Helicopter Money
Stephen Grenville, Visiting Fellow, Lowy Institute (via VOX)
Ideas about ‘printing money’ and ‘helicopter money’ are in vogue. This column unpacks these misleading terms and explores what quantitative easing and Overt Monetary Finance might mean for the deficit. The case for Overt Monetary Finance needs to be balanced by considering the distortions which quantitative easing – and, in fact, potentially Overt Monetary Finance itself – might have on bank balance sheets, as well as their potential to damage central-bank independence.
In the current debate about monetary policy, two terms are bandied about to the detriment of clarity: ‘printing money’ and ‘helicopter money’ (Sinn 2011).
Printing money
To describe quantitative easing as ‘printing money’ is a misnomer. The amount of currency held by the public is determined by demand. When the Bank of England carries out quantitative easing, it pays for the bonds by crediting the seller’s bank. There is an increase in base money in the form of bank deposits at the central bank, but the demand for currency hasn’t changed. There is no need to ‘print money’.
An individual bank with excess holdings of deposits at the Bank of England might try to reduce these by creating new credit or buying other assets. But whatever individual banks do, the total amount of base money remains unchanged.
Helicopter money
The image of the central-bank helicopter dropping currency onto the eager public below is even more misleading. Governments can do this, giving away either cash or, more realistically, cheques (the Australian government sent cheques to most taxpayers in 2009, dubbed the ‘cash splash’). But this is fiscal policy, not monetary policy. Central banks have no mandate to give money away (they can only exchange one asset for another, as they do in quantitative easing). Decisions like this are backed by the usual budget-approval process. Thus it is a government helicopter that does the drop, and it is called fiscal policy.
As usual, there are disagreements about how effective this would be in stimulating demand. Unless there is strong crowding-out or Ricardian equivalence – very unlikely when there is spare economic capacity and interest rates are held down by monetary policy – or, indeed, this deficit can’t be funded – clearly not currently applicable, with bond yields historically low – then this is very likely to boost demand. The recipient of the largess might save some, but will spend most. Thus those who explore this policy option are doubtless correct in arguing that fiscal expansion would provide a more assured boost to demand than would quantitative easing.
If there is a concern that normal funding through bond issuance might push up interest rates or that financial markets might baulk at the funding requirement, the central bank could fund the deficit, taking bonds into its balance sheet and crediting the government’s account. This is, to all intents and purposes, a quantitative easing operation, although it might be initiated by the government.
Funding the deficit
Who is bearing the cost of funding the budget deficit? When the government draws down its account at the central bank to write cheques to the public (the ‘cash splash’), these cheques are paid into banks. Even in the fantasy world of a helicopter currency drop, this ends up being deposited with banks, as the public already has all the currency it wants to hold. The banking system has more deposits from the public on its liability side, and more deposits with the central bank on the assets side. The deficit has been funded by forcing the banks to hold more base money.
Thus this approach doesn’t avoid an increase in official debt (the central bank’s increased liability to the banks has to be counted). Similarly, if the central bank pays a market interest rate on these deposits (which most central banks currently do), then it’s not even saving any funding cost. If the central bank ceases paying a market return on these deposits, that would lower the interest cost of funding the deficit, but it would be a de facto tax on banks.
There are subtle differences between this deficit-funding operation and normal quantitative easing. First, central banks decide when to do quantitative easing and how much, while an Overt Monetary Finance would be a joint decision with the government. This raises issues of central-bank independence: the ability to say ‘no’ to government requests for funding is an important discipline on budget expenditures. There may also be a different understanding in financial markets about the unwinding of this operation. The clear understanding is that quantitative easing will be unwound at some stage, while with Overt Monetary Finance this might be unclear (although the distortionary impact of the banking system’s forced holding of substantial excess reserves doesn’t seem to be a satisfactory long-term arrangement).
