When Zero Just Isn't Low Enough
brad delong is an economist at the University of California, Berkeley, and creator of the blog "Grasping Reality with the Invisible Hand." He was deputy assistant secretary of the Treasury in the Clinton administration.
Illustrations by Nigel Buchanan
Published on January 17, 2017
If you pay much attention to the chattering classes — those who chatter about economics, anyway — you've probably run across the colorful term "helicopter money."
At root, the concept is disarmingly simple. It's money created at the discretion of the Federal Reserve (or any central bank) that could be used to increase purchasing power in times of recession. But the controversy over helicopter money (formally, money-financed fiscal policy) is hardly straightforward.
Here's my take on why helicopter money has entered the zeitgeist now, why it is so appealing to those of us who worry that macroeconomic stimulus will be insufficient to keep the economy chugging forward – and why proponents and critics seem inclined to talk past each other.
With unemployment back below 5 percent and no portents of a downturn visible, it's fair to say that the American economy has recovered from the collapse of the mortgage finance bubble and the Great Recession that followed. But the recovery has been marred by the reality that a fair portion of the decline in unemployment from its 2010 peak of 10 percent has come about because millions of the unemployed have given up looking and dropped out of the labor force.
Actually, the picture is even darker. While American workers are finally enjoying the bigger paychecks expected during a recovery, in the long run increases in living standards are limited by the rate of economic growth. And growth remains anemic because the positive impact of putting Americans back to work has been partly offset by a downturn in labor productivity (output per hour worked). Indeed, the only bright spot here is a relative one: Japan and most of Europe are in worse shape.
Thus, one factor that has driven the notion of helicopter money into policy nerds' consciousness is fear of what Lawrence Summers, the former secretary of the Treasury, called secular stagnation. Another is the drift toward dependence on monetary policy for macro stabilization dating from the late 1970s, when stagflation stalked the land.
That period of little growth and much inflation convinced a lot of politicians that they did not want responsibility for managing the business cycle – that to assume responsibility was to accept blame because it would often go badly. And even when stabilization policy went as planned, it often required policymakers to exact a lot of pain from the voters.
When Congress and the White House decided to duck and cover in the face of stagflation, Fed Chairman Paul Volcker stepped up to fill the leadership vacuum. Which he did with a vengeance, engineering a nasty recession in 1980 in order to jolt Americans out of the self-fulfilling expectation of high and accelerating inflation. And so began the golden age of the central banker.
After 1980, the Fed and its counterparts elsewhere in the industrialized world were celebrated for their "independence," as they effectively freed policymaking from business-as-usual meddling by rent-seeking lobbyists and vote-seeking politicians. They were tasked to be good technocrats, finding the path between the Scylla of inflation and the Charybdis of unemployment without interference.
That was certainly the idea. But a question remained: Did the Fed have the tools to do the job alone? Volcker's view, and the consensus view of mainstream economists, was that it did. Milton Friedman and other monetarists had demonstrated that central banks' powers to create money and to both supervise and rescue the banking system were more than enough to keep the economy on cruise.
Yes, there were dissenters who nurtured the flame lit by John Maynard Keynes. Back in 1936, Keynes argued:
It seems unlikely that the influence of banking policy on the rate of interest will be sufficient by itself. … I conceive, therefore, that a somewhat comprehensive socialization of investment will prove the only means of securing an approximation to full employment, though this need not exclude all manner of compromises and of devices by which public authority will cooperate with private initiative.
By the 1980s, however, the Keynesians had scattered. The Great Moderation of the business cycle in 1984-2007, in which recessions were infrequent and mild, and inflation never reappeared, was a rich enough pudding to be widely seen as proof that Friedman, with his faith in the curative powers of monetary stability, had been right.
But in the aftermath of the crash in 2008 it became very clear that all those complacent Fed-worshipping economists – a group that included me – were dismally wrong. Thankfully, the crisis opened a window of opportunity in which politicians and economists alike could assert the need for government to offset cratering aggregate demand with a huge package of tax cuts and temporary government outlays. That window has since closed, of course, as the "Very Serious People" (Paul Krugman's mocking phrase) have reasserted their faith that budget deficits are inevitably bad for children and other living things.
