Monday, February 18, 2013

The Dangers of Misunderstanding "Helicopter Money" and Higher Inflation Targets

Ashwin Parameswaran has a fantastic post today explaining why Helicopter Money Is Not Dangerous, All Macroeconomic Policy Is Dangerousin the sense that irresponsible implementation can lead to macroeconomic chaos.” Before jumping into the main attraction of the post, I want to briefly clarify a general discrepancy regarding what helicopter money actually entails.

More than forty years ago, Milton Friedman famously quipped that price deflation can be fought by "dropping money out of a helicopter."[37] Friedman was referring to central bank policy and, to this day, a “helicopter drop” is typically associated with monetary policies, such as quantitative easing (QE). This is an unfortunate interpretation of monetary policy since most central banks, including the Federal Reserve, are as equally unable to actually implement a “helicopter drop” today as they were back in 1969. Willem Buiter clarifies how the policy could realistically be implemented in a paper on “Helicopter Money” (equations omitted):

Technically, if the Central Bank could make transfer payments to the private sector, the entire (real-time) Friedmanian helicopter money drop could be implemented by the Central Bank without Treasury assistance.
The legality of such an implementation of the helicopter drop of money by the Central Bank on its own would be doubtful in most countries with clearly drawn boundaries between the Central Bank and the Treasury.  The Central Bank would be undertaking an overtly fiscal act, something which is normally the exclusive province of the Treasury.47
An economically equivalent (albeit less entertaining) implementation of the helicopter drop of money would be a tax cut (or a transfer payment) implemented by the Treasury, financed through the sale of Treasury debt to the Central Bank, which would then monetise the transaction. If the direct sale of Treasury debt to the Central Bank (or direct Central Bank lending to the Treasury) is prohibited (as it is for the countries that belong to the Euro area), the monetisation of the tax cut could be accomplished by the Treasury financing the tax through the sale of Treasury debt to the domestic private sector (or overseas), with the Central Bank purchasing that same amount of non-monetary interest bearing debt in the secondary market, thus expanding the base money supply. (2004: p. 59-60)
One might inquire whether changing to a “permanent floor” monetary policy regime alters the necessity of monetisation. Apparently prepared for such a future outcome, Buiter says:
This difference between the effects of monetising a government deficit and financing it by issuing non-monetary debt persists even if the interest rates on base money and on non-monetary debt are the same (say zero), now and in the future.  When both money and bonds bear a zero nominal interest rate, there remains a key difference between them: the principal of the bonds is redeemable, the principal of base money is not. (2004: p. 10)
Although monetisation may be necessary to achieve the full effect of “helicopter money,” this practice does not alter the dangers associated with the Treasury’s actions. As Ashwin points out:
Whether they are monetised or not, excessive fiscal deficits are inflationary.
On the topic of inflation, I have recently been engaging in a debate with Mike Sax (see here and here) about the potential benefits of targeting a higher inflation rate. This policy has garnered support from both sides of the political and economic aisle (New Keynesians and Monetarists), yet I think its potential benefits are being extremely oversold. My two basic arguments against such a policy are the following:
1) Higher inflation does not necessarily entail higher nominal wages (which many people clearly assume). 

Aside from the top quintile of households, real income has been declining for nearly 15 years. The only way higher inflation helps reduce real debt burdens is if nominal wages increase faster than nominal interest rates on debt. If instead higher inflation stems primarily from higher costs-of living (nominal food and energy prices), than most Americans may find themselves in the precarious position of requiring even more debt to maintain current living standards.

2) Higher inflation alters saving, investment and consumption decisions which can lead to a misallocation of capital. On this second point is where Ashwin’s post really hits home:

During most significant hyperinflations throughout history, the catastrophic phase where money loses all value has been triggered by the central bank’s enforcement of highly negative real interest rates which encourages the rich and the well-connected to borrow at negative real rates and invest in real assets. The most famous example was the Weimar hyperinflation in Germany in the 1920s during which the central bank allowed banks and industrialists to borrow from it at as low an interest rate of 5% when inflation was well above 100%. The same phenomenon repeated itself during the hyperinflation in Zimbabwe during the last decade (For details on both, see my post ‘Hyperinflation, Deficits and Real Interest Rates’).
This also highlights the danger in simply enforcing a higher inflation target without taking the level of real interest rates into account. For example, if the Bank of England decided to target an inflation rate of 6% with the bank rates remaining at 0.50%, the risk of an inflationary spiral will increase dramatically as more and more private actors are tempted to borrow at a negative real rate and invest in real assets. Large negative real rates rarely incentivise those with access to cheap borrowing to invest in businesses. After all, why bother with building a business when borrowing and buying a house can make you rich? Moreover, just as was the case during the Weimar hyperinflation, it is only the rich and the well-connected crony capitalists and banks who benefit during such an episode. If the “danger” from macroeconomic policy is defined as the possibility of a rapid and spiralling loss of value in money, then negative real rates are far more dangerous than helicopter money.
These pernicious traits of higher inflation and especially negative real interest rates are entirely compatible with recent experience. Households and businesses “with access to cheap borrowing” have been pouring money into stock, bond, housing and commodity markets rather than investing in tangible capital. The remarkable rise in asset prices has unfortunately not funneled down to households in the bottom four quintiles of income and wealth, only furthering the inequality gap. Recognition of these effects is precisely why a Federal Reserve fearing bubbles, not inflation, would be a significant step in the right direction.

