30 years ago, IIRC, my colleague Steve Ferris said I should read Lloyd Metzler's Wealth, Saving, and the Rate of Interest, because he thought it was a great paper. Yesterday Brad DeLong said the same thing. David Glasner also thinks it's a classic paper. When three very good but very different economists recommend a paper that strongly, you figure they are probably right.
But when I re-read it now, I get the same impression I did 30 years ago. It's an OK theory paper, but nothing special. And not very important at all empirically. But the guys who think it's an important paper are at least as smart as me. Maybe I'm not quite getting something?
Lloyd Metzler sets up a model with two financial assets: money (issued by the central bank); and "shares". Those shares are real rather than nominal assets, because (unlike bonds) they do not promise a fixed dollar payment. Those shares are net wealth, because they represent claims on the real productive assets of firms. But he assumes shares held by the central bank are not included in the wealth of the public. He does not say this, but it is as if the central bank is owned by foreigners. (If the central bank is owned by the government, and if the government is owned by the people, and they count government wealth as part of their wealth, like under Ricardian Equivalence, we would get a different result). The demand for money, and desired consumption and saving, depend on wealth and the rate of interest.
Helicopter money is neutral in the model (all prices are flexible and there are no nominal bonds). An increase in M via helicopters causes an equiproportionate change in P, so M/P is unchanged, and real wealth is unchanged, and the real interest rate is unchanged.
Vaccum cleaner shares is not neutral in the model, for obvious reasons. If the foreign-owned central bank confiscates some of people's shares, their real wealth drops. That drop in real wealth will have other real effects, and also nominal effects. Those real effects include the real rate of interest.
An open market operation, where the central bank issues new money and buys shares, is equivalent to helicopter money (neutral) plus vacuum cleaner shares (non-neutral), which equals non-neutral.
The message Lloyd Metzler draws from this is that monetary policy (in the sense of open market operations) will affect the equilibrium real rate of interest. So the real rate of interest is partly a monetary phenomenon. OK. And helicopter money has different effects from an open market operation. OK.
But how big is this effect? How big is this difference? The assets of the central bank are a very small part of total wealth.
Let's ballpark it. If we capitalise future income at 10%, we get a conservative estimate of total wealth as 10 times annual GDP. And if the assets of the central bank are around 10% of annual GDP, we get that the assets of the central bank are 1% of total wealth. Even if the central bank doubled its size (and did so in secret, and bought shares before the price of shares roughly doubled), that amounts to a 1% confiscation of total private wealth. That's small, compared to the effects of other tax policies, recessions, and natural disasters. And that's for a truly massive change in monetary policy, that roughly doubles the equilibrium price level.
Now in the real world, central banks mostly buy government bonds, not shares in companies. Does it matter much if central banks do helicopter money rather than buy government bonds in an open market operation? Very simple arithmetic tells us the difference between them: helicopter money minus open market operations = helicopter bonds. If helicopter bonds has a big effect, then there is a big difference between helicopter money and an open market operation.
How big a $ helicopter drop of bonds would you need, to have the same effect on the equilibrium price level as a $1 helicopter drop of money? If there were a economically significant effect of helicopter drops of bonds, we would expect it to show up in the data. Do countries with higher government debt/GDP ratios also have lower base money/GDP ratios, other things equal? Because that is what we would expect to find in the long run and cross-country data, if both helicopter bonds and helicopter money increased the equilibrium price level. And how big could that effect possibly be, measured as dollars of base money equivalent to dollars of bonds? Debt/GDP ratios range enourmously, from near 0% to over 200% of GDP. Base money/GDP ratios don't vary anything like that amount, in absolute terms. They are normally around 5% to 15% of GDP.
If it really mattered whether the central bank issued base money via helicopter drop or by open market purchases of bonds, so that a $1 helicopter bonds had the same effect as some non-negligible fraction of a $1 helicopter money, the evidence would be staring us in the face in the long run and cross-country data. We would see a big negative slope (slope, not elasticity) if we plotted debt/GDP against base/GDP. And countries with 200% debt/GDP ratios would already have exploded into hyperinflation, because they couldn't make base money negative enough to compensate. It doesn't; they haven't. (Scott Sumner made a similar observation once.)
To sum up, the sort of wealth effects from monetary policy that are in Lloyd Metzler's model are peanuts. I can think of other wealth effects from monetary policy that are not in his model that are probably much bigger. And if prices are sticky, I could definitely get much bigger wealth effects. What sort of recession would we get, if the central bank suddenly decided to halve the price level, and how big an effect would that have on wealth? The last thing I would think about is whether the central bank halved the price level via open-market operation sales of bonds or by confiscating half of everyone's money.
My take-aways from re-reading Metzler's paper, and thinking about it when writing this post:
1. Even though we normally think of "pure" monetary policy as an open market operation, the theoretically "pure" monetary policy is a helicopter drop. (Patinkin said much the same thing, but after Metzler, so Metzler gets the credit, unless someone else said it even earlier.)
2. Does fiscal policy matter much? To the extent that fiscal policy matters much, it can't be through wealth effects.
3. We should be paying more attention to the temporary/permanent question, both for monetary and for fiscal policy, and less attention to what the new money is spent on.
But maybe I'm missing something, that other people can see?