The Fed – and, more reluctantly, the central banks of Britain and the eurozone – have attempted to fill the breach left by the fiscal retreat by driving interest rates to near zero (or even below) with massive conventional "open market" purchases of Treasury securities and unconventional purchases of trillions of dollars' worth of other financial assets.
This has helped prop up private demand, but not sufficiently to cure all that ails in timely fashion. Moreover, the reliance on low interest rates to drive demand is beginning to concern mainstream economists – and not just those Very Serious People who have been forecasting runaway inflation since 2008. Among other worries, very low returns on bonds have the potential to create bubbles in other assets as investors scramble for profit. Low returns on fixed-return assets are deepening the crisis for underfunded pension plans that have been counting on a bounceback to cover their obligations.
Now, in broad terms, we face a choice:
1. Acknowledge performance that a generation of economists would have characterized as grossly subpar by historical standards, demanding that central bankers improve on it without giving them additional tools.
2. Return the task of managing the business cycle to the political branches of government, which so happily ceded it to the Fed in the 1980s.
3. Supplement the Fed's tool kit, so the technocrats have a shot at meeting the mandated goals.
I believe that helicopter money (which I really will explain in more detail below) is the tool that would make Option 3 possible. Ideological conservatives intent on minimizing the reach of government generally go for Option 1, reiterating that the "cold douche" of unemployment, as Joseph Schumpeter put it in the midst of the Great Depression, would in the long run turn out to be good medicine for some reason or other. They generally go on to argue that Option 3 is really an illusion – that adopting it would eventually put central banks at great risk of losing their independence and end up as a prelude to Option 2, which must inevitably end badly.
We know that, were he alive today, Friedman would go for Option 3 because this was his recommendation for Japan two decades ago, when that country was bogged down in a situation much like the one facing the United States and Europe today. The interest rates controlled by the Bank of Japan had more or less bottomed out at zero, yet the economy was operating well below capacity.
We have yet to specify, though, just how helicopter money would stretch the Fed's powers sufficiently to make Option 3 viable.
What's the Appeal?
The argument made by Friedman in comments about Japan in the late 1990s was set out at greater length and depth by Ben Bernanke, who was then on the faculty at Princeton. Central banks, he insisted, still had the technical capacity to stimulate their economies even when interest rates could not be pushed lower. All they needed was the authority to put money in the hands of households, businesses or government agencies, giving them purchasing power without creating an equivalent liability.
The simplest way to think about this is to imagine that the Fed printed $100 million in $100 bills and dropped the cash by helicopter over downtown Chicago on a windy day. This "helicopter money" would make the finders $100 million richer without adding to the federal debt. Presumably, most of the $100 million would be spent fairly quickly, increasing the demand for everything from haircuts to ham sandwiches.
More practically, if less intuitively, helicopter money could also take the form of bank deposits – say, electronic transfers to everyone who filed a federal income tax form, or a nine-figure dollar transfer to, say, the Federal Aviation Agency, to pay for new computers for the air traffic controllers.
So, whatever happened to the no-such-thing-as-a-free-lunch adage? A large enough lunch (helicopter drop) would indeed create inflation if the newly created purchasing power exceeded the capacity of the economy to create the extra goods and services demanded. But it is surely not beyond the ability of the policy wonks at the Fed, who are less burdened by political considerations than policymakers elsewhere in the government, to prevent such overshooting.
There's also the issue of asset bubbles. It's possible that recipients of the windfall income would spend it on existing assets – stocks, real estate and the like – bidding up their value instead of buying new goods and services. But that in itself would not necessarily damage the economy. The "wealth effect" of bidding up asset prices would presumably loosen consumers' purse strings, accomplishing the desired effect, albeit indirectly.
