I read an article in the Financial Times earlier this week (September 23, 2023) -…
I was looking back through snippets I save (like a magpie) today and remembered that I hadn’t written anything in response to this Financial Times article (October 12, 2012) – UK needs to talk about helicopters – which demonstrates that a good argument can be housed in a faulty analytical structure. The reference to helicopters comes from Milton Friedman and is popularly known as “printing money” and dropping it on the populace from high. The practice – is described as the ultimate heresy for central bankers. From an Modern Monetary Theory (MMT) perspective, there is clearly no need for a sovereign government to issue debt to the private sector. Given the political issues relating to debt buildup, it would be preferable if governments moved away from that practice altogether. Whatever accounting arrangements they put in place with the central bank to ensure that its spending desires were reflected in appropriate credits going into the banking system are largely irrelevant. The inflation risk is in the spending not the monetary operations that might accompany it.
On August 30, 2012, the Financial Times published an article by Samuel Brittain (August 30, 2012) – Come on Bernanke, fire up the helicopter engines – which carried his reaction to Ben Bernanke’s speech at the Jackson Hole Symposium – Monetary Policy since the Onset of the Crisis.
Samuel Brittain posed this question as a “thought experiment” designed to be “an essential part of the growth of human knowledge”:
… what would happen if, in the main industrial countries, currency notes were to drop from helicopters as a deliberate act of policy?
The helicopter references comes from Milton Friedman’s suggestion in the introduction (page 4) to his collection of essays – ‘The Optimum Quantity of Money and other Essays”, Chicago: Aldine Publishing Company, 1969 – that a chronic episode of price deflation could be resolved by “dropping money out of a helicopter”.
Brittain notes that quantitative easing, which Bernanke had described “as being the nearest equivalent to such a drop”, is quite different to what Friedman had in mind. He says that:
QE will work through the banking system. Helicopter money is available for those fit enough to pick it up.
He also cites John Maynard Keynes who:
… raised a similar possibility during the 1930s when he said that if there was no better way of getting out of a depression, pound notes should be buried in the ground, leaving it to the well-tried forces of self interest to dig them up again.
This is an oft-quoted example and is used by opponents of fiscal intervention to deride the productivity of direct job creation.
As I have noted previously, the idea goes back to Chapter 16 of the Keynes’ The General Theory of Employment, Interest, and Money.
Many mainstream economics characterise the Keynesian position on the use of public works as an expansionary employment measure as advocating useless work – digging holes and filling them up again. The critics focus on the seeming futility of that work to denigrate it and rarely examine the flow of funds and impacts on aggregate demand. They know that people will instinctively recoil from the idea if the nonsensical nature of the work is emphasised.
Brittain’s reference in the same breath as advocating helicopter drops doesn’t help discourage this negative interpretation.
However, the critics actually fail in their stylisations of what Keynes actually said. They also fail to understand the nature of the policy recommendations that Keynes was advocating.
What Keynes demonstrated was that when private demand fails during a recession and the private sector will not buy any more goods and services, then government spending interventions were necessary. He said that while hiring people to dig holes only to fill them up again would work to stimulate demand, there were much more creative and useful things that the government could do.
Keynes maintained that in a crisis caused by inadequate private willingness or ability to buy goods and services, it was the role of government to generate demand. But, he argued, merely hiring people to dig holes, while better than nothing, is not a reasonable way to do it.
In Chapter 16 of The General Theory of Employment, Interest, and Money, Keynes wrote:
If – for whatever reason – the rate of interest cannot fall as fast as the marginal efficiency of capital would fall with a rate of accumulation corresponding to what the community would choose to save at a rate of interest equal to the marginal efficiency of capital in conditions of full employment, then even a diversion of the desire to hold wealth towards assets, which will in fact yield no economic fruits whatever, will increase economic well-being. In so far as millionaires find their satisfaction in building mighty mansions to contain their bodies when alive and pyramids to shelter them after death, or, repenting of their sins, erect cathedrals and endow monasteries or foreign missions, the day when abundance of capital will interfere with abundance of output may be postponed. “To dig holes in the ground,” paid for out of savings, will increase, not only employment, but the real national dividend of useful goods and services. It is not reasonable, however, that a sensible community should be content to remain dependent on such fortuitous and often wasteful mitigations when once we understand the influences upon which effective demand depends.
