macroresilience

resilience, not stability

Helicopter Money Is Not Dangerous, All Macroeconomic Policy Is Dangerous

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In my previous post I argued that introducing helicopter money does not imply that the inflation target must change. Another misguided criticism of helicopter money is that it is somehow more dangerous than other forms of monetary policy. The reality is very different – all forms of macroeconomic stimulus (fiscal or monetary) are equally “dangerous” in the sense that irresponsible implementation can lead to macroeconomic chaos.

Fiscal Deficits Are Dangerous

Whether they are monetised or not, excessive fiscal deficits are inflationary. The best example is the historical experience of Turkey where inflation remained out of control from the 1980s till 2001 despite there being no monetisation of deficits by the central bank. Innovations such as repos enabled the private sector to monetise government deficits as effectively as the central bank would have (For details, see section titled ‘Bond-financed or Money-financed deficits’ in my post ‘Monetary and Fiscal Economics for a Near-Credit Economy’).

Negative Real Rates Are Dangerous

During most significant hyperinflations throughout history, the catastrophic phase where money loses all value has been triggered by the central bank’s enforcement of highly negative real interest rates which encourages the rich and the well-connected to borrow at negative real rates and invest in real assets. The most famous example was the Weimar hyperinflation in Germany in the 1920s during which the central bank allowed banks and industrialists to borrow from it at as low an interest rate of 5% when inflation was well above 100%. The same phenomenon repeated itself during the hyperinflation in Zimbabwe during the last decade (For details on both, see my post ‘Hyperinflation, Deficits and Real Interest Rates’).

This also highlights the danger in simply enforcing a higher inflation target without taking the level of real interest rates into account. For example, if the Bank of England decided to target an inflation rate of 6% with the bank rates remaining at 0.50%, the risk of an inflationary spiral will increase dramatically as more and more private actors are tempted to borrow at a negative real rate and invest in real assets. Large negative real rates rarely incentivise those with access to cheap borrowing to invest in businesses. After all, why bother with building a business when borrowing and buying a house can make you rich? Moreover, just as was the case during the Weimar hyperinflation, it is only the rich and the well-connected crony capitalists and banks who benefit during such an episode. If the “danger” from macroeconomic policy is defined as the possibility of a rapid and spiralling loss of value in money, then negative real rates are far more dangerous than helicopter money.

Helicopter Money + Rate Hike Is Not Dangerous

If helicopter drops are implemented without any concern for how negative real interest rates may get, they are dangerous. But, as I mentioned in my previous post, “helicopter drops can be implemented without any change in inflation so long as interest rates are hiked to counteract the inflationary impact of helicopter money”.

“Permanent” helicopter money is no more dangerous than “temporary” QE. In a world where the central bank pays interest on reserves, money itself is just a form of government debt. Even prior to the crisis, the ability of the private sector to repo government bonds for cash meant that government bonds function as money-equivalents. Once the deficit has been incurred, the nature of financing (bond or money) is irrelevant. All that matters are the level of fiscal deficits and the level of real interest rates.

As always, the conventional wisdom simply mirrors the interests of the 1%. It is considered “normal” to dole out favours to well-connected crony capitalists. It is considered “safe” for the central bank to drive down real rates, buy financial assets and prop up asset prices. But it is considered “dangerous” to direct stimulus to the asset-poor masses.

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Written by Ashwin Parameswaran

February 18th, 2013 at 11:11 am

Posted in Monetary Policy

16 Responses to 'Helicopter Money Is Not Dangerous, All Macroeconomic Policy Is Dangerous'

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  1. Ashwin,
    At the ZLB and with ER’s, any velocity-increasing fiscal stimulus is “helicopter money” since it’s financed at 0% through either reserves or T-bills. At the margin, QE is irrelevant (either way taxpayer duration risk increases).

    What then is the relationship between a “helidrop” and inflation at the ZLB? Inflation in Japan and the U.S. reacted quite differently to expanding deficits at the ZLB, so there is no direct causality. Total Credit, however, is a potential driver. The U.S. has had brisk (5%) TC growth, while I believe Japan’s contracted or at least flattened. Basically, TC is a proxy for government-created velocity.

    So at the ZLB, growth in TC results in inflation and negative real rates. The more TC growth, the more negative, the more TC growth. The problem with this thesis is that we have not seen a self-sustaining negative rate/inflation feedback loop take hold in the U.S., despite 5% TC growth. This is essentially a function of the willingness of the top 1% to hold a depreciating asset (in real terms). In other words, there has been no rush to preserve wealth by shortening duration as the real yield curve went negative to 10yrs. This is implies the Fed hit a narrow corridor b/t inflation credibility and real wealth erosion — like landing on an aircraft carrier. Its likely this is a function of agency issues and money illusion, both of which may dissipate if real rates go more negative.

