Fly Away From Helicopter Money
Photo Credit: Shiny Things || Apologies, this was the best I could find at Flickr with a Creative Commons License
Once I wrote a piece advocating helicopter money, and I called it 2300 Smackers. For those who were not reading me back during the bailout, you should know that I vociferously opposed it, and wrote a lot to encourage everyone to oppose it.
The 2300 Smackers piece was meant to advocate giving the bailout to the American people, and not the banks. The piece would have been better if I had advocated limiting the money to debt reduction, but anyway…
Now we are in a situation where helicopter money is once again being advocated — surprising to me, in this Wall Street Journal article, which probably should be an editorial, by Greg Ip, someone I usually respect. This is what he advocates:
Helicopter money merges QE and fiscal policy while, in theory, getting around limitations on both. The government issues bonds to the central bank, which pays for them with newly created money. The government uses that money to invest, hire, send people checks or cut taxes, virtually guaranteeing that total spending will go up. Because the Fed, not the public, is buying the bonds, private investment isn’t crowded out.
Unlike with QE, the Fed promises never to sell the bonds or withdraw from circulation the money it created. It returns the interest earned on the bonds to the government. That means households won’t expect their taxes to go up to repay the bonds. It also means they should expect prices eventually to rise. As spending and prices rise, nominal GDP goes up, so the debt-to-GDP ratio can remain stable.
If this sounds too good to be true, it’s because usually it is. Throughout history, governments that couldn’t or wouldn’t collect enough taxes to finance their spending resorted to the printing press, from the U.S. Confederacy in the 1860s to Zimbabwe in the 1990s. It’s why so many central banks, including the ECB, are prohibited from financing government deficits.
But just because monetizing the debt can cause hyperinflation doesn’t mean it must. In ordinary times, the Fed is continuously monetizing debt to create enough currency to lubricate the wheels of commerce. Between 1997 and 2007, before QE began, its holdings of government debt rose by $355 billion, and currency in circulation rose by a similar amount. In effect, the government borrowed and spent $355 billion and never has to repay it.
In that instance, the Fed only created as much currency as the public wanted. What if it created more, to finance government spending? Even that isn’t necessarily catastrophic. In his book “Between Debt and the Devil,” which advocates helicopter money, the British economist Adair Turner cites Pennsylvania in the early 1700s, the U.S. Union government in the 1860s and Japan in the early 1930s as examples of governments that used monetary finance without triggering hyperinflation.
An even better example is World War II. The federal government had to borrow heavily to finance the war effort and the Fed helped by buying bonds to keep their yields from rising above 2.5%. Between 1940 and 1945, the Fed’s holdings of debt rose from $2.5 billion to $22 billion, an increase roughly equal to 9% of annual GDP. Though this only financed a fraction of the war, it was still debt monetization: most of those purchases proved to be permanent.
The war effort massively boosted nominal GDP. Initially, only part of that showed up as higher prices, thanks to wage and price controls. Most of it came through a stunning rise in real output, made possible by the economy’s depressed prewar state, a flood of women into the labor force and business innovation to meet the demands of war and the civilian economy. As wage and price controls ended, prices shot up 34% between 1945 and 1948. But then, inflation reverted to low single digits.
I would encourage Greg Ip, Adair Turner and anyone else who is interested to read the book Monetary Regimes and Inflation by Peter Bernholz. Even if there have been some times where monetizing debt has not led to inflation, the odds are really low that that happens historically. Why?
Well, when a government gets a new policy tool, they tend to use it until it stops working or blows something up. Seeming success leads to more use (think of trying to trade lower employment for higher inflation in the ’60s), and lack of success leads policymakers their economist lackeys to try more because they say it will work when you do enough of it (think of QE, spit, spit).
It’s kind of like knowing that you have a difficult time with self-control issues, and wondering if you should try a drug offered to you at a party (even alcohol). You shouldn’t want to take the risk. Upside is low, downside could be very high, and probabilities are tilted the wrong way also.
Now to his credit, Greg Ip ends his piece like this:
Another obstacle is the institutional separation between monetary and fiscal policy. That separation exists for a good reason: Central banks were granted independence so that they would not become the printing press for feckless politicians. The Fed was uncomfortable doing the Treasury’s bidding during World War II and dates its de facto independence to the end of the arrangement in 1951. In 2013, Treasury was advised to sell the Fed a platinum coin to get around the statutory debt ceiling. Treasury dismissed the idea as a dangerous violation of Fed independence.
Tampering with this long-standing separation should not be done lightly. For the U.S., which is at close to full employment and in no imminent danger of deflation, the tradeoff hardly seems worthwhile. But there may be times, and countries, when it is. Monetary finance isn’t riskless, Mr. Turner says, but the alternatives may be worse: stagnation and deflation, or perpetually low interest rates that fuel dangerous bubbles: “The money finance option should not be excluded as taboo.”
No, money finance should be taboo. Monetary history is replete with examples of where it ended very badly, and with few examples of success.
You know my opinion here. It would be far better as a society to get the government out of the macroeconomic policy business, except to regulate banks tightly as they are the source of systemic risk, and let the economy endure booms and busts. We won’t have perpetually low interest rates unless the government interferes, as they have done recently and during the Great Depression. If anything, government policy has amplified our booms and busts, and makes the present situation worse.
That said, we are going to take some pain from the present economic difficulties, it is just a question of what pain we will get because of too much debt. It could be inflation or more debt deflation. There could be defaults on government debt or considerably higher taxes. I can’t tell what the government will try to do, but whatever it will be, it will be painful.