So while the narrative style is typical Keynes the message is clear. Digging holes will stimulate aggregate demand when private investment has fallen but not increase “the real national dividend of useful goods and services”.
Keynes also noted that once the public realise how employment is determined and the role that government can play in times of crisis they would expect government to use their net spending wisely to create useful outcomes.
Earlier, in Chapter 10 of the General Theory you read the following:
If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing.
Again a similar theme. The government can stimulate demand in a number of ways when private spending collapses. But they should choose ways that will yield more “sensible” products such as housing. He notes too that politics might intervene in doing what is best. When that happens the sub-optimal but effective outcome would be suitable.
The point is that the workers who “dig the holes” will be paid (as opposed to receiving no paid when unemployed) and will then spend a proportion of their weekly incomes on other goods and services which, in turn, provides wages to workers providing those outputs. They spend a proportion of this income and the “induced consumption” (induced from the initial spending on the road) multiplies throughout the economy. That is, the expenditure multiplier will amplify the initial wage boost.
Back to Brittain who probes the thought experiment further.
The object of the helicopter drop would be to boost spending for those who pick up the money, who should feel wealthier and not become more indebted. They should have every reason to spend. The more worried they became about helicopter money, the faster they would spend it.
Would this be inflationary? In many situations, yes. But a drop, whether actual or metaphorical, would only occur when the danger is that of deficient demand. And we are dealing with a world in which there is not enough spending to keep resources reasonably well employed. So the main initial effect will be to boost output and employment. Should the danger become one of demand inflation, the normal instruments of higher central bank interest rates and budget surpluses would be available. There is no technical problem about how to reverse it if circumstances change.
So a very simple encapsulation of how introducing new spending capacity into the economy would stimulate demand and real output and, as long as their is excess productive capacity, there would be no inflation threat.
His reservations focused on whether a government, captured by various political lobbies, could put the brakes on when the economy approached the inflation threshold.
He thinks it would be better if the stimulus would focus on “infrastructure spending and temporary tax cuts”, which is uncontroversial. But then we read this statement:
It goes without saying that such expansionary measures should be financed by central banks and not by market borrowing that could push up interest rates in an unhelpful way.
The “goes without saying” is a ploy to alert the reader that they would be stupid to question the statement – that is it is a incontestable doctrine of economic theory. The only problem is that it is wrong.
I am not against “central bank financing” – indeed, I am clearly in favour of governments no longer issuing any debt and ending the practices that are legacies of the fixed-exchange rate, convertible currency world we (mostly) abandoned in 1972.
But the alternative of issuing debt to the private market does not push up interest rates. The central bank has all the capacity to control interest rates and bond yields at its leisure.
Please read my blog from yesterday – Government budgets bear no relation to household budgets – for more discussion on this point.
His last point is clearly true – that the rejection of deficits not being matched by bond issuance to the private markets (which is what he calls “central bank financing”) – is “ideological. The prevailing dogma is that anti-slump measures must be on the monetary side rather than the fiscal one.”
That is one of the main reasons the world remains in crisis. Governments have relied to much on monetary policy and when they have used the more powerful fiscal levers they have imposed austerity as an attempt to clear the decks.
Anyway, this was an interesting article because it squarely introduces the notion that a currency-issuing government can spend without having to match that spending with private debt-issuance. In other words, given the central bank and treasury are parts of the consolidated government sector – the government has no financial constraint (even though Brittain wouldn’t express it in that way).
Please read my blog – The consolidated government – treasury and central bank – for more discussion on this point.
Sometime later, on October 11, 2012 to be exact, the Chairman of the British Financial Services Authority, Adair Turner, delivered the Lord Mayor’s – Mansion House Speech – in London.
He was one of the hopefuls for the Bank of England job and given the – lurid details – \ emerging about the pay package for the successful applicant, Adair Turner probably wishes he had schmoozed the Chancellor a bit more.
