Tuesday, August 6, 2013

Helicopter Drops As Insurance Against Central Bank Incompetence: A Reply to Scott Sumner

Back in June I proposed that helicopter drops become a normal, systematic part of countercyclical policy. Here is what I said:
First, the Fed adopts a NGDP level target. Doing so would better anchor nominal spending and income expectations and therefore minimize the chance of ever entering a liquidity-trap. In other words, if the public believes the Fed will do whatever it takes to maintain a stable growth path for NGDP, then they would have no need to panic and hoard liquid assets in the first place when an adverse economic shock hits. 
Second, the Fed and Treasury sign an agreement that should a liquidity trap emerge anyhow and knock NGDP off its targeted path, they would then quickly work together to implement a helicopter drop. The Fed would provide the funding and the Treasury Department would provide the logistical support to deliver the funds to households. Once NGDP returned to its targeted path the helicopter drop would end and the Fed would implement policy using normal open market operations. If the public understood this plan, it would further stabilize NGDP expectations and make it unlikely a helicopter drop would ever be needed.
This two-tier approach to NGDP level targeting should create a foolproof way to avoid liquidity traps. It should also reduce asset boom-bust cycles since NGDP targets avoid destablizing responses to supply shocks that often fuel swings in asset prices.
Scott Sumner was not impressed and argued that helicopter drops have been tried for 20 years in Japan to no avail.  Like Steve Randy Waldman, I belive not all helicopter drops are the same. What I envisioned is not what happened in Japan prior to Abenomics, but having the Fed (via the Treasury Department) directly deposit dollars into tax fillers' checking accounts in conjunction with a clearly communicated NGDP level target. That approach has not been tried and would directly address the excess money demand problem that is behind aggregate demand shortfalls. 

Helicopter drops along these lines also need not imply large distortionary taxation in the future. The stable nominal income expectations that they would create and the relative ease of implementing this kind of helicopter drop would prevent the buildup of excess money demand in the first place. But even if the Fed did need to reverse itself in the future, one could always allow the Fed to start issuing it's own bills and notes. They could be funded by current and future seigniorage and would not be that different than its current practice of paying interest on excess reserves.

The real reason, however, Sumner should be for this proposal is that it provides insurance against central bank incompetence. Sumner loves to say that the fiscal multiplier is nothing more than an estimate of central bank incompetence. That is, the fiscal multiplier is large only when the central banks fail to properly stabilize aggregate demand. Well, helicopter drops are fiscal policy and in my proposal they would be applied only when the Fed failed to stabilize demand. Therefore, it is a perfect fit. Employ fiscal policy only when it packs a punch and do so in a manner to preserve a NGDP level target.

Yes, if central bank were to adopt a NGDP level target and faithfully execute its mission then none of this would be necessary. But if the past four years have taught us anything, it is that central banks can be very incompetent. And of all people, Scott Sumner has been the loudest in making this point. He, therefore, should excited about insurance against central bank incompetence. This is a modest proposal to that end.

P.S. Thanks to Ryan Avent, Matthew C Klein, Cullen Roche, and Michael Sankowski for earlier discussions of my proposal.

14 comments:

  1. Since this is, at best, a workaround to the zero bound problem, a better idea is to get rid of the zero bound (or at least, make preparations so it can be removed on short notice).

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  2. Since I like the idea of a 'Citizens Income' to replace all welfare etc. transfers (aka Guaranteed Basic Income, and others) I call this direct helicopter drop a 'Citizens Bonus'.

    And I also like the idea of everyone having a 'government' bank account: risk-free, but zero yielding. Digital cash. In that world, all bank deposits are at risk. You want risk free? Keep it in e-cash. You want to receive interest? Take some risk.

    The Citizens Income and Bonus would be deposited to that account.

    Then you phase out physical cash, so that the e-cash accounts represent all liquid funds. By monitoring that in aggregate, you can get statistics on velocity of money, and do your Citizens' Bonusing if there's hoarding (when velocity falls).

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  3. if the solutions to an output gap is to simply print money and never have a down cycle, why hasn't it been done already as it would clearly lead to prosperity to all those who go down this route?

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  4. This solves one of the key flaws of NGDP targeting, the central bank's lack of fiscal power, by giving the central bank the ability to directly donate money to the population. Given the appointed rather than elected nature of the Fed it seems unlikely to happen, though. Why is "helicopter money" different from and better than having the government send out checks, as the Bush administration did? I suspect the answer is that you don't think there's any hope of getting enough votes for that in the legislature. I understand Bush wasn't explicitly targeting NGDP.

    This doesn't solve the other, more critical flaw of NGDP targeting that it boils down to an effort to substitute inflation for growth rather than reform the economy to cope with lower potential growth as we age, have less kids and (perhaps) productivity becomes more difficult to increase.

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    1. Yes, central banks have no fiscal power. That only is in Treasury's hands thus the "helicopter drop" thesis has long been a myth.

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  5. I just don't see how Scott can extract himself from the logical consequences of his constantly-repeated dicta, consequences that are perfectly explicated here.

