditional quantitative easing), one might increase the monetary base through a purchase of government bonds by the central bank, and commit to maintain the monetary base permanently at the higher level. On the other (‘helicopter money’), one might print new base money to finance a transfer to the public, and commit never to retire the newly issued money. The fiscal consequences of the two policies are exactly the same. Under the quantitative easing policy, the central bank acquires assets, but it rebates the interest paid on the government bonds back to the Treasury, so that the budgets of all parties are the same as if no government bonds were actually acquired, as is explicitly the case with helicopter money. Willem Buiter writes that QE relaxes the intertemporal budget constraint of the consolidated Central Bank and Treasury – so that there will have to be some combination of current and future tax cuts or current and future increases in public spending to ensure that the intertemporal budget constraint of the State remains satisfied – either if nominal interest rates are positive or because fiat base money is irredeemable.

Mike Woodford writes that the effects would only be different if, in practice, the consequences for future policy were not perceived the same way by the public. Under quantitative easing, people might not expect the increase in the monetary base to be permanent – after all, it was not in the case of Japan’s quantitative easing policy in the period 2001-2006, and US and UK policymakers insist that the expansions of those central banks’ balance sheets won’t be permanent, either – and in that case, there is no reason for demand to increase. Perhaps in the case of helicopter money, it would be more likely that the intention to maintain a permanently higher monetary base would be believed. Also, in this case, the fact people get an immediate transfer should lead them to believe that they can afford to spend more, even if they don’t think about or understand the consequences of the change for future conditions [brought by the relaxation of the intertemporal budget constraint of the State], which is not true in the case of quantitative easing.

Mike Woodford proposes a policy that delivers exactly the same effect as helicopter money, but would preserve the traditional separation between monetary and fiscal policy. One could achieve a similar effect, with equally little need to rely upon people having sophisticated expectations, through a bond-financed fiscal transfer, combined with a commitment by the central bank to a nominal GDP target path (the one that would involve the same long-run path for base money as the other two policies). The perfect foresight equilibrium would be exactly the same in this case as well; and as in the case of helicopter money, the fact that people get an immediate transfer would make the policy simulative even if many households fail to understand the consequences of the policy for future conditions, or are financially constrained. Yet this alternative would not involve the central bank in making transfers to private parties.

Read more blog reviews:

The economics of P2P Lending

The Superiority of Economists

 

 


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article More on this topic More by this author

Blog Post

Silvia Merler

Big data and first-degree price discrimination

What’s at stake: first-degree price discrimination - or person-specific pricing, had until recently been considered a theoretical case with unlikely real-world application. Yet the increasing availability of big data could make this possible. We review recent contributions on this issue.

By: Silvia Merler Topic: Innovation & Competition Policy Date: February 20, 2017
Read article More on this topic More by this author

Blog Post

Pia Hüttl

Inflation's comeback

What at stake: After years of deflationary pressures and anaemic economic performance, inflation seems to be on the rise again, both in the US and the euro area. Does this comeback mark a return to target? Will it be sustained, and what should central banks be thinking? These are among the questions raised in the blogosphere.

By: Pia Hüttl Topic: Global Economics & Governance Date: February 13, 2017
Read article More on this topic More by this author

Blog Post

Silvia Merler

Is Germany a currency manipulator?

What’s at stake: the Financial Times reports that Peter Navarro, head of the US’s National Trade Council, has accused Germany of currency manipulation. He claims that the country uses a 'grossly undervalued' Euro to 'exploit' its trading partners. Angela Merkel replied that the Euro is managed by the European Central Bank, on which Germany does not exert influence. We review what the economic blogosphere thinks of this.

By: Silvia Merler Topic: Global Economics & Governance Date: February 6, 2017
Read article More on this topic More by this author

Blog Post

Headshot

Demonetisation: India’s stress test

What were the reasons for the Indian government's sudden decision to remove 86% of hard currency from circulation? Will Modi's monetary intervention achieve its stated aim of fighting corruption? And what will be the wider implications for growth?

By: Suman Bery Topic: Global Economics & Governance Date: January 30, 2017
Read article More by this author

Blog Post

Silvia Merler

Climate change and financial markets

What’s at stake: Ever since the 2016 Paris Agreement to reduce emissions was signed, researchers have been looking at the impact that moves towards a low-carbon economy might have on financial markets and financial stability. We review these contributions here. 

By: Silvia Merler Topic: Energy & Climate, Finance & Financial Regulation Date: January 30, 2017
Read article More on this topic More by this author

Blog Post

Silvia Merler

Tariffs and the American poor

What’s at stake: much has been said and debated — during the US election and beyond — about the distributional impact of free trade on the disadvantaged. But what would be the distributional impact of a new protectionism instead?

By: Silvia Merler Topic: Global Economics & Governance Date: January 23, 2017
Read article More on this topic More by this author

Blog Post

Silvia Merler

The economic effects of migration

What’s at stake: migration is currently a very hot topic in both the US and the EU. Immigration issues have come to the forefront due to the problem of rapidly ageing populations, the refugee crisis, and growing anti-immigration political rhetoric. But what do we know about the economic effects of migration?

By: Silvia Merler Topic: European Macroeconomics & Governance Date: January 16, 2017
Read article More on this topic More by this author

Blog Post

Silvia Merler

Compensating the “losers” of globalisation

What’s at stake: According to some, 2016’s political turmoil shows that the so-called “losers” of globalisation are striking back. There is, however, little agreement on how government should respond to this challenge.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: January 9, 2017
Read article More on this topic More by this author

Blog Post

Silvia Merler

2016: The end

What’s at stake: 2016 is coming to an end. It will be remembered as an annus mirabilis and horribilis, at the same time. 2016 brought us some previously unthinkable political shocks, and admittedly took away some of our finest musicians. It also couldn’t help taking away Willy Wonka and Princess Leia, making this a much sadder Galaxy. This raises an obvious question: what are we in for, in 2017?

By: Silvia Merler Topic: European Macroeconomics & Governance Date: December 31, 2016
Read article More on this topic More by this author

Blog Post

Silvia Merler

The American dream

What’s at stake: historian James Truslow Adams, in his 1931 book The Epic of America, stated that the American dream is "that dream of a land in which life should be better and richer and fuller for everyone, with opportunity for each according to ability or achievement”. Few ideas have ever been as powerful as the “American Dream”, and many recent political events hinge on the fear that this “dream” may be dead. Meanwhile, researchers have been trying to measure the reality behind the dream.

By: Silvia Merler Topic: Global Economics & Governance Date: December 19, 2016
Read article More on this topic More by this author

Blog Post

Silvia Merler

The political economy of macroprudential policy

What’s at stake: the emergence of renewed interest in macroprudential policy has characterised the aftermath of the great recession. There is not yet full agreement on what the tasks of macroprudential policy is or how it should be carried out, but there is a clear understanding that there is an important political economy dimension to it. We review some of the recent contribution on this.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: December 12, 2016
Read article More on this topic

Opinion

MariaDemertzis1 bw
Guntram B. Wolff

Eurozone QE and bank profitability: Why it is too early to taper

In the eyes of the critics, the quantitative easing programs have been of little help to growth and inflation and have instead been an attack on savers, undermining the profitability of banks and insurances. Do these arguments stand scrutiny?

By: Maria Demertzis and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: December 8, 2016
Load more posts