Lord Turner (2013) is right in criticising the inflation alarmists, who carry outdated views on the relationship between money and prices. Similarly, the ‘deficit-fetishers’ who argue that stimulus will be futile and harmful should be required to make their case within the current context of spare capacity. Lord Turner’s cautious case for Overt Monetary Finance needs to be balanced by considering the distortions which quantitative easing (and potentially Overt Monetary Finance) have on bank balance sheets, as well as the damage to central-bank independence.
References
Sinn, Hans-Werner (2011, “The threat to use the printing press”, VoxEU.org, 18 November.
Turner, Adair (2013), “Debt, Money and Mephistopheles: How do we get out of this mess?”, speech, Cass Business School.
15 Comments
Not perfectly in sync with the MR view of the world, but not bad at all….
“Central banks have no mandate to give money away (they can only exchange one asset for another”
Perhaps central bank would care to buy my home made mortgage back bond at a yield of 0.25% or a personal loan (secured against my future earning capabilities) at 0.5% ?
Lending money at negative rates is giving money away.. Overpaying for my old ford is giving money away.
http://soberlook.com/2013/02/the-fed-to-face-some-challenges-as-it.html
When the Fed decides to raise rates the central bank does not have to contract its balance sheet (drain reserves). Instead the CB will raise interest on Reserves (IOR). There reason being is the IOR has become the de facto Fed funds rate. Thus there is no economic incentive for a bank to extend credit (take on risk) to an individual at a rate lower than the IOR (risk free rate).
Yes it appears the UK debate is a little more open to fiscal stimulus, though the deficit hawks have the upper hand at present.
I get the entire intellectual exercise about the subtleties of monetary theories. I agree with most of the ideas to some extent. However, I cannot avoid thinking more realistically that these are all theories, and that it is dangerous to be overly confident in these theories to make these new monetary operations look less dangerous than they might be. The truth is that a) we just do not know what the side effects will likely be in a complex global economy and b) we have no living precedents.
One of the biggest dangers is to leave hidden assumptions unaccounted for. For example (from the linked article):
“those with a deficit fetish who argue that stimulus will be futile and harmful should be required to make their case within the current context of spare capacity”
This is clearly a different “fetish” about the effectiveness of monetary policy to help fix what are really “structural” problems with the underlying economies. In the end, the real problem is not the financial philosophy of what government debt really is, but that this financial engineering is encouraging economies to develop excessive entitlements and malinvestment not supported by adequate productivity.
To the extent that quantitative easing encourages the preservation of the status-quo, that is bad enough in an on itself.
“When the Bank of England carries out quantitative easing, it pays for the bonds by crediting the seller’s bank.”
Which, by definition, is indeed money printing.
Cullen,
Sorry but I’ve followed your write ups for some time now and I’m amazed at how you manage to glaze over the facts underlying America’s economy.
For all your ‘clarifications’ and ‘insights’ into the supposedly ‘actual workings’ of the American empire or rather Federal Reserve Empire, you conveniently forget to mention one phrase-’petrodollar’.
Its either you are one of the ignorant hordes of educated ‘economists’ & ‘financial experts’ or you are just a paid disinformation agent.
Questions for you…
1. What would happen to the Federal Reserve and by extension Wall Street if the OPEC countries were allowed to sell their crude in currencies other than the dollar?
2. What would be the outcome on the local American retail scene if demand for American debt suddenly falls due to (1) above?
3. What excuse would you use to justify QE by the Fed if the massive defense budgets used to prop up the fake wall street figures can’t be sustained due to the FRN losing the petrodollar prop?
4.What would the Fed use to stimulate the economy if the BRICs succeed in boycotting the petrodollar scam?
5. Who would break the news to millions of Americans that ‘unfunded entitlements’ & ‘welfare benefits’ are actually financed by the printing
presses of the Fed?
Love to read your responses.
Akademos,
I am not sure you’re as familiar with my work as you might think. Let me clarify why I think that.
1. USD demand in foreign markets is primarily a function of the fact that we sell a huge amount of goods and services abroad. The US $ is the reserve currency because the USA is the largest economy with over 2 trillion dollars in exports per year. Lots of things are priced in USD’s because it doesn’t make sense to price things in other currencies when we buy/sell the most of just about everything….If that changes it’s because someone surpasses us on the scale of economic supremacy which, as you imply, would likely be a sign of changing living standards for Americans (at least on a relative basis).