    Scott: Fiscal policy works when the Fed is incompetent

    Scott: The Fed is incompetent

    Ergo: Fiscal policy works.

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  6. I like this idea, if I understand it. You mean the Fed prints up (digitizes) new money, and it is deposited directly into citizen bank accounts? In other words, the US Treasury first does not go out and borrow the money to be deposited into citizen accounts?

    Politically, I wonder if the above idea will fly.

    Now, think about lotteries. We just had a huge Powerball, and a lot of people lost small sums to one big winner. The big winner will likely bank most of it. This is reverse stimulus.

    What if the federal government funded state lotteries in which there were many small winners? In other words, a typical player buys three $25 tickets and wins $100. You have to give your Social Security number to collect, and you can only win $10k a year. The maximum ticket sold is $25, and buyers can only buy one ticket per location (this is to try to prevent large buyers buying lots of tickets).



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  7. David,

    By helicopter drop do you mean a permanent gift to households, or a loan that households must ultimately pay back to the Treasury? According to your plan the Treasury gets funds from the Fed in order to execute the drops. Must the Treasury eventually pay the Fed back, or can we assume that the Fed's funding of Treasury-managed drops is permanent?

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  8. JP,

    It would be a permanent injection/withdrawal to the extent it kept NGDP on track. I haven't worked out the logistical details completely, but the Treasury has the infrastructure to reach tax payers and the Fed has the funding capacity. That is why I talked about using Treasury. The withdrawals would occur via Fed bills and notes, though Treasury could do it with its own securities. However, my sense is that if if we kept it all within the Fed it would be more politically palatable.

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    1. David, a trillion dollar coin deposit at the fed would do it and the accounting would be consistent. The tax payers need income not money(debt) public or private. If we had a better distribution of income the velocity would be higher. The private sector is still deleveraging and they would use the money to pay down debt first, so a policy to provide a helicopter drop for debt repayment should come first and get it over with.

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  9. Mr. Beckworth,

    I wrote this early. Would you like to critique this? My goal is to really understand the MM position.
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    I think Market Monetarists suggest that the Fed could help by engaging in QE that results in a permanent monetary base. In think about this, I do see this as a possibility actually. Imagine a scenario where I issued a bond where the fed purchased it. The banking system would credit my bank account. The Fed would credit my bank’s reserve balance, and the fed would be holding my security as an asset. Now imagine, I defaulted and the fed accepted this outcome without any punishment toward me. I would have increased my net worth balance sheet position at the expense of the fed. The increase to the monetary base would be permanent as the fed would not have a security to sell back to the banking system. The fed would have a negative net worth position… BUT this is a form of fiscal policy! The fed would no longer be able to remit the same level of interest payments to the treasury resulting in an increased budget deficit. This process would eventually result in negative remittances, which increases government spending and the budget deficit.

    Now the Fed could just as easily state that the increase in the monetary base is permanent and that they will “destroy” the treasury securities leaving the fed with negative net worth which would result in negative remittances. However, this is still reliant on the treasury issuing new securities. So, the Fed policy depends upon on the private sector or treasury issuing securities.

    Alternatively, if the Fed were given legal permission to force banks to credit private bank accounts while increasing the bank’s excess reserves without swapping for an asset, the Fed would increase the private sector’s aggregate net worth position. The Fed would run a negative net worth position which is still fiscal policy due to the negative remittances. This is the Fed engaging in helicopter drops which is not something that they can currently do.

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  10. I think Market Monetarists suggest that the Fed could help by engaging in QE that results in a permanent monetary base. In think about this, I do see this as a possibility actually. Imagine a scenario where I issued a bond where the fed purchased it. The banking system would credit my bank account. The Fed would credit my bank’s reserve balance, and the fed would be holding my security as an asset. Now imagine, I defaulted and the fed accepted this outcome without any punishment toward me. I would have increased my net worth balance sheet position at the expense of the fed. The increase to the monetary base would be permanent as the fed would not have a security to sell back to the banking system. The fed would have a negative net worth position… BUT this is a form of fiscal policy! The fed would no longer be able to remit the same level of interest payments to the treasury resulting in an increased budget deficit. This process would eventually result in negative remittances, which increases government spending and the budget deficit.

    Now the Fed could just as easily state that the increase in the monetary base is permanent and that they will “destroy” the treasury securities leaving the fed with negative net worth which would result in negative remittances. However, this is still reliant on the treasury issuing new securities. So, the Fed policy depends upon on the private sector or treasury issuing securities.

    Alternatively, if the Fed were given legal permission to force banks to credit private bank accounts while increasing the bank’s excess reserves without swapping for an asset, the Fed would increase the private sector’s aggregate net worth position. The Fed would run a negative net worth position which is still fiscal policy due to the negative remittances. This is the Fed engaging in helicopter drops which is not something that they can currently do.

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  11. David,


    Given that "heli drops" might have a greater chance of success than asset purchases (possibly for political rather than economic reasons) then what would your views be on this proposal from Russ Abbott?

    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1977688

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  12. This sounds like the Bush-Feldstein plan of 2008--ie., fiscal stimulus.

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