The FSA boss (out-going) presented a wide-ranging speech. He noted that my profession had contributed to the crisis by seriously ignoring the links between their abstract models and the real world financial system.
Please read my recent blog – What have mainstream macroeconomists learn’t? Short answer: nothing – for more discussion on this point.
He quoted the out-going Bank of England boss Mervyn King who told an audience in London (in October) that:
the dominant school of modern monetary policy theory – the New Keynesian model as it is called – ‘lacks an account of financial intermediation, so money, credit and banking play no meaningful role’.
The section in the last quote in parentheses were quoted from King’s speech.
He also canned the IMF for having their head in the sand. As late as 2006, the IMF was praising the deregulated financial sector and its flexibility and resilience.
He believes the self-confidence of the economists and the agencies led the financial regulatory authorities to go to sleep at the wheel. In fact, it was more than a lulled sense that was going on. The links between Wall Street and the City and the legislators were close and there was massive pressure placed on the legislators to relax regulation and permit the self-regulating market to go for it.
Adair Turner said that the “dominant assumption was that monetary stability – low and stable inflation – was sufficient in itself to ensure financial and macroeconomic stability” and that:
That assumption turned out to be profoundly wrong and dangerous, a major intellectual failure.
Although barely anyone in the macroeconomics profession has blinked an eyelid and it is largely business as usual with a few new mathematical gymnastics being added to the models under the name of banks or financial sector. The models are still rotten to the core and useless for real policy development.
All this was leading up to his conclusion that the “deflationary impact on economic growth” of the “(p)ost-crisis deleveraging … could extend for many years ahead”.
So what can be done to stop this descent into extended stagnation?
He told the audience:
The policy response has to include, and has included, unconventional monetary policies – quantitative easing – which as best we can tell has produced a path of real output growth and inflation slightly higher than would otherwise have occurred.
But quantitative easing alone may be subject to declining marginal impact, the economy facing a liquidity trap in which replacing private sector holdings of bonds with private sector holdings of money has little impact on behaviour and thus on demand. So optimal policy also needs to include a willingness to employ still more innovative and unconventional policies, and to consider the combined impact of multiple policy levers – monetary policy, Bank of England liquidity insurance, prudential regulation and direct support to real economy lending – which we used either to consider quite separately, or else avoid entirely.
What was he getting at?
First, it is obvious that quantitative easing has not been the success the mainstream had hoped for. I explained why it would not work in this early blog – Quantitative easing 101.
Basically, it is just an asset swap – bank reserves for a government bond – and the only way it can impact positively on aggregate demand is if the lower interest rates it brings in the maturity range of the bond being bought stimulates borrowing and spending.
The problem is that borrowing is a function of aggregate demand itself (and expectations of where demand is heading) and with unemployment persisting at high levels, firms going broke all over the place and government imposing harsh net spending cuts, the sentiment that might lead to increased borrow has been absent – lower interest rates notwithstanding.
Second, the only monetary policy options that are available are what he calls “still more innovative and unconventional policies”, with the aim of supporting “lending and as a result, maintain nominal demand”.
It is interesting that he understands the damage that the credit binge had (his early comments in the Speech were about that) but still considers that more private indebtedness is the way forward.
He also admitted his previous support for the creation of the Eurozone (and “Britain’s eventual membership”) was wrong and that he failed to understand the basic limitations that the Euro design imposed on the capacity of the economies to respond to a large, asymmetrical aggregate demand shock.
He noted that his crucial mistake:
… was a failure to recognise that debt issued by a nation within a multinational currency zone is quite different from debt issued by a nation which also issues its own currency – it is inherently more susceptible to default risk, it is inherently less likely to be perceived as risk-free. As a result, in a multi national currency zone with significant debt issued at national level, bank solvency and national solvency can become linked in a potentially fatal embrace.
You can see he still doesn’t quite get the magnitude of the difference between a sovereign nation that issues its own currency and a Eurozone member-state. The former has no default risk” rather than is “inherently” less susceptible to default risk. The US, Japan etc are perceived as being risk-free – there is no qualification.
