When is helicopter money optimal?

Money is fungible. And things get lost in translation, especially between micro and macro.

"Helicopter money" is when the central bank prints money, gives it to the government, and the government gives it to everyone, as a freebie.

When is helicopter money optimal?

Preliminary answer: almost all the time. Because almost every year, it is optimal for the Bank of Canada to print money to keep inflation at 2%. And it earns seigniorage profits from printing money, and it gives those profits to the government. And it is optimal for the government to give money to some people, like the very poor. And you could say that those welfare cheques are financed (in part) by printing money. Or you could say that it is road repairs that are financed by printing money. Since money is fungible, you could say that anything (but not everything) the government spends money on is financed by printing money.

But welfare isn't universal; the helicopter drops the money only on the poor, unlike a real helicopter. And I'm playing fast and loose with fungibility. So you might not like this answer.

Better answer: For simplicity, assume a linear tax/transfer system so that the amount of tax Ti paid by individual i depends on his income Yi: Ti = A+bYi. The parameter 'A' could well be a negative number, like under the Negative Income Tax system. (We would still have a constant term for any non-linear tax system, so I don't really need that assumption.) If A is negative, you can think of it as a lump-sum transfer payment that every individual gets from the government, and if b=0.5, they then pay 50% tax on all their income.

There is a whole micro "Optimal Tax" literature that tells you how to set the parameters A and b. Under any vaguely reasonable Social Welfare Function and utility function, the optimal A will be negative for a rich country (we don't let anyone starve). What does (should) A depend on? Ummmm, a whole host of stuff. Like: GDP per capita (richer countries should have a more negative A); the marginal benefit curve for government spending on goods (a rightward shift in that curve should make A less negative, because it means higher spending and taxes are optimal); a load of distributional and consumption/leisure preference stuff (ask Frances); and in an intertemporal model it should also depend on a load of expectations about the future and on the real interest rate (a lower real interest rate should mean a more negative A this period relative to future periods, because a lower real interest rate means you want to do nice things now and postpone nasty things into the future).

Unless none of those things ever change over time, the optimal universal lump sum transfer payment -A will change from year to year. It will change partly in an anticipated way, and partly in response to new information, or "news". In some years the government will get news which tells it to increase that transfer payment.

Now let's switch to macro. In some years, it is optimal for the central bank to increase base money M, to keep inflation on target, or NGDP on target, or whatever. Sometimes those changes in M will be anticipated, and sometimes they will be in response to "news". And increasing M means seigniorage revenue for the government, which owns the central bank. (See how simple macro is!)

Now let's put macro and micro together. Add that seigniorage revenue to the microeconomist's intertemporal government budget constraint. (Yes, I know that intertemporal government budget constraint will not exist if r < g always, but that isn't an optimal tax/transfer equilibrium, and I'm talking about what is optimal.)

Nearly done.

Suppose, in the same year (or month, whatever) the central bank gets news that tells it to increase M, and the government gets news that tells it to cut A (increase the universal lump sum transfer). Though it is very very unlikely the magnitudes of the change in A and the change in M will be exactly the same, they will overlap to some extent. We could say that such a government is then doing "helicopter money". Relative to the benchmark of what was anticipated, the combined sets of news will be telling us to do money-financed universal lump-sum transfer payments.

Will those two sets of news be positively correlated? Probably yes, because anything that decreases the real interest rate would increase the current optimal transfer payment and also increase the demand for base money. But all my argument depends on is that they are not perfectly negatively correlated.

If there is zero correlation, helicopter money will be optimal 25% of the time.

If my brain were working better, I would probably talk about the effect of increased seigniorage on reducing the shadow price of public funds. But it isn't, so I won't. And it probably doesn't matter much anyway, because it's a wealth/income effect, and I think the substitution effects usually matter more. If marginal benefit curves slope dowqn, and marginal cost curves slope up, it's normally better to spend an increase in public funds on a little bit more of everything, today and tomorrow. Unless the curves shift at the same time.

I don't think there is anything here that either Scott Sumner or Rajiv Sethi would fundamentally disagree with. It's just that things get lost in translation.

Comments

[CMA]

"If there is zero correlation, helicopter money will be optimal 25% of the time."

Based on the amount of seignorage the gov gets? Just impose fees on users of monetary system to get whatever seignorage you want. Seignorage the gov doesnt get is more money for others.

[Market Fiscalist]

May I ask a clarifying question?

If the CB is targeting 2% inflation and everything else stays equal (demand for money etc), then the money supply will need to increase by 2%. Say this amounts to $1B, and the govt is running a $10B deficit. The money supply can be increased either via:

1. the govt selling $10B of bonds to finance the deficit and the CB then buying $1B of these bonds in return for new money.
2. the govt only issuing $9B of debt to cover the deficit.

