The helicopter paradox

I recently suggested that there's a paradox about inheritance tax - that the sort of people who instinctively support it should in fact oppose it, and vice versa. I suspect there's a similar paradox with the debate about helicopter money - those who advocate it should in fact think it'll be little better than other policies, whilst those who should most favour it seem not to do so.

To see what I mean, let's define helicopter money. It does not mean that Sir Mervyn throws £20 notes from a heliopter. Instead, it means that the government hands money to the private sector - by, say, a tax cut or increased investment.It finances this by issuing gilts which are immediately bought by the Bank of England with newly-created base money. Those gilts are then cancelled. A helicopter drop, then, as Simon says, is just a money-financed fiscal expansion. But how does this differ from a bond-financed expansion, in which the government sells gilts to the private sector?

The standard answer* is that the extra supply of gilts reduces their prices and hence raises their yields; in the textbook model, we move up the LM curve. This increases borrowing costs for companies, thus  reducing capital spending and so - to some degree - offsetting the fiscal stimulus.

The case for a money- rather than bond-financed fiscal stimulus thus rests upon the response of gilt yields to extra supply. The more gilt yields rise if their supply increases, the better - in terms of macro stimulus - is a money-financed expansion.

Who, then, would we expect to support a money-financed stimulus? Obviously, the sort who think that extra gilt issuance would frighten the markets.

By contrast, the sort of people who think there's huge demand for safe assets - so the government can sell gilts without depressing their prices much - won't see much advantage in a money-financed fiscal expansion over a bond-financed one.

Which brings me to my paradox. This exactly not the division we're seeing. For example, Martin Wolf endorses a helicopter drop, but he has written that "the massive fiscal deficits being run by the UK and US are not...crowding anybody out of the market." But if you believe the latter - as I suspect you should - then a bond-financed expansion is fine and we don't need a helicopter drop.

On the other hand, we'd expect Tories - who want government debt to come down - to favour a helicopter drop. But AFAIK, few do so.

There is, I think, an explanation here. A money-financed fiscal expansion, as Simon and Sir Mervyn agree, tends to raise future inflation. To some this is no problem and might even be a good thing. To others, it is. Perhaps, then, the old division between rightist inflation hawks and leftish/Keynesian inflation doves lingers on**.

* I'm ignoring Ricardian equivalence, as this doesn't seem a live issue now.

** Sir Mervyn and Mark Carney both oppose helicopter drops. This isn't necessarily because they are inflation hawks. It might be because they see the inconsistency between raising future inflation and retaining an inflation target.

Comments

[PoachedWonk]

Yes that's exactly the point. Its fears over inflationvs the political situation in the UK in which the government is loath to increase debt.

This isnt a paradox, the left are being realists, the right are unfortunately being irrational (based on current economic conditions)

[Luis Enrique]

"the government hands money to the private sector"

odd choice of words, it makes me think of corporate welfare, but of course seigniorage financed fiscal expansion could involve such things as increased benefits for the unemployed, low income households, more spending on the NHS or public infrastructure (roads, parks etc.) and all manner of things one would not usually characterise as handing money to the private sector.

[Luis Enrique]

what about this alternative case for helicopter money?

1. we need to tackle unemployment directly by having the government hire workers, we need to give poor households more disposable income, via tax cuts or benefit increase. Anyway, some version of "we need fiscal stimulus" argument
2. we can't afford to borrow any more (either can't or won't)

so burst of seigniorage will unlock the needed fiscal stimulus.

[Bill le Breton]

Is it not a case of paying a nurse or a builder with a cheque drawn on the Government’s account at the Bank of England?

When the nurse and the builder take their cheques to their commercial banks, the banks present them to the Bank of England which then credits the commercial bank’s account at the Bank of England with deposits.

The newly created money goes directly into the income stream [for cheque substitute electronic transfer]as recommended by Friedman in 1948.

The change in the money supply is equal to the PSBR + change in bank lending to non-bank private sector – change in non-bank private sector lending to the public sector + overseas impact on money supply

Other than trying to get around Maastricht why involve gilts?

Central Bankers don’t want this cat let out the bag again – but one could link the extent of this kind of money creation to the cyclical element of the deficit

The advantage is that it leads directly to increased aggregate demand.

[monoi]

"it means that the government hands money to the private sector - by, say, a tax cut ..."

Do you mean the money that the governement took from that private sector in the 1st place via, let's say, a tax!?

[Ralph Musgrave]

Luis Enrique above asks if helicopter money is justified on the grounds that we cannot afford to borrow more. The answer is “no”. Reason is that the real, or inflation adjusted rate of interest that government pays on its debt is around zero. I.e. the UK government could easily borrow more, not that I’m in favour of that.