To be clear, similar to Ashwin, I am in favor of “helicopter money” and believe higher wages for the bottom 80 percent are key to ending the balance sheet recession as well as ensuring more sustainable growth and unemployment going forward. Targeting higher inflation and larger negative real interest rates is the wrong approach to achieve these goals and may actually work in the opposite direction. Yes, all macroeconomic policy is dangerous. But even more dangerous is misunderstood and misrepresented macroeconomic policy.

Buiter, Willem H., Helicopter Money: Irredeemable Fiat Money and the Liquidity Trap (December 2003). NBER Working Paper No. w10163. Available at SSRN:


  1. Interesting piece Woj. I'm not sure of a few things though. ARe you saying you are for "helicpoter drops"-which you see as fiscal actoins but are against "macroeconomic policy?"

    If that's what you're syaing I'm totally confused.

    Are you suggesting that there is a danger of hyperinflation if there is too much more easing?

    "These pernicious traits of higher inflation and especially negative real interest rates are entirely compatible with recent experience"

    I realy don't get why as we haven't had high inflation since the 70s-and we've never had hyperinflation. I can understand if you don't prefer certain macroeconomic actions but you seem to be suggesting that they could cause hyerpinflation, something that certainly isn't in our recent experience.

    1. In recent posts I keep weighing length versus clarity and clearly still need to figure out the correct balance.

      My view is that some type of macroeconomic policy will be enacted. Assuming that's true, I agree with Ashwin and many others that "helicopter money" (which really means fiscal deficits) is preferable. The point of this post was to remind many proponents of this policy that dangers do exist in regards to implementation. IMO this aspect is too frequently hand-waived away, which makes poor implementation all the more likely.

      As for hyperinflation, I don't even think current deficits pose a serious inflationary threat. The pernicious traits I was referring to are declining real wages for a majority of Americans and asset bubbles driven by negative real interest rates.

    2. “The point of this post was to remind many proponents of this policy that dangers do exist in regards to implementation.”

      Strikes me there is not much danger of “proponents” and others being unaware of the “dangers”. You only have to mention words and phrases like “helicopter drop” and “print money” and every Austrian and similar economic illiterate starts foaming at the mouth and incanting the words “Mugabwe”, “Weimar”, etc.

      The central point to get across is that (as pointed out by Mervyn King), helicopter drops simply equal monetary and fiscal stimulus combined. I.e. treasury borrows and spends, while central bank prints money and buys back the treasury’s bonds.

      I.e. the central point to get across is that whatever inflationary dangers are involved with helicopter drops, exactly the same dangers apply to monetary and/or fiscal stimulus.

      Which is pretty much what Ashwin said in the quote above: “Whether they are monetised or not, excessive fiscal deficits are inflationary.”

    3. Point taken, although I don't think the dangers of inflation apply to monetary stimulus in the same way as fiscal stimulus, just as the benefits heavily favor the latter (as Warren Mosler has pointed out to me).

      The "dangers" I was hoping to point out were not actually with regard to inflation but rather the unequal distribution of benefits stemming from both forms of stimulus, though primarily fiscal. If proponents of fiscal policy are unaware of this possibility than I think that is a problem and it would help explain the present wealth and income inequality in the US.

      I acknowledge that I should be clearer when discussing inflation and should be more direct in pointing out that fiscal stimulus currently poses no inflationary threat. At the same time I wish MMTers, Post Keynesians and others would follow Ashwin's lead, more frequently discussing the potential distribution and malinvestment problems associated with larger deficits and negative real rates.

  2. As I've mentioned elsewhere the devil is in the detail,There is a great (I think) related post here by Frances Coppola

    Squint hard enough and monetary policy can look like fiscal policy and vica versa, in fact to me it's all about "the powers that be" picking winners. Seems like MM would like central bankers to do this while MMTers would like government to do this. Both sides of that coin can abuse the power, in the past the constraints on money creation power was the distancing of monetary policy from government, this of course proved fatally flawed for two reasons, one, 99% of economists apparently don't understand or have never heard of endogenous money, two, the finance industry on the other hand knew all about it and ran amok.

    Result massive private sector credit missallocation and bubble.

    I'm cynical about both sides of that coin, in fact which ever route you take (monetary/fiscal) I suspect the coin will be rigged on the side of cronyism.

    That said even given the risks I favour the fiscal side, simply because to me it seems that in a balance sheet recession it would be more effective.

