Submitted by Michael Krieger:
What follows are some excerpts from Banana Republic Ben’s latest blog post titled, What Tools Does the Fed Have Left? Part 3: Helicopter Money.
When monetary policy alone is inadequate to support economic recovery or to avoid too-low inflation, fiscal policy provides a potentially powerful alternative—especially when interest rates are “stuck” near zero. However, in recent years, legislatures in advanced industrial economies have for the most part been reluctant to use fiscal tools, in many cases because of concerns that government debt is already too high. In this context, Milton Friedman’s idea of money-financed (as opposed to debt-financed) tax cuts—“helicopter money”—has received a flurry of attention, with influential advocates including Adair Turner, Willem Buiter, and Jordi Gali.
In this post, I consider the merits of helicopter money as a (presumably last-resort) strategy for policymakers. I make two points. First, in theory at least, helicopter money could prove a valuable tool. In particular, it has the attractive feature that it should work even when more conventional monetary policies are ineffective and the initial level of government debt is high. However, second, as a practical matter, the use of helicopter money would involve some difficult issues of implementation. These include (1) the need to integrate the approach with standard monetary policy frameworks and (2) the challenge of achieving the necessary coordination between fiscal and monetary policymakers, without compromising central bank independence or long-run fiscal discipline. I propose some tentative solutions for these problems.
To be clear, the probability of so-called helicopter money being used in the United States in the foreseeable future seems extremely low. The U.S. economy has continued to strengthen and is not today suffering from the severe underutilization of resources and very low inflation (or even deflation) that would justify such an approach; and, as I’ve noted, the Fed has other tools still available. Nevertheless, it’s important that markets and the public appreciate that, should worst-case recession or deflation scenarios occur, governments do have tools to respond. Moreover, with central banks in Europe and Japan struggling to reach their inflation targets, money-financed fiscal actions may receive more attention outside this country.
As I learned when I spoke about it in 2002, the imagery of “helicopter money” is off-putting to many people. But using unrealistic examples is often a useful way at getting at the essence of an issue. The fact that no responsible government would ever literally drop money from the sky should not prevent us from exploring the logic of Friedman’s thought experiment, which was designed to show—in admittedly extreme terms—why governments should never have to give in to deflation.
To get away from the fanciful imagery, for the rest of this post I will call such a policy a Money-Financed Fiscal Program, or MFFP.
This is textbook Bernanke. Use a sophisticated sounding term to describe a scheme as old as the hills; the printing of money to directly finance government spending.
To illustrate, imagine that the U.S. economy is operating well below potential and with below-target inflation, and monetary policy alone appears inadequate to address the problem. Assume that, in response, Congress approves a $100 billion one-time fiscal program, which consists of a $50 billion increase in public works spending and a $50 billion one-time tax rebate. In the first instance, this program raises the federal budget deficit by $100 billion. However, unlike standard fiscal programs, the increase in the deficit is not paid for by issuance of new government debt to the public. Instead, the Fed credits the Treasury with $100 billion in the Treasury’s “checking account” at the central bank, and those funds are used to pay for the new spending and the tax rebate. Alternatively and equivalently, the Treasury could issue $100 billion in debt, which the Fed agrees to purchase and hold indefinitely, rebating any interest received to the Treasury. In either case, the Fed must pledge that it will not reverse the effects of the MMFP on the money supply (but see below).
Could the central bank implement an MFFP on its own? Some have suggested an alternative approach in which the central bank prints money and gives it away—so-called “people’s QE.” From a purely economic perspective, people’s QE would indeed be equivalent to a money-financed tax cut (Friedman’s original helicopter drop, although perhaps more targeted). The problem with this policy, which would certainly be illegal in most or all jurisdictions, is not its economic logic but its political legitimacy: The distribution of what are effectively tax rebates should be subject to legislative approval, not determined unilaterally by the central bank. I’ll return to the issue of MFFP governance in a moment.The most difficult practical issues surrounding MFFPs involve their governance—who decides, and how? Unlike orthodox fiscal and monetary policies, MFFPs would seem to require close coordination of the legislature and the central bank, which may be difficult to manage in practice. To the extent that that coordination is successful, some worry, it might put at risk the longer-term independence of the central bank. Another concern is that the option of using money finance might be a “slippery slope” for legislators, who might be tempted to use it to facilitate spending or tax cuts when such actions no longer make macroeconomic sense.
Of course, this is exactly what would happen. Moreover, can you even begin to imagine the inside deals and crony spending that would follow such a policy? It’ll make the wasteful spending seen in Afghanistan and Iraq look responsible by comparison.
The writing is on the wall, and the choppers are being warmed up. You’ve been warned.
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