The Wrong Debate: Helicopter Drops vs. Quantative Easing

A central theme of this blog is that the economy is still starved of the monetary assets needed to restore full employment. That is, the ongoing shortfall of aggregate demand is at its core caused by a shortage of money and money-like assets relative to the demand for them. The question, then, is what can be done about this problem.

I have long argued, along with other Market Monetarists, that the Fed could solve this problem by adopting a NGDP level target. Why would this help? The key reason is that it would create an expectation that some portion of the monetary base growth from the asset purchases would be permanent (and non-sterilized by IOER). That, in turn, would mean a permanently higher price level and nominal income in the future. Such knowledge would cause current investors to rebalance their portfolios away from highly liquid, low-yielding assets towards less liquid, higher yielding assets. The portfolio rebalancing, in turn, would raise asset prices, lower risk premiums, increase financial intermediation, spur more investment spending, and ultimately catalyze a robust recovery in aggregate demand. (One could also tell a New Keynesian story where the higher future price level implies a temporary bout of higher-than-normal inflation that would lower real interest rates down to their market clearing level.)

The key to the above story is that some portion of the monetary base expansion is expected to be permanent. If the public believes the Fed's asset purchases are not going to be permanent and therefore the price level and nominal income will not be permanently higher, the rebalancing will not take place. I bring this up because this same point applies to helicopter drops or any other kind of fiscal policy stimulus. Yet many of my fiscalist friends miss it. They seem to think that helicopter drop will solve the excess money demand problem, period. That is not the case if the Fed continues to hit its inflation target.

Imagine, for example, that Congress approved a $10,000 check be sent to every household. Even in a non-Ricardian world where households are liquidity- and credit-constrained, the increased private sector spending created by the checks would be offset by monetary policy if it started to push inflation above its target.

This is why helicopter drops by themselves are not a fix. Nor or large scale asset purchases. As noted by Christina Romer, there has to be a regime change in how monetary policy is conducted, one that signals a commitment to a permanent expansion of the monetary base (via a commitment to a higher price level and nominal income). From this perspective, it does not matter whether one does helicopter drops or large scale asset purchases. They would have the same effect if tied to the same target, such as a NGDP level target. 

Michael Woodford has made this point before:

It is possible for exactly the same equilibrium to be supported by a policy of either sort. On the one hand (traditional quantitative easing), one might increase the monetary base through a purchase of government bonds by the central bank, and commit to maintain the monetary base permanently at the higher level. On the other (‘helicopter money’), one might print new base money to finance a transfer to the public, and commit never to retire the newly issued money. Suppose that in either case, the path of government purchases is the same, and taxes are raised to the extent necessary to finance those purchases and to service the outstanding government debt, after transfers of the central bank’s seignorage income to the Treasury. Assuming the same size of permanent increase in the monetary base, the perfect foresight equilibrium is the same in both cases...

However, he notes the two approaches would have different effects if the public thought the permanency of the monetary base injections differed:

The effects could be different if, in practice, the consequences for future policy were not perceived the same way by the public. Under quantitative easing, people might not expect the increase in the monetary base to be permanent – after all, it was not in the case of Japan’s quantitative easing policy in the period 2001-2006, and US and UK policymakers insist that the expansions of those central banks’ balance sheets won’t be permanent, either – and in that case, there is no reason for demand to increase. 

In other words, we should not be surprised that the Fed's QE programs have not packed more of a punch. U.S. monetary authorities have clearly indicated the programs are temporary. (QE3, though, has added some permanency with its data-dependent nature and appears to have offset much of the 2013 fiscal drag.) We should also, then, not be surprised that Abenomics--which has signaled a permanent expansion of the monetary base--is doing so much better than the original Bank of Japan QE program of 2001-2006. Finally, we should also not be surprised as to why FDR's 1933 decision to go off the gold packed such a punch. It permanently raised the monetary base. All of these experiences paint a picture of the relationship between the expected permanency of monetary base injections and aggregate demand growth. This relationship is sketched in the figure above.

So stop worrying about whether large scale asset purchases or helicopter drops are more effective. This is the wrong debate. Instead, start worrying about how we can change the Fed's target to something like a NGDP level target.

P.S. Paul Krugman's 1988 article also implies that the temporary versus permanent distinction is important in determining the efficacy of monetary policy, particularly at the ZLB.

P.P.S. The above discussion is why I have previously argued for helicopter drops to be tied to NGDP level targets.

Update: Compare this picture of Japan's monetary base to those of the U.S. monetary base in 1933.