Worthwhile Canadian Initiative

Fewer Fiscal Multipliers and more Clarity from the Bank of Canada

At the risk of being thought "cavalier", I don't like what Bank of Canada governor Stephen Poloz is reported as saying by Kevin Carmichael.

Inflation targeting is supposed to be inflation forecast targeting. The Bank of Canada is supposed to do what is needed to ensure that its own internal forecast of future inflation (at a roughly 2-year horizon), conditional on the Bank's information, remains at the 2% target.

Inflation targeting is supposed to be symmetric. The Bank is supposed to respond to new information about any shock to Aggregate Demand to prevent that shock affecting its forecast of inflation, whether that shock is positive or negative.

The Bank of Canada is not supposed to follow any simple instrument rule, like a Taylor Rule, if that simple rule leaves out any information that might be relevant for the Bank's internal inflation forecast. For example, the only information in the Taylor Rule is the output gap (the difference between current output and potential output) and the inflation gap (the difference between current inflation and target inflation). Using a Taylor Rule implies ignoring any information the Bank of Canada might have about shocks to the natural rate of interest. [I say this notwithstanding the internal inconsistency, like the Cretan Liar Paradox, of the Bank's own Totem model assuming that its own future actions will follow a slightly-modified Taylor Rule.]

The whole point of inflation forecast targeting is that the Bank of Canada does not "accommodate" any shock to Aggregate Demand that would change its internal forecast of future output and hence future inflation. And that includes fiscal policy shocks. The Bank of Canada is supposed to offset any such shock, 100%. It makes no sense for the Bank of Canada to provide any estimate of fiscal policy "multipliers" other than zero. Even calculating a hypothetical "multiplier", for how output would respond if the Bank did "nothing", makes no sense, because the definition of "doing nothing" is arbitrary. Even if we agree that "doing nothing" means "doing nothing with the nominal rate of interest", that leaves open the question of how long the Bank holds the nominal rate of interest constant. And "forever" is not a meaningful answer to that question, because standard New Keynesian models (and the Bank is New Keynesian) tell us that monetary systems will either explode or implode if the central bank holds the nominal interest rate constant forever. [The Bank says it does accommodate the "first-round effect" of short-run supply-side or price shocks, like changes in indirect taxes, but that's not what we are arguing about here.]

Fiscal Balance and Unemployment

As we all know, Canada will be running deficits well into the foreseeable future.  Based on the figures from the 2016 Federal Budget, as a percentage of GDP Canada will see its deficit go from a surplus of 0.1% in 2014 to -1.5% in 2016 and then will range from a low of -0.6 percent in 2020 to a high of -1.4% in 2017.  Canada will be in good company as the accompanying figure shows.

Neo-Fisherian Microfoundations, with non-binding price ceiling and floor

Update: Here's a picture:

Original post follows:

On Central Bank Lending to Government

The central bank prints money, lends it to the government, and the government sooner or later spends it (or uses it to cut taxes or increase transfer payments).

There seem to me to be two views on this question that are equally daft:

1. The Orthodox Daft View: "Central bank lending to government is a Bad Thing and should be prohibited!"
2. The Revolutionary Daft View: "Central bank lending to government is a Good Thing and should be mandatory!"

I don't get it.

Two Problems with Designing a Basic Income Experiment

WARNING: I don't do (micro) Public Finance. And I don't do experimental economics. Those who have read the literature may tell me they are well aware of these problems, or that I'm wrong about something.

Suppose someone asked me to design an experiment to test whether Basic Income would be a Good thing. (They wouldn't ask me, but let's suppose.) I can see two major problems.

1. Temporary experiment vs permanent policy.

Let us suppose that the worst fears about Basic Income were true. If you gave anyone (say) $10,000 per year whether they worked or not, everyone would stop working. Just suppose. Would the experiment be able to tell you that? Because if the experiment weren't able to tell you that, if it were true, it wouldn't be a very informative experiment.