    Also, given that I think all economists should have "The pretense of knowledge" stamped on their forehead, caution and baby steps would be my watch word in any policy change.

    TDC my arse!

    1. Haven't had a moment to read Frances' post yet but her work is already very good.

      "The pretense of knowledge" is definitely one of the most memorable articles I've ever read.

  3. Well Ralph, I'm not sure the type of "helicopter" drops that have occurred under all the TALF, TARP and QE initiatives to date, would qualify as both fiscal and monetary actions. Most of the money from these efforts have gone primarily to financial institutions, propping up balance sheets and attempting to extinguish bad debt. One could argue that the purchasing of these so called "assets" would be considered a fiscal action. But, I'd much rather look at fiscal action as being a direct transfer to taxpayers. Let's just cut out the middleman. Besides, with the amount of consumer debt, the financial sector would get a certain amount of that direct transfer anyway. Michal M. Thomas had a solution to the problem along these lines published in 2009:

    1. In one of Ashwin's earlier posts on "helicopter money" he refers specifically to direct transfers, which I agree is more in line with the positive effects many associate with such a policy. Thinking about the topic more I actually don't think the Fed's actions of monetising even matter that much at the permanent floor. I'll have to take a look at that post later.

  4. Thanks Woj. I see that you're tyring. I'm still not sure how much I'm with you. You seem to be saying that fiscal stimulus is preferrable to monetary-and that the ill effects you're describing come mostly from monetary?

    I'm not at all sure I agree with you and Ashwan about negative interest rates. Historically speaking when was the last time we've ahd them so we can factor in history in this judgment?

    What interests me-but I haven't figured out yet-is how you can mix post Keynesiansm and Austrianism. On the level of policy at least aren't they totally opposed to each other? Austrianism says you should not have either fiscal or monetary stimulus. any problems will only be exacerbated when the Govt gets involved.

    PK says the opposite-we need a deficit during recessions. Indeed, PK-as opposed to the New Keynesians-even thinks we need deficits during up times though even they recognzie an outer limit when there's no more slack in the economy.

    As for worries about inflation would you agree that it's only even a hypothetical probelm when there's no more slack in the economy?

    1. Fiscal stimulus is preferable to monetary AND the ill effects stem largely from fiscal.

      Here is a chart of Fed funds minus CPI (,). Negative real rates at the short-end have actually been quite common in the past 15 years. It would be interesting to compare this data against changes in real assets over time.

      Austrian does not explicitly or implicitly say that counter-cyclical fiscal or monetary actions shouldn't be taken. It does warn that these policies are likely to be implemented in manners that don't achieve the desired outcome (sometimes intentionally). Post-Keynesians either have far more faith in positive outcomes from these actions or see the downside of not acting as worth the risk. In terms of understanding monetary operations and macroeconomics interactions, I think the Post-Keynesians are much more on target. Simply knowing what should be done, however, does not make it significantly more likely politicians will have incentives to implement those policies (as we've seen). Furthermore, there are many more policies on the fiscal side that don't affect the budget but nonetheless alter the allocation of capital (i.e. housing and debt subsidies).

      As I frequently try to point out, if you read the proposals of Minsky or Mosler they display a far smaller govt than we have today. It's perfectly compatible to have a smaller government in terms of regulation and tax policies while maintaining deficits throughout the business cycle. Focusing on the deficit as the size of govt is highly misleading.

      Greece has experienced consistent inflation recently despite enormous slack and massive declines in output. The normal mainstream view that inflation (as measured) can't exist with slack appears wrong based on recent experience. I would agree that high inflation seems unlikely with significant slack, outside of a govt collapse (more in line with the Middle East at present).

    2. My reading (purely blogosphere though) of what separates post keynesians from well everyone else including Austrians is a recognition of the realities of banking and endogenous money or do Austrians recognise endogenous money?

      Once you get past that it's all whether you believe lever pulling based on this understanding will give you the results you desire.

      Given that context I then think having an "Austrian" mindset is perfectly valid. That said I find it harder to justify a monetarist mindset given that context.

    3. The majority of Austrians (today) don't appear to recognize endogenous money in the Post-Keynesian sense. Hayek and Mises both considered the potential of a boom being led by excessive "inside" money, with Hayek far more open to the idea.

      As for everything else you said...exactly!

  5. I think your point Nanute is not that stimulus is bad per se, but more you want it allocated in a more progressive way.

    There's a big difference between saying that more money in the hellicopter drop should go to the little guy and saying it shouldn't happen at all.

    According to Steve Keen-and he would know-Australia did what we probably would have liked-each taxpayer got an average of $968 in "hellicopter money' via a check from the Treasury.

  6. Mike
    Follow my link. Thomas was proposing 25k per taxpayer based on the amount of the bailout. I strongly favor direct transfer fiscal stimulus under current conditions. More bang for the buck.

    1. Study my Letter on (Search: Crazy Inbox)