Some interpreted this Speech – especially the part about “still more innovative and unconventional policies” as being an endorsement of the idea that the Bank of England should cancel:
… the gilts bought by the Bank of England and telling the Treasury it need not repay the debt …
That quote came from a Financial Times article (October 12, 2012) – UK needs to talk about helicopters – which, presumably, was in response to Adair Turner’s speech the day before.
The FT article said that Adair Turner favoured “monetary policy’s nuclear option: “helicopter drops” of newly printed money”. So also back Samuel Brittain’s discussion above.
The FT article says that:
Printing money – not just temporarily for trading securities in the market, but permanently handing it over to be spent by someone – is the central banker’s ultimate heresy. Yet it would be irresponsible to rule the option out, no matter what the circumstances.
It was not always a heresy. But that is another topic.
It is interesting that they distinguish between quantitative easing (“trading securities”) and direct demand stimulus – a distinction that was certainly lost in the early days of the quantitative easing furore in 2009 and still lost on most financial commentators.
The FT article reiterates the obvious point:
Throwing enough cash at an economy cannot fail to have an impact. The question is whether a sustainable and significant effect on aggregate demand can be had for the price of only a moderate and manageable effect on inflation.
The fear – inflation – the reality lots of excess capacity (“when deflation and contraction threaten”).
They reject the “Adair Turner approach” – saying that there would be no change if the “BoE cancels its gilts rather than collects coupon payments, returning them to the Treasury as profit”.
The preferred option is to be targetted at “boosting aggregate demand” and “be directed to more rather than less useful spending” and the best way to achieve that would be to give “newly minted money away, not shifting large asset balances between the BoE and the Treasury with no new money creation”.
Underlying the previous discussion are inherently mainstream ideas that “central bank financing” is one of the ways in which governments can fund their spending. The key point is that it leaves the myth that they have to “fund” spending intact and then the descent into analogies between the government budget and the household budget follow as night follows day (or does it?).
The analysis comes straight out of the mainstream macroeconomic textbooks where the notion of the so-called Government Budget Constraint (GBC) is introduced – in one way or another depending on the level of the course being taught.
The GBC entered economic texts in the 1960s in a formal way as part of the claims that Keynesian macroeconomics had no firm microeconomic foundations, which reduced its credibility.
These microfoundations are notions such as rational, optimising agents driving resource allocation and seeing through nominal veils etc. That is another blog again. It was all hype and led to the destruction of some of the essential insights in macroeconomics and paved the way for the total mess that we have today (New Keynesian macro).
The point was that the argument went that we can supplant the idea of an individual consumer maximising utility in his/her spending decisions subject to the budget constraint to the government level analysis.
So the government is seen as being constrained by the need to fund its spending (the budget constraint). Accordingly, governments are construed as having three sources of “finance”: taxation; debt-issuance; and/or money creation.
The logical idea that students are presented in these courses is captured in the following sequence:
1. The government wants to spend some money to buy something.
2. It doesn’t have any money.
3. It can raise taxes using its legislative authority and get some money that way. But taxing is bad (creates disincentives to work and enterprise) and so there should be very little of it, which limits the volume of spending that the government should engage in (an absolute minimum to maintain law and order and defence is the usual scale conceived).
4. What happens if its wants to spend more than it taxes – that is, run a deficit?
5. It can sell debt to the private sector and draw on the savings available. This is bad because it competes for those scarce savings with private investment opportunities and this drives up interest rates. The replacement of private spending with public spending in this way is inefficient because the private sector is disciplined by share markets and optimal behaviour whereas the public sector is wasteful and not scrutinised by the market. Further eventually the private markets will worry that the debt is getting too large and the government will default and so the funding will dry up.
6. The alternative is that the treasury borrows from the central bank (so-called printing money) and spends up big. The problem here is that this method of financing is considered to result in more inflation than private bond sales, because the latter soaks up some purchasing power and replaces it with public spending. So “money creation” adds more to aggregate demand than bond sales, because the latter forces up interest rates which crowd out some private spending. Therefore it is very dangerous to print money to fund government spending.
That is the standard sequence that students learn in their undergraduate and post-graduate programs and, is unfortunately, wrong at its most elemental level.