If the experiment were temporary, and known to be temporary, it probably wouldn't be able to tell you that. Because getting $10,000 per year for one year is very different from getting $10,000 per year for life. (Colby Cosh tells me the Dauphin experiment did run for 4 years.)

If people do spend the extra money on taking time off work, that doesn't mean they spend it all immediately. If the average person in the experiment will work for (say) 20 more years, and people spread their extra time off work evenly over their remaining years ("consumption-smoothing"), the effects of a lifetime of basic income will be 20 times bigger than measured by a one year experiment.

It could be even worse than that, because people tend to bunch their leisure towards the end of their lives. We call it "retirement". Maybe the effect of getting $10,000 per year for one year will be that people will retire one year earlier. In which case, the experiment will show zero effect for everyone, except the small fraction of people who were planning to retire soon. If a one year experiment cuts working life from (say) 40 years to 39 years, the effects of a lifetime of basic income will be 40 times bigger than measured by a one year experiment.

You might need to run the experiment for three score and ten years to get some idea of the life-cycle effects. Which is a bit awkward.

2. Funded experiment vs self-funded policy

It's OK if experiments cost money. It's worth paying (sometimes) to get the information. But a basic income policy needs to be self-funding. Free ponies don't grow on trees. If you simply give everyone in the experiment a free $10,000 per year, then (as Stephen Gordon tweeted) good things will very probably happen. But what we want to know is whether good things will happen if we give a group of people $10,000 per year each and that same group of people have to somehow pay for that $10,000 per year each. What we want is a self-funding or revenue-neutral experiment (except for the cost of paying the researchers). The subjects would have to give up all other forms of support that the basic income is designed to replace, and pay the extra taxes that would be needed to make up the difference. Labour supply is not just about income effects; it's about substitution effects caused by changing the marginal (net) tax rate.

Almost any change in tax/transfer policy creates winners and losers. And with informed consent, the losers won't sign the Consent Form. Which would make it a bit awkward getting it past the Research Ethics Board.

It's the external validity of experiments that matters, not the damned T-statistics.

But, as a (moderate) supporter of Basic Income, I think I might just have a Cunning Plan. Which I will leave till later, if and when my head is clearer. But I think we are thinking about this Basic Income thing the wrong way.

Helicopter Bonds as Qualitative Easing

Accounting can be fun.

Helicopter Bonds is when the government prints some bonds and drops them out of a helicopter, so whoever picks up the bonds now owns them. It's identical to a bond-financed lump-sum transfer payment. It's identical to a bond-financed lump-sum tax cut (because only net taxes=taxes-transfers matter). The government borrows money from the population by selling bonds, then gives them the money back, and lets them keep the bonds. At the end of the day the population has the same amount of money, and more government bonds.

If Ricardian Equivalence were true, Helicopter Bonds would have no effect on anything. It is exactly as if, when the government gives me a government bond worth $100, the government demands I give it my personal IOU (my personal bond) for $100 worth of future taxes. It is exactly as if the government and I simply swapped a government bond for my personal bond. And in the world of Ricardian Equivalence, where it doesn't matter whose name is on the bond, the net effect is zero.

Now let's consider a simple case where Ricardian Equivalence is false. Half the population is borrowing-constrained. They can't borrow. That means they want to sell their personal bonds (IOUs) but nobody will buy them. So Helicopter Bonds causes half the population to sell their government bonds to the other half, so they can spend the proceeds. Again, it is exactly as if the government and I swapped a government bond for my personal bond. But in this case, where Ricardian Equivalence is false, it does matter whose name is on the bond. Because only the government will buy a bond with my name on it, if I am one of the borrowing-constrained half of the population.

Quantitative Easing is the silly new name for Open Market Operations. It's when the central bank prints money to buy a bond. It expands both sides of the central bank's balance sheet. Qualitative Easing is when the central bank changes the composition of the asset side of its balance sheet, leaving the liability side unchanged. It sells government bonds, and buys some riskier or less liquid asset.