2. Why will demand for US govt debt go away? We sell the safest paper on the planet backed by the most output on the planet. You have to provide some reasoning for your thinking there. Saying rates might just rise is not practical as it skips the most important questions….
3. I don’t “justify” QE. I’ve been a critic of it since day 1.
4. If the BRICs want the USA to stop buying goods and services from them (which is the equivalent of a USD boycott since they get their USDs via trade) then they can do that. And they can suffer the economic consequences as a result. Will they do that? No chance.
5. Why is that going to happen? Is the USA going to run out of money it could literally print if it so chose to? Is there going to be high inflation? Again, you’re not qualifying your statements….
Thanks for the quick response, but again you conveniently skipped the question…
I’m pretty sure you get my point when I asked the questions:
1.Assuming the Fed won’t order the Pentagon to blow the bejesus out of the innards of any OPEC country attempting it…have you truly considered the effect on US govt debt of say 50% of the OPEC countries selling their crude for say in euros? Or if they can pull it off…entering into bilateral agreement with importers to trade in mutual currencies? Pls ponder well on this & respond within the context…
2. From your response, I perceive you are not giving due attention to the erosion of the local industrial & retail base due to cheap imports driven by the huge demand for USD…which as you noted the Fed literally prints for free.
3. Also the US is not the only supplier of quality goods & services…it just has the distinctive advantage of being the owner of the worlds reserve currency.
The BRICs can conveniently fill in most of America’s imports by other countries.
Or how do you see it?
1. Again, why in the world would OPEC do that and why would it matter as much as you think? Currency’s are fungible. It might cost the USA a bit more to exchange USD for Euro, but it’s not the end of the world if it comes down to that. But still, why would OPEC piss off their biggest customer?
2. Most of the money in our system is actually created by banks. The Fed and Tsy only create currency (reserves, notes and coins).
3. Again, reserve currency is just a function of economic prowess.
4. I see the BRICs as heavily dependent on US consumers. That’s why China keeps their currency low primarily. So they can export cheap crap to Americans….
Make more sense?
Yes, because a sovereign wealth fund holding Argentine Pesos, Venezuelan Bolívars, or the Iranian Rials would have been a real store of value.
If I may add, are you aware that a large of OPEC crude proceeds end up in the Fed banks?
If you get the import of the above statement, I believe your perspective on ‘deficit funding’, QE, MMT and ‘free market economy’ etc would be significantly altered.
Also, aren’t you assuming it is cheaper to trade with America only? And even using USDs for that matter?
My point…there is a lie in the foundations of the American economic system. Its not about QE, MMT, modern economic theory or whatever brand of financial theory is accepted by Wall street.
Its a game of empire & military might…to not see that would be to get lost in so called ‘expert financial analysis’ and as you’ve discovered your own niche…MMT.
A storm is brewing…a storm driven by unsustainable economic lies & fallacies. Don’t mean to play the jeremiah…but I fear most folks who’ve not lived abroad just can’t see the picture.
Atleast you can inform the public well using grounded & realistic facts…not rehashing Wall streets modified credo in various formats.
Peace.
You haven’t read my work in a while have you? I dropped the MMT govt centric model over a year ago when I had several disputes with them over how I thought the money system works. I’ve written extensive critiques on MMT….
http://pragcap.com/mmt-critique
You seem to mix up the fake digital accounting game played locally by the Fed,Tsy and the Wall street banks with the actual REAL big game…the need for countries to hold huge piles of USD reserves by selling literally free to America, the recycling of OPEC petrodollar proceeds to the NY banks and America’s privilege of tearing itself a blank check whenever it feels like.
Don’t mean to burst your bubble, but your critique of MMT is still based on the Fed’s fake digital accounting. In a balanced global market…America’s govt would attempt to balance budgets & account for unfunded deficits. But have you ever wondered why Washington is not even bothered?