The Wilberforce Society (a student-run think-tank in Cambridge) have just released an interesting paper arguing that central banks should have the power to implement helicopter drops by giving money directly to consumers. They term this policy ‘helicopter money’. The full paper is available here and there is a shorter summary given here. The authors begin with a fairly uncontroversial statement of reasons as to why monetary policy is preferable to fiscal policy under normal circumstances. The problem they identify with current monetary policy is the issue of what happens when we reach very low nominal interest rates.
However, when interest rates reach their zero lower bound (ZLB), theory and common sense
indicate that this severely constrains the power of monetary policy to stimulate the economy through interest rate policy. This is because central banks cannot cut interest rates below zero, stopping their ability to add stimulus through that channel.
First negative interest rates can be a thing. Obviously if a central bank accepts the constraint that interest rates must or ought to remain positive then it will be constrained in its ability to undertake monetary policy if the only policy tool is manipulation of nominal interest rates. The paper goes on to correctly identify a problem with quantitative easing as it has been implemented in the United Kingdom – the fact that financial intermediaries remain in a relatively weak state and hence aren’t lending out much of the money created by QE. In my mind this misses the relationship between monetary policy and the action of financial intermediaries. Scott Sumner makes the point that bank lending is largely a result of future expectations of nominal income. This points to one of two things – either the BoE’s QE was insufficiently large or not enough was done to suggest to markets that such increases in the money supply would be maintained for a sufficient period before the inflation hawks stepped in to limit the process. It should of course be remembered that the Carney Rule is a relatively recent development that was not indicative of the BoE’s policy advice over much of the crisis. I would go further and suggest a system of nominal GDP targeting ought to make the expectations based channel of monetary policy much stronger. The paper then identifies three main costs they believe that QE has.
Many fear that the combination of QE and forward guidance will mean financial asset
prices shift away from fundamentals, causing a so-called bubble. Currently, this seems to
be a remote possibility
I am glad that this is indeed identified as a remote possibility. I don’t really understand this argument. Of course it is true that if the BoE decided tomorrow that it was going to engage in large-scale purchases of apples this would cause distortions in the market for apples. The difference when the BoE decides to purchase 30-year government bonds is that this action changes not just the price of those bonds but the determinants of that price. The effective interest rate of a long-term bond doesn’t simply change because the demand for that bond changes; instead the change occurs because the purchase of these bonds using newly created money increases the money supply, nominal income and changes expectations of future interest rates. Hence it is entirely possible that QE could increase interest rates on long-term bonds even though their purchase ought to imply higher bond prices and therefore lower interest rates because changes in the money supply have effects on other markets. It is plausible that the central bank could cause similar changes to bond prices by purchasing assets in other markets entirely – the reason why bond purchases make sense are because this minimises the distortionary effects that would occur if the BoE were to fill warehouses with purchased fruit. The paper’s second concern regarding QE is that large-scale government purchases of risk-free assets crowd out the ability of other parties to use gilts for their own financial needs. At the point this becomes a problem the solution should be to simply change the purchases from bonds to purchases of foreign currency. The important issue here is not the specific asset being purchased but that we change the money supply and in effect debase the domestic currency. The third concern regards inequality:
As discussed, unconventional monetary policy necessarily works through financial
markets, increasing asset prices and lowering interest rates in the hope of stimulating
growth. It therefore tends to disproportionately benefit those who hold a significant
proportion of their wealth in financial assets.
Again this misses the point. The reason why the value of financial assets increase is because QE changes expectations of the future growth path of the economy. The increase in inequality will be a problem with all instruments that return the economy to its growth path. By way of example when it became publicly known that Larry Summers would not become chairman of the Federal Reserve stockmarkets rallied and gained US$1tn in value. To the extent these assets are owned by rich people this increased inequality. But the values of shares are not just random numbers plucked out of the air – instead they represent the net present value of the future dividend stream of a company. The value of shares increased because investors believed that growth would increase and these companies would hence be worth more. Not as a result of some type of financial manipulation!
Apparently the solution to all of these “problems” is to give the Bank of England the power to directly give money to individuals. The authors assume that the effect of this policy would be similar to that of a tax cut. This ignores the difference between adjustments in permanent income and one-off level effects on wealth. Consumers are far less likely to spend wind-fall payments and instead are more likely to use this money to pay off debt or save. Of course it is still almost certainly true that the increase in the money supply required to return to trend growth would still be much less than with QE. It does however seem bizarre that the paper condemns the effects of QE on creating increased inequality through level effects on wealth whilst simultaneously suggesting that central banks ought to implement a policy that has significant short-term distributional consequences. Such decisions are far more likely to be manipulated by governments because whilst the extent of QE may be of interest to readers of The Economist and The Financial Times the stance of monetary policy is much more likely to be politicised when it means every man, woman and child receives a lump-sum payment.
There is a nice graph in the paper which shows that the BoE did a fairly good job of meeting its inflation target over the relevant period. It was most likely fears of run-away inflation that resulted in reluctance to implement further QE. For much of the recession period the BoE should have accepted a higher inflation rate in order to boost real output but was unwilling to do so. To the extent that the BoE is still bound by these fears then helicopter money ought not to produce better results as the BoE will still select a rate of monetary growth consistent with a level of aggregate demand that produces a desired rate of inflation. This argument assumes that the BoE’s expectations of QE were realistic and that they were not in fact trying to target a higher inflation target. To the extent that the views of MPC led them to overestimate the expansionary stance of QE then helicopter money might have been a better way of achieving the MPC’s desired growth rates. It is sad however that the best argument for this policy may be that the current MPC’s members are wrong about market monetarism.
The Wilberforce Society has done a good job in (hopefully) making the arguments about monetary policy reform relatively accessible. However their contribution to the debate ignores the real takeaway from the global financial crisis and resulting recession – money still matters even at the ZLB!