If we consolidate the balance sheets of the central bank and the government that owns that central bank, that means we can see Helicopter Bonds as a form of Qualitative Easing. The government/central bank swaps safe and liquid government bonds for less safe and less liquid private bonds. In my example above, where half the population is borrowing-constrained and unable to sell their personal bonds at all, Helicopter Bonds is just an extreme case of Qualitative Easing where their personal bonds are extremely unsafe or illiquid. In a less extreme case, the borrowing-constrained can borrow, but only from loan sharks.

Helicopter Money is Permanent

The shocks in a random walk process are permanent. That does not mean it is impossible for a positive shock to be followed by a negative shock. It does mean it is equally likely that a positive shock will be followed by a positive shock as by a negative shock. That's what I mean by "permanent".

Consider two policies:

A. I print $100 and give you $100. Period.

B. I print $100, and give you $100, and at the same time tell you (lead you to expect) that I will take $100 away from you next year, and burn it.

A is an outright gift of newly-printed money. It is helicopter money.

B is not a gift. B is an interest-free loan. The fact that you do not give me an IOU is irrelevant. The fact that I do not buy your IOU is irrelevant. If I know where to find you, and have no problems remembering that I lent you $100, and have no problems forcing you to pay me $100, I do not need little bits of paper with "IOU" written on them to help jog my memory and help me get the $100 back through the courts. But it is exactly as if I printed $100 and bought your one-year IOU for $100 with it. Or bought an IOU from you that someone else had signed. And bonds are IOUs.

B is an Open Market Operation, in which I print $100, buy $100 worth of bonds from you, and reverse that operation one year later. B is not Helicopter Money.

If the central bank had a Price Level Path target, or an NGDP level path target, then helicopter money is equivalent to raising that Price Level path target, or NGDP level path target. Because the stock of money will be permanently higher than it otherwise would be, and so the price level or NGDP level will be permanently higher than it otherwise would be. Or, as I argued in my old post, raising the Price level or NGDP level path target converts some existing money into helicopter money. (As Brad deLong put it) it's helicopter money without the helicopters.

I think I'm disagreeing with Simon Wren-Lewis and Eric Lonergan. (Or maybe I'm misunderstanding them, because my brain is tired.)

The Neo-Fisherian Counterfeiter

Just a thought-experiment that's been running through my head.

You are a saver and lender. You take some of the money you have earned as income, that you don't want to spend yourself, and lend it to people who want to borrow so they can spend it instead of you. Suppose you want to lend more than people want to borrow at the current rate of interest you charge, and you are unwilling to lend to riskier borrowers. You decide to lower the rate of interest you charge, so people will want to borrow more from you. You face a downward-sloping demand curve for loans. If you want to save and lend more of your income, you will need to lower the rate of interest you charge your borrowers. The greater the substitutibility between you and other lenders, and the smaller you are in the total market for loans, the more elastic will be the demand curve you face. Only in the limit, as the market for loans approaches perfect competition, does your downward-sloping demand curve become perfectly elastic at the market rate of interest.

Maybe you start borrowing from other savers, so you lend even more. You are now a financial intermediary, because you both borrow and lend.

Now suppose you go over to the Dark Side. You become a counterfeiter. You print money that is indistinguishable from central bank money. You lend out not only the money you have saved from your income, and the money you have borrowed from other savers, but you also lend out the money you have printed. The central bank knows there's a counterfeiter out there somewhere, but doesn't know it's you. And the central bank wants to keep inflation at the 2% target, so adjusts its own money printing one-for-one to your money printing, so your counterfeiting activities have no effect on the money supply growth rate and no effect on the inflation rate. You still face a downward-sloping demand curve for loans. If you want to print more money and lend more money, you will need to lower the rate of interest you charge your borrowers.