Some observers say the Fed is out of ammo, that any further attempts by it to stimulate nominal spending is like pushing on a string--it's futile. This understanding ignores the fact that the Fed has yet to use all of its big guns and that these guns were found to be highly effective in ending the Great Contraction of 1929-1933. Moreover, Fed officials including Bernanke believe the Fed could do more if it wanted to do so. So the "Fed is pushing on a string" folks are simply wrong. Still, it is always useful to consider exactly how the Fed could stimulate total current dollar spending. Ricardo Caballero does just that in his recent proposal to have the Fed do a helicopter drop via the U.S. Treasury Department. His proposal is very explicit in how it would work and with a few minor tweaks I believe it could be effective in stabilizing aggregate demand. Here is Cabellero:
[T]he Federal Reserve has the resources but not the instruments, while the US Treasury has the policy instruments but not the resources. It stands to reason that what we need is a transfer from the Fed to the Treasury...what we need is a fiscal expansion (e.g. a temporary and large cut of sales taxes) that does not raise public debt in equal amount. This can be done with a “helicopter drop” targeted at the Treasury. That is, a monetary gift from the Fed to the Treasury.
I would tweak this proposal in two ways. First, I would do fiscal expansion via a payroll tax holiday. Second, I would announce that this payroll tax holiday would be contingent on hitting an explicit nominal GDP or price level target. Thus, as long as the target was not being met the payroll tax holiday would be in effect. I really like this proposal for the following reasons:
- The money is sent directly to the public; it bypasses the credit-clogged banking system and puts into the hand of the spenders.
- There is no increase in the public debt, thus there is no Ricardian Equivalence problems.
- It is politically feasible: the Republicans get a payroll tax cut and the Democrats get fiscal expansion.
- It is radical enough to work. To change expectations there has to be some shock-and-awe break from the current policy of allowing declines in inflation expectations, core prices, and nominal spending. This should do it.
The biggest drawback to this proposal is the issue of how the Fed could unwind the monetary expansion at a later date. This program would have the Fed increase its liabilities (i.e. the monetary base) without any offsetting increase in Fed assets (e.g. treasury securities). Having these assets available would be important for the Fed down the road if, say after the economic recovery, it needed to pull back some of the money created through this program. Caballero suggest the Fed could use some of its new tools (e.g. Fed term deposits ) or add contingency conditions that would require the Treasury to return money to the Fed. None of these solutions would be painless. Felix Salmon suggests a way around this problem is simply to front-load the seigniorage (i.e. Fed profit) returned to the Treasury. It is unclear, though, how well this would work. Seigniorage is limited and thus the Fed could not unconditionally commit to an explicit NGDP or price level target with it. It would therefore be difficult shake deflationary expectations. One soultion might be to have the Fed simply buy treasury securities directly from the U.S. Treasury instead of giving it a "monetary gift" via a helicopter drop. As long as the Fed held securities there would be no increase in the amount of publicly held debt. Some of the debt may ultimately leak bank into the public domain if the Fed used it to reverse some of the monetary expansion. As long as the leakage was not too much the same benefits outlined above would apply.