    At the ZLB and with TC growth, therefore, helidrops are fine as long as they don’t change duration preferences.

    Diego Espinosa

    18 Feb 13 at 3:42 pm

  2. Diego – thanks for the comment. I agree with everything you’ve said. I would just add that Japan probably has to climb a much steeper structural hurdle ( e.g. population) to get any significant credit growth.

    Ashwin

    18 Feb 13 at 4:53 pm

  3. Ashwin,
    Japanese seniors will likely see 2% inflation as a true threat to their retirement. I would expect them to move quickly to preserve real wealth (shorten duration, buy FX, pull forward purchases) in way that fuels inflation.

    When countries are abnormally old or unequal, I would argue their savers are less prone to money illusion. Latam is a nice example of “unequal”. There, the top 1%’s desire to protect real wealth was constant fuel for the inflationary dynamic.

    Diego Espinosa

    18 Feb 13 at 5:55 pm

  4. Diego – Thanks. That is a compelling argument.

    Ashwin

    18 Feb 13 at 6:53 pm

  5. Diego

    In both cases (Japan & LatAm), you mean, fuelling inflation *without* fuelling growth. Correct?

    Ritwik

    18 Feb 13 at 6:58 pm

  6. Ritwik,
    That’s correct, at least after the very short term. A lot depends on whether feedback loops quickly take hold or are “dampened”.

    Diego Espinosa

    18 Feb 13 at 9:56 pm

  7. […] Ashwin Parameswaran has a fantastic post today explaining why Helicopter Money Is Not Dangerous, All Macroeconomic Policy Is Dangerous “in the sense that irresponsible implementation can lead to macroeconomic chaos.” Before jumping into the main attraction of the post, I want to briefly clarify a general discrepancy regarding what helicopter money actually entails. […]

  8. Excellent article! I’ll be subscribing to your blog via Google Reader.

    Kyle

    19 Feb 13 at 2:35 am

  9. Strikes me the central reason helicoptering is not particularly dangerous is that it simply equals fiscal stimulus and monetary stimulus combined (as Mervyn King pointed out recently here:

    http://www.bankofengland.co.uk/publications/Documents/speeches/2012/speech613.pdf

    See para starting “There has been some talk…”.

    I.e. to the extent that helicoptering has problems, fiscal and/or monetary stimulus must have the same problems.

    Ralph Musgrave

    19 Feb 13 at 5:55 am

  10. Ralph – absolutely!

    Ashwin

    19 Feb 13 at 5:29 pm

  11. Given that it is well documented that money velocity increases exponentially with interest rates, its not clear how one may raise rates and print money without inflation.

    There are two ways to ‘agree’ with this data and thus two ways to evaluate Ashwin’s idea. Either we say that raising rates increases velocity exponentially, or we say that the causality is that rising velocity leads to rising interest rate with an relation of the form

    Rates = log(velocity).

    If its the former, then inflation will get out of control. If its the latter, then one cannot ‘raise rates’ successfully (defined by not having an inverted real yield curve) unless velocity is raised.

    And printing money doesn’t target velocity.

    Targeting velocity is the missing secret ingredient.

    scepticus

    26 Feb 13 at 9:57 am

  12. scepticus – increased velocity is just another way of saying that we have a hot potato effect. When money itself earns interest i.e. interest is paid on reserves then there is no reason for a hot potato effect. Excess money simply flows back to the CB and earns interest.

    Ashwin

    27 Feb 13 at 3:21 pm

  13. Where does the money to pay interest on reserves come from?

    scepticus

    27 Feb 13 at 6:54 pm

  14. same place its coming from today! the central bank.

    Ashwin

    27 Feb 13 at 11:51 pm

  15. Raising tax rates (or defaulting on public debt) isn’t costless, so fiscal policy is dangerous in the sense that you may end up painting yourself into a corner.

    If you somehow knew that real rates on government borrowing would remain low forever, then there would be no reason to worry. But you can’t know that, you can only guess.

    Max

    28 Feb 13 at 12:36 pm

  16. I don’t understand why you are in favor of helicopter drops, but against fiscal stimulus. Personally, both are OK with me, but I would prefer if something tangible that improved society was done in exchange for the drop. If the government is going to drop $500 to someone, you might as well have that someone perform some service to society. Have them help build a new road, fix a bridge, help some old people cross the street, or whatever they are capable of doing. Everyone can do something to move the needle forward. That’s the way I see fiscal spending is. The government drops money in exchange for a service. I can see how you may be against fiscal spending that directs money to corporations rather than individuals. But that’s not necessarily how it works or has to work.

    Yehuda

    6 Dec 13 at 4:41 am

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