Moreover, as pointed out on the Billyblog site and the New Economic Perspective blog recently, a monetarily sovereign country can pay any rate of interest on its debt it wants. I explained the latter point on my own blog recently:

http://ralphanomics.blogspot.co.uk/2013/02/the-national-debt-and-deficit-are-total.html

[Luis Enrique]

Ralph

you've missed my meaning somewhat, no doubt my fault. I know we could easily borrow more. But we might be at a point where we don't want to borrow any more, for whatever reason.

p.s. I'm less keen than you on arguments along the lines of "we don't need to worry about inflation created by monetary largesse, we can always disinflate by raising taxes sharply". That's much easier said than done. Which politicians do you see capable of driving through sharp tax increases for that reason? Plus I think even the most ardent deficit fetishist would have fewer worries if they thought it would be easy for us to raise future taxes sharply.

[Brian S.]

"There is, I think, an explanation here. A money-financed fiscal expansion, as Simon and Sir Mervyn agree, tends to raise future inflation."
- and the empirical (rather than an appeal to authority or dodgy theory) proof of this is where exactly?

Always, when this fiscal solution is discussed, the heads of the equilibrium gurus shake and the Weimar-Zimbabwe demon is invoked. I say try it and see what happens - maybe, just maybe, the sky might not fall down.

[aragon]

Following the pathetic announcement from the Labour party. What matters is the size of the drop. A Helecopter drop has the advantage of been immediate and is a one off.

QE is added to the defict on the assumption it will be unwound in the future.

A move to MMT or IHT funding would allow an escape from the 'Bond Vigilantes', who serve no purpose but their own. MMT would also involve more fundimental changes to the money supply and IHT/LVT to the distribution of capital.

Luis raising IHT or other taxes on wealth like a LVT, should be possible, as it does not impact on most of the population, the problem with the economy is the concentrations of wealth (accumulated capital) and a uncontrolled of control finance sector, controlling the money supply.

[Luis Enrique]

Aragon,

Unless the tax increase has a broad impat on the economy, I don't think it would be deflationary, which is the purpose in this context

[aragon]

Luis,
Price inflation from devaluation and debt deflation following asset inflation.

IHT has the potential to impact in the order of one percent of GDP per annum.

The top ten percent of the population, or even one or top tenth of a percent, have seen thier wealth increase the most.

As the bank robber said about banks: "That's where the money is..."

I don't see price inflation other than from currency devaluation is likely,given debt deflation and I suspect any fiscal stimulus will be small.

[aragon]

I have read the Martin Wolf article and I subscribe to MMT - Chicago plan etc.

I did not associate the term 'Helecopter money' with full MMT but the short term stimulus.

Which implied debt-deflation rather than hyper-inflation, and fund a least half a trillion of public investment, and a short term stimulus.

An effective IHT tax could be used as a sheet anchour, in the event of unexpected (an unpredicted) inflation.

I don't know what others are proposing.
There is always interest rates!

[oldcobbler]

Most mainstream politicians currently seem to regard 'helicopter money' as dangerously inflationary, leading to "too much many chasing too few goods". Meanwhile, the same politicians make repeated calls for increased bank lending. Am I alone in finding this bewildering ?

[gastro george]

"Most mainstream politicians currently seem to regard 'helicopter money' as dangerously inflationary, leading to "too much money chasing too few goods"."

Which is not appropriate in the current climate, when there is plenty of spare capacity.

What inflation we have would appear related to energy and commodity costs, and devaluation (which is, of course, a risk).

[Ralph Musgrave]

Luis, I quite agree that there are political difficulties in raising taxes (even where the purpose of the tax increase is simply to head off inflation – i.e. the tax increase has no effect whatever on disposable incomes). But there is a dilemma there: do we abstain from giving the economy an adequate boost NOW and endure excess unemployment and all on the grounds that reversing the boost might be difficult in two years time? Difficult.

Brian S., Simon and Sir Mervyn’s thinking in this area is even less well thought out than you suppose. Given that they both concede that helicoptering comes to the same as combining fiscal and monetary stimulus, I fail to see how they can claim helicoptering is more inflationary than a combination of fiscal and monetary stimulus! If A+B=C, then A+B=C, unless I’ve missed something.

[Luis Enrique]

Ralph,

well if you think that "reversing" helicopter money via increasing taxes and giving the money thus gathered to the central bank to remove from circulation is harder than having the central bank sell the bonds it bought during QE (or conventional MP), there's your answer. Particularly if you give lots of weight to the expectations channel, then inflation today will be lower if people are expecting inflation tomorrow to be kept under control. If you think helicopter money decreases the ability to keep inflation tomorrow under control, then inflation today will be higher.

[Jordan Retro shoes]

Great stuff!

Words and thought are inextricably linked. Sloppy wording produces, or is a product of, sloppy thought.