The catch cited by Bernanke was that the public would consider the gift too good to be true – that recipients would hoard their new wealth in expectation of future tax increases. But, on reflection, this echo of the "Ricardian equivalence" argument against the lack of efficacy of deficit spending doesn't make much sense. Helicopter money doesn't create a debt that needs to be repaid any more than running the mint's printing presses to satisfy the public's demand for currency creates a government liability.
For the record, neither Friedman nor Bernanke seems to have been the first widely respected economist to conjure the virtues of helicopter money. Jacob Viner, the great economist who led the University of Chicago's rise as the intellectual counterweight to Keynesianism, opposed government deficit spending during the Great Depression, but argued that "the simplest and least objectionable procedure would be for the federal government to increase its expenditures or to decrease its taxes, and to finance the resultant excess of expenditures over tax revenues either by the issue of legal tender greenbacks or by borrowing from the banks."
Thus, the concept has a long and impeccable right-wing pedigree. Helicopter money – or as I'll refer to it interchangeably, money-financed fiscal policy – would allow us to preserve our current institutional order and keep macroeconomic stabilization policy on a technocratic, central bank-focused basis. Yet it would avoid burdening future generations with the task of amortizing interest-bearing debt that comes with standard expansionary fiscal policy. Arguably most relevant for the deflationary world we now live in, helicopter money could stimulate aggregate demand at times when conventional monetary policy is running on fumes.
Arguably most relevant for the deflationary world we now live in, helicopter money could stimulate aggregate demand at times when conventional monetary policy is running on fumes.
Why it Isn't Catching on
Why, then, have the latest proponents of helicopter money – notably, Adair Turner, the former chief regulator of Britain's banks – been greeted with skepticism verging on blunt dismissal? Those of us intrigued by the idea have been trying to figure that out for quite a while now. I suspect it has a lot to do with many commentators' deep ambivalence toward central bankers' independence, along with nostalgia for the decades in which conventional monetary policy worked wonders.
On the one hand, leaving monetary policy solely to members of the Fed's Open Market Committee – some of them appointed by the White House for long terms and some appointed by private bankers – seems undemocratic. On the other, the Fed's freedom from second-guessers is widely believed to make it more effective in balancing competing goals and even pioneering new policy strategies (think quantitative easing) when the times called for more.
This offers clues to why opponents of money-financed fiscal policy almost always begin their critiques by asserting the obvious: the use of helicopter money for stimulus would largely mimic the impact of conventional fiscal policy, minus the residue of government debt that the latter leaves in its wake. Claiming the authority to use helicopter money would thus extend the powers of the Fed into the space reserved for the executive and legislative branches, increasing concerns that an agency with vast power would be free to act without the consent of elected officials.
Actually, these concerns cut both ways. The choices made in targeting a helicopter-money drop – say, offsetting payroll taxes rather than income taxes, or adding money to the FAA's infrastructure funds rather than supporting railway repair – would invite public second-guessing and intervention by Congress and the President. Indeed, it is hard to imagine the Fed singling out beneficiaries without soliciting advice from the other branches of government. Thus, for better or worse, the status quo would be upset; in acknowledging its fiscal powers, the Fed would almost inevitably lose some measure of independence to determine the magnitude, means and timing of its efforts to stimulate the economy.
A close look suggests, however, that there is a bit less to these concerns than initially meets the eye. One perceived vice of money-financed fiscal policy is that it is not constrained by fears of raising the government debt. Hence, the worry that the Fed would come under pressure from elected representatives to stimulate the economy by more than is prudent. The irony, of course, is that one of the great virtues of helicopter money for Japan is that it could deliver much-needed stimulus without adding to an already humongous public debt.
In any event, this is an issue the Fed has faced for a century in its exercise of conventional monetary policy, where the short-term benefits in terms of growth, employment and profit must be weighed against the risk of future inflation. Indeed, it looks like the rerun of the even older argument about the gold standard, which guaranteed that the government would keep its hands out of the proverbial cookie jar at the cost of leaving that same government powerless to manage short-term fluctuations in aggregate demand. I see no reason to conclude that giving the Fed authority to mix and match fiscal and monetary measures would tempt the agency to change its priorities in macroeconomic management.
