Monday, April 18, 2016
Helicopter Money to the Rescue
Following the unconventional monetary policy of negative interest rates, central banks are now considering an even more desperate measure: “helicopter money.” Milton Friedman is credited with this idea:
The goal of such a policy is to put money directly into people’s pockets to boost aggregate demand. The post-2008 QE policy had similar objectives. The lowering of interest rates was intended to boost bank lending and indirectly consumer spending. Instead, the result was a boom in asset prices and a surge in excess reserves. The idea of helicopter money — in contrast — is to bypass the middleman, the banks, and provide funds directly to consumers.
How would such a policy be implemented? One idea is for a tax rebate financed by more government bonds purchased by the central bank. The tax cuts would be financed by printing money. The only real difference between helicopter money and the QE implemented since 2008, is that the private sector would be spending the money instead of the government. A large part of the debt issued since 2008 to finance government spending has been purchased by the central bank. It now holds $2.5 trillion of the $19 trillion dollars of US debt, effectively monetizing much of the additional borrowing since 2008. The effect on aggregate demand would simply be for the private sector to spend the money instead of the government sector. It would be a continuation of the current policy of financing expenditures by creating intrinsically worthless pieces of paper.
There’s Never a Shortage of Demand
Of course, this is a very Keynesian perspective that the economic problem is a lack of aggregate demand. The reality is that we never have a shortage of demand. The reason we work, we produce, is to consume; there is never a lack of demand. The primary function of prices is to ration output against an insatiable desire to consume or demand. As Ricardo said in 1820, “men err in their production; there is no deficiency of demand.”
The problem is never one of insufficient demand, but of supply being misaligned with demand. This faulty widespread educational indoctrination about aggregate demand is the poison eating at the heart of macroeconomics and similar to past universal beliefs in truisms that were never true — like the sun revolving around the earth.
The economic literature has focused on the permanency of such a helicopter drop. Such a policy is seen by contemporary economists as more effective if it was permanent. If so, people would expect inflation and advance their purchases to take advantage of current lower prices. In a Keynesian framework, this is viewed as beneficial since it would move demand forward. A similar but opposite argument has been promulgated to demonize deflation (see here and here). Of course, people are not lab rats, and they formulate their expectations on a multiple of different factors. They may even pay higher prices if current purchases better align with the timeline of needs. This is why few buy Christmas presents during January sales.
Another excuse for helicopter money is to allow the central bank to reach its 2 percent inflation target. As though 2 percent was some magical number that would allow the economy to reach its economic sweet spot.
Problems with Money Creation
Of course, 2 percent growth over 35 years cuts the purchasing power of money in half. It is a wealth transfer from the late recipients of the money, wage earners and the poor, to the early recipients of the money, the government and the banking sector: the central bank acting as a reverse robin hood. Also such monetary shenanigans simply interfere with the function of prices to allocate resources where society deems most urgent (see here). The reality is that there is no empirical or theoretical justification to support a 2 percent target. The period of the greatest growth in the US during the nineteenth century, from 1820 to 1850 and from 1865 to 1900, was associated with significant deflation. In those two cases, prices were cut in half.
Common sense states that you cannot repeal the law of scarcity by printing intrinsically worthless pieces of paper to finance private or government expenditures. If that were true, counterfeiting would be legal and Zimbabwe would be like heaven. The initial effect of such printing is a temporary illusion of prosperity which begets more printing leading to ever increasing amounts of distortion to prices.
Friedman’s comments about helicopter money included an important caveat: it is unlikely that the helicopters would fly only once.
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