Is this a correct understanding ?

If so would you agree that if things are not equal and inflation moves off target (and the money supply needs adjusting by other than 2%) then this could be corrected either by changing the size of the unfunded deficit, or by OMOs ?

[Nick Rowe]

CMA: or just raise the target inflation rate. There exists a revenue maximising inflation tax (Zimbabwe went over the top of that Laffer Curve). But it's a distorting tax, just like the parameter b in my linear tax system. It isn't optimal to do that.

MF: Yes. And yes (but one will be better than the other).

[acarraro]

I really don't understand what makes future monetary operations predictable.

If you assume that changes in demand for money are temporary, doesn't that invalidate the hot potato effect?

If they are not predictable, there is no reason to assume the helicopter drop needs to be unwound.

[Market Fiscalist]

"MF: Yes. And yes (but one will be better than the other)."

They are the functional equivalent but the mechanisms seem different to me.

The unfunded deficit version works by making people feel richer so they spend more (but this just leads to 2% inflation) - and they save more so real interest rates fall.
The bond-funded version works by having the CB lower the real rate of interest a bit so that people will sell them bonds , and spend more. Again the result is 2% inflation (and an bump in the nominal IR).

In theory both methods are scalable - you can keep increasing the size of the deficit and you can keep either lowering the interest (or flattening the yield curve when you reach the ZLB) until you hit your target.

But is there not more risk attached to flattening the yield curve at the ZLB than there is in exploiting the wealth effects of unfunded deficits ?

[Too Much Fed]

""Helicopter money" is when the central bank prints money, gives it to the government, and the government gives it to everyone, as a freebie."

That sounds like the central bank's liabilities are increasing without increasing its assets. Is that correct?

[Nick Rowe]

acarraro: I don't see the problem. Changes in M will be partly predictable, and partly unpredictable, and partly temporary, and partly permanent. 2% inflation by itself says we will probably need 2% money growth, other things equal. Add some for real growth too.

MF: you lost me. And this post isn't about how monetary policy affects AD.

TMF: the government gives the central bank an IOU (bond) for the money. But it doesn't matter, since the government owns the central bank. My right pocket lends money to my left pocket.

[Market Fiscalist]

"And this post isn't about how monetary policy affects AD"

But it was from your blog that I learned that almost everything interesting in economics is about how monetary policy affects AD :)

[Too Much Fed]

"TMF: the government gives the central bank an IOU (bond) for the money. But it doesn't matter, since the government owns the central bank. My right pocket lends money to my left pocket."

It is still a new bond (debt) then. New demand deposits and new central bank reserves for the new bond. The new bond may not be in the private sector, but the private sector expects it to be honored.

I have seen many definitions of "helicopter money". Some say with a bond attached. Some say not. There is a big difference between creating more MOA/MOE with a bond attached and without a bond attached.

Also, from a demand deposit point of view, would the scenario be the same if a commercial bank bought the new bond from the gov't and decided to donate the interest back to the gov't?

[PeterN]

TMF,

I believe our agreements concerning the Bank for International Settlements limit the sort of helicopter the central bank can use (as does the Federal Reserve Act). That is, the bank can't just create a liability and transfer it to the public. It has to, in some ways, pretend to be a bank. It must buy bonds on the open market and not directly from the Treasury. This is so that it doesn't look like the Fed is monetizing the deficit, though, of course, it in no way actually prevents this.

The existence of a bond shouldn't matter, as long as the bond remains on the Fed's balance sheet, and expectations are that it will remain there for a long enough time. If the Fed was expected to shrink its balance sheet reasonably soon, there might be some Ricardian equivalence type argument for the bond purchase two step having a different effect from just creating a liability and mailing out checks.

Unfortunately in our current circumstances, even helicopter money will become excess reserves once it's deposited. By itself, a helicopter drop won't cause banks to multiply the money by lending. It's worth considering that some ways of putting money into the system may produce more dollars of transaction flow per dollar dropped than others, sort of like a matching grant compared to an ordinary donation.

[Nick Rowe]

PeterN: "This is so that it doesn't look like the Fed is monetizing the deficit, though, of course, ***it in no way actually prevents this***." (my emphasis added).

Yep. The government sells the bond to the public, and the central bank buys a bond from the public a minute later.

TMF: "There is a big difference between creating more MOA/MOE with a bond attached and without a bond attached."

No there isn't, if you buy the bond from the government, and you then pay the interest on that bond back to the government. Except maybe, in terms of the central bank's operational independence from the government.

Stop now.

