The authors call it a primer on helicopter money which will be missed by most as another of those primers which are hardly a primer. But this one is and needs to be read.
The authors take the balance sheet approach and explain how helicopter money actually works.
First, why Friedman version does not work today?
In an essay published in 1969, Milton Friedman described what he believed to be a surefire mechanism that central banks could use to generate inflation (were that desired): drop currency straight from helicopters on to the population, while promising never to remove it from circulation. The result would be higher prices (and, if you keep doing this, inflation).
In his thought experiment, Friedman assumed that by altering the monetary base – the sum of currency and commercial bank reserve deposits at the Fed – the central bank could control the supply of transactions money (such as the aggregate M2). Second, he assumed that reserves were not compensated: that is, commercial bank holdings at the central bank had a zero interest rate.
Now, there are three problems with this thought experiment.
- First, transferring funds to households is what fiscal policymakers do, not central bankers. The latter issue central bank money to acquire assets.
- Second, except when interest rates are at the effective lower bound, monetary policymakers today control interest rates, not the monetary base (or another monetary aggregate). The monetary base is determined by the demand of individuals to hold currency and of banks to hold reserves at the central bank’s interest rate target. In practical terms, this means that the central bank cannot credibly promise to permanently increase the monetary base.
- Third, 21st century central banks pay interest on reserves. And they do so precisely to control the level of interest rates in the economy.
How will it work then?
….in the pre-Crisis world, the multi-stage process goes like this:
- The Treasury issues a bond to the central bank in exchange for a deposit balance.
- The Treasury spends the funds in its central bank deposit, shifting the central bank’s liability to commercial bank reserves and leading to an increase in expected future tax revenues (a Treasury asset).
- Commercial banks, not wanting the additional reserves, exchange them for a government bond, reducing central bank assets and liabilities. The central bank accommodates this exchange unless it wishes to alter the interest rate target.
- The result is an increase in the Treasury’s issue of publicly held bonds, rather than an increase in central bank money.
Admittedly, no one has suggested the use of helicopter money during normal times when bank demand for reserves is downward-sloping and the central bank accommodates that demand to hit its rate target. (For description of Fed operating procedures in this setting, see Figure 1 in Cecchetti and Schoenholtz 2015.) Instead, the recommendation is that it be used as a last resort – one that comes after QE has been exhausted and interest rates have plunged to the effective lower bound. At that stage, reserves have been supplied massively in excess of the volume needed to hit any interest rate target and banks’ demand for reserves is fully elastic so that they will be indifferent between holding billions more or less (see Figure 2 in Cecchetti and Schoenholtz 2015). Put differently, once QE drives interest rates to zero or lower, the level of reserves is supply determined. That means that when a commercial bank goes to the central bank to try to exchange the additional reserves for bonds (in Step 3 above), the central bank will refuse. As a result, Figure 3 describes the final position of the balance sheets.
Does this make any difference? Is helicopter money in this setting any different from standard QE when the Fed purchased long-term bonds in exchange for reserves in an effort to flatten the yield curve? Since the alternative is for the fiscal authorities to sell long-term bonds, the answer is no. To see why, note first that, following Steps 1 and 2, the consolidated government bank balance sheet shows a $100 increase in both reserve liabilities and the present value of future tax revenue assets. Recall that, in contrast to Friedman’s world, central banks now pay interest on excess reserves. So, banks are compensated for the additional $100 they hold in their account at the central bank at the zero-maturity government rate.
If the yield curve still has any upward slope, issuing reserves rather than long-term bonds to finance fiscal expenditure will appear cheaper in terms of current debt service. However, this apparent saving is an illusion because it ignores interest rate risk. If the government chooses to issue long-term debt, it must compensate investors to take this risk; if it issues short, the government itself assumes the risk.
Despite being much simpler, requires careful reading..