Helicopter drops reloaded
What’s at stake: Central banks have recently been scaling up their unconventional monetary policy measures. Discussions about helicopter money seem to be getting ever louder. We review the theoretical discussions, the effectiveness of tax-rebates and legal and political complications
Helicopter money and its popularity
In a paper delivered to the IMF, Adair Turner argues that monetary finance of fiscal deficits (helicopter money) is both technically feasible and desirable. There is no doubt that helicopter money will stimulate aggregate nominal demand, and in some circumstances it is even a better and less risky tool than any of the available alternatives. These alternative options include negative interest rates, debt-financed fiscal deficits, quantitative easing, forward guidance, or a combination of debt-financed fiscal stimulus plus quantitative easing.
Tony Yates looks at the symbolic power of Turner’s statements, which show how far the crisis had brought previously fringe ideas into the mainstream. Turner, who was once considered a potential Governor of the Bank of England, is now writing forcefully about the advantages of helicopter money. He is even pushing it as an option to be preferred over debt-financed fiscal policy and forward guidance.
Choosing between negative interest rates and helicopter money
However, Yates is unconvinced by Turner’s assertion that helicopter money is a less dangerous option for the economy than negative interest rates. In fact, this sets up a false choice. Yates argues that helicopter money effectively lowers interest rates, by increasing the supply of money and liquidity (because of a reduction in the liquidity premium on securities). It is not possible to control both the quantity and price of money at the same time. The argument that a central bank can require banks to hold reserves and charge whatever negative rates it likes on the reserves is not sufficient. This is just a tax, which will not prevent the injection of money affecting the interest rates on all other assets. Helicopter drops might have the same effect that which worries Turner concerning negative interest rates: it can lead, through lower interest rates, to excessive borrowing and leverage.
Krugman points out that this misses Turner’s point, which is all about the effect of helicopter money on expectations. His idea is that helicopter drops and negative interest rates have different implications because they have different effects on expectations about the future. This confusion might be due to the fact that Yates is using a static IS/LM-type model. However, Krugman also sees a weakness in Turner’s argument. The method by which monetary base is injected into the economy does not have a clear causal link with expectations. On the one hand, you could have perfectly conventional monetary expansion now, coupled with a promise never to withdraw the monetary injection. On the other, you could have a helicopter drop which is nonetheless ineffective because people believe that the central bank will eventually do whatever it takes to bring the monetary base back to its previous trend. The real point should be that measures to raise expectations of future inflation, whatever they are, do indeed offer an alternative to negative interest rates. It is always about expectations.
Yates believes that what Krugman is drawing attention to is the difference between the liquidity effect of a monetary expansion, which is captured in IS/LM, and the Fisher effect, which is not. However Yates does not think that Turner is making a case that the Fisher effect kicks in earlier than with a conventional monetary policy loosening: this case is arguable, perhaps the ‘shock and awe’ element of helicopters would be so powerful that the Fisher effect dominates right away. But Turner does not stress this. Part of his case for helicopter money is that – so he argues – it works more effectively if expectations are not very forward-looking. But it is these same expectational effects that determine the speed with which the Fisher effect works on the nominal interest rate. If we downplay them, then we slow down the point at which the Fisher effect outweighs the liquidity effect.
So, to restate, helicopter money involves taking your hands off interest rates for a while. It might be more stimulative than lowering rates from their current level, or it might not, but it works partly through exactly the same interest rate channel as lowering interest rates directly.
Simon Wren-Lewis writes that we are in a world of inflation targeting. Anything that raises demand will tend to raise inflation, and so the monetary authorities will tend to raise nominal interest rates. This leads Wren-Lewis to conclude that there are two possible outcomes from helicopter money. It could be that the nominal interest rate lower bound constraint continues to bite. This means that helicopter money will leave nominal interest rates unchanged, but the economy better off Or it could be that there is no constraint (or that constraint is removed), in which case rates will rise (sooner) with helicopter money.
Is there a trade-off between helicopter money and counter-cyclical fiscal policy?
Wren-Lewis also addresses a second topic: whether helicopter money in some way precludes undertaking counter-cyclical fiscal policy. It does not. One lesson of the Great Recession is that we cannot rely on governments to do the right thing with fiscal actions, so the availability helicopter money instruments could act as an insurance policy actionable by central banks to counteract inappropriate government fiscal policy. If governments do spend more or tax less as we approach the zero lower bound, that insurance policy may not be needed. Nevertheless, even if governments try to do the right thing, a lack of good projects or information delays may mean they do not do enough. In this case the very quick action that central banks could take with helicopter money could be a useful complement. To put it another way, helicopter money is best seen as an alternative to QE rather than as an alternative to fiscal action.
On the effectiveness of stimulus payments
Helicopter drops have never been implemented in the real world (except like this). However, one-off tax rebates can give an indication of what to expect. Parker and coauthors measured the response of household spending to the economic stimulus payments (ESPs) disbursed in mid-2008 as part of the Economic Stimulus Act of 2008. They find that, on average, households spent about 12-30% (depending on the specification) of their stimulus payments on nondurable expenditures during the three-month period in which the payments were received. Further, there was also a substantial increase in spending on durable goods, bringing the average total spending response to about 50-90% of the payments. In a more recent paper, Parker asks why households do not smooth consumption. He evaluates the theoretical explanations for the propensity of households to increase spending in response to the arrival of predictable, lump-sum payments, looking at households in the Nielsen Consumer Panel who received $25 million in Federal stimulus payments in 2008. The pattern of spending is inconsistent with models in which identical households cycle through high and low response states as they manage liquidity. Instead, the propensity to spend is a persistent household trait, which is unrelated to expectation errors and highly related to a measure of impatience.
Legal and political feasibility of helicopter drops
Cullen Roche points out that the Fed does not in fact own a helicopter. First, the Fed does not control the quantity of deficit spending. Congress sets the size of the deficit (outside of automatic stabilisers) and the Fed can be said to “monetise” it after the fact. So, even if it chooses to “monetise” this debt the Fed cannot increase the quantity. It cannot just force Congress to spend more. Even if the Fed “monetises”, then the Fed is just engaging in asset swaps such as QE – thereby swapping very safe bonds for very safe cash. Calling this “monetisation” is probably misleading. Second, the Fed has no legal authority to implement an actual helicopter drop. It is legally bound in its ability to swap assets with the private sector. These are generally limited to government-guaranteed assets. So, not only is it impossible for the Fed to fire cash into people’s wallets without taking something nearly equal out of their front pocket (the aforementioned asset swap), Roche would argue that the Fed does not even own a helicopter in the first place.
On political feasibility, Turner in his piece states that the most important issues are in fact political. Once we recognise that monetary finance is feasible, and remove any legal or conventional impediments to its use, political dynamics may lead to its excessive use. The most important question relating to monetary finance is therefore whether it is possible to construct a set of rules and responsibilities which will guard against its dangerous misuse, while still enabling its use in appropriate quantities and in appropriate circumstances.
Lonergan sees the case quite differently, and states that helicopter drops in the euro area may be a legal obligation of the European Central Bank (ECB). The trick lies in the proper construction of helicopter drops. The euro-area version of it would be cash transfers from the ECB to households, which could take the form of perpetual zero coupon loans, intermediated by banks (TLTRO). This is not fiscal policy as defined by EU law. It involves the monetary base and would be implemented independently of national treasuries and budgetary policies, and would therefore count as monetary policy. This would protect the independence of the ECB and fall within the price stability mandate.
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.