[Majromax]

> "Helicopter money" is when the central bank prints money, gives it to the government, and the government gives it to everyone, as a freebie.

Is this definition actually that used in practice?

From a 24-hour-news-cycle perspective, this looks like monetary easing combined with deficit-based fiscal policy. That's a two-agent problem, as the nation requires both a central bank committed to money-printing and a government committed to distribution in an optimal way.

That's arguably not the case in the US, where the "helicopter money" of QE can only be distributed according to the legal environment available to the Fed.

Ultimately, that means that the US Fed *can't* distribute helicopter money via an optimal, lump-sum payment without the complicity of the legislature and executive. In turn, that means that the helicopter money will be distributed in a suboptimal manner, meaning that its effect is greatly reduced or even eliminated.

That then dovetails with what PeterN suggests above, that suboptimal helicopter money "will become excess reserves".

[Ralph Musgrave]

Nick says, "Helicopter money" is when the central bank prints money, gives it to the government, and the government gives it to everyone, as a freebie.” What about where “the central bank prints money and government spends it on the usual public sector items, e.g. infrastructure? That’s also helicopter money isn't it?

[Ralph Musgrave]

Too much fed,

Re your suggestion that base money is a central bank liability, my basic answer to that is: “no it’s not”. Bank of England notes say something like “I, governor of the BoE, promise to pay the bearer on demand the sum of £10”. But if you demand £10 of gold or anything else from the BoE, you’d be told to shove off. So in that sense base money is not a central bank liability.

Base money is ARGUABLY a government / CB liability in the following slightly odd sense. It’s a characteristic of a liability that it can be used to cancel out an equal and opposite liability. So if the tax authorities demand $X from you, and you have $X of those central bank notes, you can use them to pay your taxes.

[Ralph Musgrave]

Contrary to Nick’s 25% claim, I suggest helicoptering is the best option 100% of the time and for the following very simple reason. What’s the point in government borrowing money when it can print money?

[Nick Rowe]

Ralph: "What about where “the central bank prints money and government spends it on the usual public sector items, e.g. infrastructure? That’s also helicopter money isn't it?"

I would say "no". That is "money-financed government expenditure". Helicopter money is "money-financed transfer payments (or tax cuts)". It's Milton Friedman's metaphor, IIRC. The idea is that the central bank prints a lot of banknotes, loads them in a helicopter, throws them out the door, and people pick them up. That's a transfer payment, rather than buying goods.

Helicopter money + increase in government spending financed by taxes = increase in government spending financed by printing money.

[Too Much Fed]

Can I respond to PeterN and Ralph?

[Nick Rowe]

TMF: No. You have already dragged the conversation off-topic.

[Scott Sumner]

Nick, All that sounds reasonable to me, and also consistent with my rigid opposition to any sort of fiscal policy (helicopter drop or otherwise) that tries to do what monetary policy alone should be doing---determining NGDP growth.

But, yes, there will be times that for very sound classical (non-Keynesian) public finance reasons base money is injected in the economy during a recession, and the deficit gets much larger for reasons such as low real interest rates on infrastructure projects, optimal smoothing of tax rates, etc., etc.

If the government does lump sum transfers to the public, I doubt you'd want to vary those with the business cycle, but who knows? However the magnitudes would be small.

It's also worth noting that all of the "helicopter drops" (i.e. massive base injections combined with tax cuts) that have been done in various developed countries since the 1990s have done far, far, less than the proponents claimed they would do. A helicopter drop doesn't overcome the expectations trap problem, or at least not necessarily.

Ralph, You said;

"Contrary to Nick’s 25% claim, I suggest helicoptering is the best option 100% of the time and for the following very simple reason. What’s the point in government borrowing money when it can print money?"

Have you thought of trying to sell your ideas in Zimbabwe? They might be interested.

[CMA]

"If the government does lump sum transfers to the public, I doubt you'd want to vary those with the business cycle, but who knows? However the magnitudes would be small.

It's also worth noting that all of the "helicopter drops" (i.e. massive base injections combined with tax cuts) that have been done in various developed countries since the 1990s have done far, far, less than the proponents claimed they would do. A helicopter drop doesn't overcome the expectations trap problem, or at least not necessarily."

Magnitudes would be small and massive? Did I understand correctly?

"and the deficit gets much larger for reasons such as low real interest rates on infrastructure projects, optimal smoothing of tax rates, etc., etc."

Not if heli's are performed by fed without cooperation of treasury.

"Have you thought of trying to sell your ideas in Zimbabwe? They might be interested."

No one is saying heli's should be performed without targeting something like inflation or ngdp.