Michael Heise, the chief economist of Allianz SE, a German financial services conglomerate, offers a variation on this theme. Access to helicopter money, he suggests, would give ill-disciplined governments one more way to delay the structural reforms that are keeping unemployment high and growth low.
The catch here is that every empirical study of when structural reform works and when it doesn't concludes that success is more likely in an economy operating near full capacity. This stands to reason: getting a government agency to shed employees or persuading a dominant business to lower barriers to its industry is a lot easier when jobs are easy to find and profits are high. In other words, helicopter money could serve as a complement to structural reform – not a substitute.
There's another dimension to the power-independence calculus, however. The Fed's power, now primarily exercised through purchases and sales of securities, must inevitably favor some interests over others, changing the distribution of income and wealth between savers and borrowers, between banks and industrial entities, between labor and the owners of capital, between capital-intensive industries and others – you name it. Extending its reach into fiscal policy might make the awesome power of the Fed more visible and thus invite more pushback from other branches of government, but it would not fundamentally change the tension between the competing attractions of making economic policy by representative democracy and leaving it to the technocrats.
Bernanke, who, unlike a majority of policy economists who have spoken out on the subject, favors the use of helicopter money in some circumstances, would directly address the power-independence tension. He would formally assign the Fed the authority to propose the timing and magnitude of money-financed fiscal policy, while giving Congress and the White House the power to determine how the stimulus would be spent – or to veto the initiative.
That's certainly a plausible way to divide the baby. One must wonder, though, whether giving Congress and the White House so much discretion would really lead to evidence-based public policy in an era in which so many elected officials are proud of their ignorance of macroeconomics and so determined to reduce the reach of government. An alternative would be to curtail the independence of the Fed only in terms of how the helicopter money could be spent. One might, for example, ask Congress to choose one large, broad target that is relatively uncontroversial – say, limiting it to rebates on the federal payroll tax.
Why it Isn't too late, or too soon
The argument over helicopter money may strike some as an argument whose time has passed, at least in the context of the U.S. economy. For one thing, the economy seems to be inching toward full capacity, at least by the diminished expectations of the 21st century. Accordingly, the Fed is now debating when to retreat, not how to squeeze a bit more juice out of monetary policy. For another, while Keynes may be dead, he can always be resurrected. Governments retain the power to stimulate the economy using old-fashioned expansionary fiscal policy – as in, borrow and spend.
But, all too recently, we have heard various and sundry conservative thought leaders ranging from House Speaker Paul Ryan to German Chancellor Angela Merkel insist that expansionary fiscal policy would be fine – but only if government debt were lower. So if you really want to retain expansionary fiscal policy as an option, but acknowledge that the political lift is Sisyphean in today's environment, helicopter money no longer looks like an academic curiosity. Money-financed fiscal policy delivers the high without the hangover – a big advantage in these (and other) times.
Then there's the matter of the efficacy of conventional monetary policy the next time recession looms. Right now, the projection by participants in the Fed Open Market Committee meetings is that the Treasury bill rate will most likely top out at 3 percent in this business cycle, and it would be a brave meeting participant who would claim we're likely to get there (if we get there at all) before 2020. That would not provide enough room for the Fed to loosen monetary policy by even the average amount of slack seen in previous post-World War II recessions. Odds are, then, that standard open market operations will not be up to the task when the next adverse shock hits the economy.
Of course, necessity is the mother of invention and all that. As Fed chairman, Ben Bernanke took a lot of criticism in pushing quantitative easing as a means of supplementing stimulus when conventional monetary policy reached its limits and the Tea Party made further fiscal stimulus unthinkable. But do we really want to postpone a serious discussion of helicopter money until Janet Yellen or her successor hits the wall the next time around?
related topics: Financial System, Economy: Global