The recent debate in the United States over helicopter drops and quantitative easing is very important. It is, therefore, essential that sound economic logic is applied to separate out key issues.
In ‘Helicopters Don’t Help (Wonkish)’, New York Times, 9 December, Paul Krugman compliments David Beckworth on trying to establish the irrelevance of ‘helicopter money’. A rebuttal of the Beckworth analysis is at ‘Helicopter Drops and Quantitative Easing are Different’, Richard Wood, EconoMonitor, December 11.
The debate about helicopter drops extends beyond the United States to Japan and to Europe. Helicopter drops are most acutely relevant to highly-indebted countries suffering from recessions/depressions and with no independent monetary policy, and no capacity to achieve external devaluation. But it is also relevant to Japan and the United States.
Krugman asserts that ‘…in financial terms, at least, the central bank is part of the government’. There is one sense, at least, in which this assertion is invalid. If the central bank was to create new money and transfer it to the Treasury to finance a budget deficit in exchange for government bonds then general government debt is increased. This follows because government bonds held by the Federal Reserve are classified as ‘debt held by the public’, as the central bank is defined as being an ‘outside investor’, for this purpose. Credit rating agencies focus on general government debt when considering adjustments to credit ratings, and they ‘see through’ to recognise that central banks could on-sell government bonds back to the public at any time. These considerations mean that, in practice, and in one important respect at least, the central bank is not regarded as part of the government in financial terms.
For this reason, those among us who propose giving serious consideration to helicopter drops recommend, as one option, that the Treasury, and not the central bank, create the money for use in the helicopter drop. In this way there can be no increase in public debt. In the special case of the Eurozone countries, and to address Article 123 of the Lisbon Treaty, it is proposed that special non-transferable, non-redeemable, and non-interest bearing (in other words, non-debt) bonds be issued to the central bank in exchange for newly created euros to finance fiscal reflation programs. One could read this either as non-debt financing or as monetization of new debt issues, but in any case there would be no new net debt creation (See Biagio Bossone and Richard Wood, ‘Overt Money Financing of Fiscal Deficits: Navigating Article 123 of the Lisbon Treaty’, EconoMonitor, July 22). Such a solution would replicate Krugman’s “permanence” condition of the central bank buying government debt via QE.
Later in his article, Krugman asserts that …’ banks briefly hold some government bonds, before selling them back to the government via the central bank’. This assertion includes the erroneous implicit assumption of ‘hypothecation’. Not only that, but it ignores the fact that the new government bonds were in fact issued to the private sector (banks, in his example). This directly increases public debt.
Differences between helicopter drops and quantitative easing
The key differences between properly constructed helicopter drops (option i) and quantitative easing combined with bond financed budget deficits (option ii) are that:
a) ‘public debt’ is not increased under option i) but is under option ii);
b) under option ii) the new money is provided to commercial banks, high wealth investors and speculators, whereas under option i) it flows directly to the real economy. Thus, under option i) it reaches the unemployed, the disadvantaged and workers employed in the infrastructure sector, areas in the economy where the marginal propensity to consume and the multipliers are relatively high;
c) under option i) all the many adverse side effects of option ii) are avoided. The Ricardian equivalence issue does not arise under option i).
d) Under option ii) the policy is designed to increase asset prices not consumer prices, whereas under policy option i), as the new money gets injected directly into the real economy, there is a greater chance that the tendency toward consumer price deflation — apparent after years of applying option ii) — could be addressed. If excess liquidity were to develop as the economy approaches full employment it could easily be withdrawn by sterilisation under option i). That is why the obsession in the American debate with ‘permanency’ of the monetary injection seems misplaced, at least in relation to a properly constructed helicopter drop;
e) the fiscal and monetary policy combination under option i) is far more powerful than that under option ii): there is a much stronger impact on consumer spending, and it can address recessions/depressions, high unemployment, the deflationary tendency and high public debt simultaneously. (See McCully and Pozsar, ‘Helicopter Money: Or how I stopped worrying and love fiscal-monetary cooperation’, Global Society of Fellows, 7 January 2013).
Krugman assumes that there is a public deficit to be financed, to start with, and argues that financing it directly or indirectly through QE would be equivalent (under the permanence condition). However, QE is intended to lower interest rates, and the uncoordinated action by the government and the central bank risks creating opaqueness and misperception as to who does what, and for what purpose. Policy effectiveness would be much improved under a clear, transparent, time-bound, and outcome-related understanding that the government would commit to a fiscal program to support demand and high-powered money would be used to finance it. (The implications of the various forms of unconventional monetary policy are discussed in Biagio Bossone, Unconventional monetary policies revisited (Part I & II), Vox 4/5 October 2013).