[Gzibordi]

I have been waiting for a while to have an excuse to ask NR take on our (helicopter) solution for a large southern european beleaugered country, which cannot ask for its CB money, because of EU treaties restrictions and teutonic money views. I know the title here is "WHEN IS the Helicopter...", but maybe it is possibile to enlarge it a bit ? We (me, my colleague Cattaneo, an ex-FMI economist Biagio Bossone and Warren Mosler who is known over here) just published a book to argue that the Italian government should unilaterally go with the following helicopter scheme, (which is actually a remake of Hjialmar Schacht's successful solution for Germany in the Thirties to exit the Great Depression)

Italy could issue (free-of-charge, electronic) Tax Credit Certificates to enterprises and workers. As bills of exchange, tax credits would not require future reimbursement from the State. Rather, two years after issuance, the State would accept them for the payment of all taxes and financial obligations to itself. Deferred Tax Credit would be deferred money. Yet, their recipients could immediately convert them in euro (by selling them in the financial market at a discount comparable to that on a two-year, zero coupon government bond), and use them for cutting taxes.

The two-year deferral provision would allow output to respond to increased demand and generate the revenues to (somehow) offset the shortfalls that payments in CCF would cause to tax receipts in euro. Facing a €300 billion gap vis-à-vis its pre-crisis output trend, and assuming estimates of the fiscal multiplier (I know...that is tricky..), Italy could close the gap in 3 to 4 years by issuing tax credits at a €200 billion yearly rate (13% of GDP), without (maybe) exceeding the Maastricht treaty 3% budget deficit limit and steadily reducing the debt/GDP ratio, as required by the fiscal compact.

With current output slack, even a 200 billions money issuances would not impact inflation much (maybe 4% max...like the UK with its 12% deficit in 2011 ?), expecially since allocations to enterprises would deflate gross labor costs. (BTW, No additional public expenditure for us, only huge tax cuts! maybe they will like it in Chicago!).

Since 200 billions euros is a huge chunk of money and markets and could spooke markets (I am a professional trader BTW), we add Warren Mosler's brilliant idea to issue a new type of government debt: the “tax-backed bond”, similar to current government bonds except that they would contain a clause stating that if the country failed to make its payments when due—and only if this happens—the bonds would be acceptable to make tax payments within the country in question. This tax backing, (the Gov that values them at par), would set a floor below which the value of Italian BTP could not fall, assuring investors that Italy's bonds are always “money good” and dwarfing an attack like the one of the summer of 2011

Basically we would create 200 billions of "new euros", only for Italy, through deferred tax credit and use the money to cut 200 billions of taxes. Plus we would somehow transform Italian gov bonds into "money" (10 year bonds accepted at par to pay taxes).

Sorry to be so long, for the poor English and to be maybe off topic, but it is an ingenuos, Helicopter, "quasi monetary solution" to the EU crisis and maybe NR would be interested enough to tell us which flaws he sees in it
---
See our post at www.economonitor.com/blog/2014/07/which-options-for-mr-renzi-to-revive-italy-and-
save-the-euro/ and http://www.levyinstitute.org/publications/tax-backed-bondsa-national-solution-to-the-european-debt-crisis
http://www.amazon.it/soluzione-miliardi-rimettere-leconomia-italiana/dp/8820359162

[Nick Rowe]

Scott: "If the government does lump sum transfers to the public, I doubt you'd want to vary those with the business cycle, but who knows? However the magnitudes would be small."

I think you (probably) would want to vary those with the sort of shocks that normally would cause the central bank to increase the base to prevent a recession, but normally yes, the magnitudes would be small. But, theoretically, we can at least imagine cases where the magnitudes would be large. A world for example where there are no real investment opportunities (or none at the margin), where a big shock to desired savings causes the natural rate of interest to drop below the growth rate. A Samuelson 57 world, for example. So the central bank runs out of assets to buy, and the private sector still considers holding base money better than consumption. You have a choice: either raise the NGDP/inflation growth target, or else do big amounts of helicopter money.

The main argument against Ralph is that he is throwing away one policy tool: bonds (government liabilities that pay a variable rate of interest). Suppose you want to reduce AD. Without bonds, and with base money paying 0% nominal, you would either need to cut G or increase T. Those cuts in G or increases in T could be truly massive. E.g., suppose a world with no bonds, where initially the government debt is all in 0% interest currency, and is 100% of GDP. Then people decide they only want to hold 10% currency to GDP.

Gzibordi: I will take a look. I think I read that Greek economist (sorry, temporarily forgotten his name) propose something similar.

[Scott Sumner]

Nick, I agree about Ralph's proposal. BTW, that's an argument I used against David Beckworth's claim that monetary injections at the zero bound could be permanent under NGDPLT. Or perhaps I misunderstood David.