All these claims are without foundation in a fiat monetary system and an understanding of the banking operations that occur when governments spend and issue debt helps to show why. Note I have considered these issues many times in many blogs.
Lets just ask the question what would happen if a sovereign, currency-issuing government (with a flexible exchange rate) ran a budget deficit without issuing debt? So this is the option discussed above in the FT articles.
First, governments spend in the same way irrespective of the monetary operations that might follow. There is no sense in the claim that the government gathers money from taxes or bond sales in order to spend it.
If they didn’t issue debt to match their deficit, then like all government spending, the Treasury would credit the reserve accounts held by the commercial bank at the central bank. The commercial bank in question would be where the target of the spending had an account. So the commercial bank’s assets rise and its liabilities also increase because a deposit would be made.
The transactions are clear: The commercial bank’s assets rise and its liabilities also increase because a new deposit has been made. Further, the target of the fiscal initiative enjoys increased assets (bank deposit) and net worth (a liability/equity entry on their balance sheet).
Taxation does the opposite and so a deficit (spending greater than taxation) means that reserves increase and private net worth increases.
This means that there are likely to be excess reserves in the “cash system” which then raises issues for the central bank about its liquidity management. The aim of the central bank is to “hit” a target interest rate and so it has to ensure that competitive forces in the interbank market do not compromise that target.
When there are excess reserves there is downward pressure on the overnight interest rate (as banks scurry to seek interest-earning opportunities), the central bank then has to sell government bonds to the banks to soak the excess up and maintain liquidity at a level consistent with the target. Some central banks offer a return on overnight reserves which reduces the need to sell debt as a liquidity management operation.
There is no sense that these debt sales have anything to do with “financing” government net spending. The sales are a monetary operation aimed at interest-rate maintenance. So M1 (deposits in the non-government sector) rise as a result of the deficit without a corresponding increase in liabilities. It is this result that leads to the conclusion that that deficits increase net financial assets in the non-government sector.
What would happen if there were bond sales? All that happens is that the banks reserves are reduced by the bond sales but this does not reduce the deposits created by the net spending. So net worth is not altered. What is changed is the composition of the asset portfolio held in the non-government sector.
The only difference between the Treasury “borrowing from the central bank” and issuing debt to the private sector is that the central bank has to use different operations to pursue its policy interest rate target. If private debt is not issued to match the deficit then it has to either pay interest on excess reserves (which most central banks are doing now anyway) or let the target rate fall to zero (the long-time Bank of Japan solution).
There is no difference to the impact of the deficits on net worth in the non-government sector.
Mainstream economists would say that by draining the reserves, the central bank has reduced the ability of banks to lend which then, via the money multiplier, expands the money supply.
However, the reality is that:
- Building bank reserves does not increase the ability of the banks to lend.
- The money multiplier process so loved by the mainstream does not describe the way in which banks make loans – Money multiplier and other myths
- Inflation is caused by aggregate demand growing faster than real output capacity. The reserve position of the banks is not functionally related with that process.
So the banks are able to create as much credit as they can find credit-worthy customers to hold irrespective of the operations that accompany government net spending.
This doesn’t lead to the conclusion that deficits do not carry an inflation risk. All components of aggregate demand – government and non-government – carry an inflation risk if they become excessive, which can only be defined in terms of the relation between spending and available productive capacity. The FT articles clearly recognise that point.
The “stock of money” can expand by some percent per month without there being any additional inflation risk if real productive capacity is also expanding at a rate sufficient to absorb the extra nominal aggregate demand.
The idea that debt-issuance to the private sector in some way is less inflationary (for a given injection of government spending) is totally fallacious.
From an Modern Monetary Theory (MMT) perspective, there is clearly no need for a sovereign government to issue debt to the private sector. Given the political issues relating to debt buildup, it would be preferable if governments moved away from that practice altogether.
Whatever accounting arrangements they put in place with the central bank to ensure that its spending desires were reflected in appropriate credits going into the banking system are largely irrelevant.
Further, the inflation risk is in the spending not the monetary operations that might accompany it.
Lots of travel coming up today – so …
That is enough for today!
(c) Copyright 2012 Bill Mitchell. All Rights Reserved.