Yes, if the central bank runs out of assets to buy, then we obviously need to consider something like a helicopter drop. But I see near-zero probability of that ever happening. It's not even on the radar screen as a plausible hypothetical. In contrast, I see Keynesians engaged in very serious talk about helicopter drops, so they cannot be assuming a world where there is nothing for a central bank to buy.

Alternatively, I see about a 1000 times greater chance of a solar flare knocking out the entire US electrical system for months, plunging us back into the dark ages. But I don't see any Keynesian modeling of what to do with monetary policy in that case. Since that's much more likely than the central bank running out of things to buy, why not talk about that scenario?

And there's no one better at analyzing those sorts of unusual hypotheticals than you. :)

[Nick Rowe]

Gzibordi: Yanis Varoufakis is the Greek economist I was thinking of.

A very quick answer: I think it all depends on whether the TCCs would or would not actually be used as media of exchange. (How would Gresham's Law play out?).

If people do not use them as a medium of exchange, then they are just bonds. And even if they can always be used to pay taxes when they mature, so can regular bonds, in effect, be used this way. Provided the government does not default. When the bond matures, the government gives you money, and you can use that money to pay your taxes.

If people do use them as a medium of exchange, then it is as if the individual EU countries can print their own money, at a floating exchange rate. Then they might work.

[Nick Rowe]

Scott: now that I think about it: just as the existence of land rules out Samuelson 57, I think it also rules out helicopter drops as being the only option. The central bank can always buy land.

[Majromax]

@Nick:

> Suppose you want to reduce AD. Without bonds, and with base money paying 0% nominal, you would either need to cut G or increase T. Those cuts in G or increases in T could be truly massive.

Is an open market operation (which I presume you mean here?) really different than changing G/T, in a New Keynesian framework?

A government-owned central bank pays interest income back to the government coffers, and government debt represents deferred taxation. An OMO that results in the central bank purchase of government securities in effect is then a commitment to reduced future taxation. New Keynesian agents would then interpret that commitment as a reduction in permanent taxation.

The effect is the same sign (but probably much reduced magnitude?) as the primary effect on interest rates. This might be what you're hinting at in your post when you contemplate "reducing the shadow price of public funds."

> Scott: now that I think about it: just as the existence of land rules out Samuelson 57, I think it also rules out helicopter drops as being the only option. The central bank can always buy land.

Would that really work? I'm not sure it would, at least not without more discussion on how monetary policy translates into real AD shifts.

Your post above contemplates helicopter money in a system of optimal monetary and fiscal policy. That necessarily means that any time monetary easing doesn't (but should) coincide with a transfer payment increase, the policy is suboptimal.

Ultimately, that has to mean that for a fixed-size expansion in the monetary base, the economy will see a lessser increase in aggregate demand. Or, to put it the other way, the central bank's balance sheet will increase much more than it would have otherwise for a fixed AD increase.

That expansion might be important because while money may be ultimately neutral, land isn't. Who owns land (for what purpose) is a very important public policy and distributional question, and CB purchase of any nontraditional asset has a differential impact on those who hold that asset. CB land purchases will obviously further increase the price of land, which will affect everything from property tax payments to urban development.

That's perhaps why there's so much skepticism related to non-traditional CB purchases: as soon as the CB starts purchasing things that aren't government bonds, it's making a decision about *who* gets the liquidity. That distributional question is conventionally a political matter.

[Frank Restly]

Nick,

On your response to Gzibordi:

"If people do not use them as a medium of exchange, then they are just bonds."

You missed this statement:

"Yet, their recipients could immediately convert them in euro (by selling them in the financial market at a discount comparable to that on a two-year, zero coupon government bond), and use them for cutting taxes."

If they are just bonds, they would not trade at a discount to a two-year, zero coupon government bond.

[Nick Rowe]

Majromax: in a world of Ricardian Equivalence, and lump sum taxes (which is the simplest NK model) I agree there is no difference. But as soon as we drop the assumption of lump sum taxes, and replace it with distorting taxes, it matters. 100% marginal tax rates (or even anticipated fluctuations in marginal tax rates) would have welfare costs). And in an OLG model, or one with borrowing constrained agents, the distinction between bonds and taxes would matter.

Frank: no, I did not miss that statement. Plus, you misread that statement.

Stop now.

[Nick Rowe]

Scott: OK, I cooked up a little model with land. In an extreme case, with a big enough temporary shock to savings, the central bank might need to buy all the land to keep NGDP on target. Helicopter money is like buying land, then giving it away again.

[Too Much Fed]

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