A brief reply to Bank Underground

Fergus Cumming at the Bank of England has written this blog on the subject of helicopter drops.

It is encouraging that the Bank is discussing the matter, but unfortunately the references are too narrow and the arguments are weak. The debate has moved on considerably since this discussion on Vox, and the version of helicopter drops presented is a straw man. Fergus fails to address the really substantive analytical and policy questions.

I will summarize briefly where I take issue. Rather than explain each point at length, I will provide links to blogs which have already done so:

1) The smart version of “helicopter drops” involves equal cash transfers from the central bank to the household sector subject to its inflation target. The reason for having this tool is precisely the ineffectiveness of existing tools. This policy does not require a “joint operation” by fiscal and monetary authorities, as Fergus suggests, any more than the current framework is a joint operation on the basis that parliament has legislated an inflation target. Simon Wren-Lewis, Mark Blyth and I have outlined how to do it here. Parliament legislates the means of the transfer, and the Bank determines when and how much – just as it does with interest rates.^[1]

2) The distinction between monetary and fiscal policy deserves more subtle analysis than is presented in the blog. Most of the time, the distinction is largely one of institutional design. As regards central bank accounting losses – which have questionable economic significance – this rubicon has already been crossed. So have many others, as we discussed in the Guardian article, and at more length in this Vox article. There is a case for outlining a clear distinction between fiscal and monetary policy, which I have done here. Base money-financed cash transfers are entirely consistent with this distinction, and they are monetary policy.

3) The blog conflates the issue of whether or not base money is a liability with the issue of “reversibility”. There is disagreement on this, but if you accept that money has distinct properties, which seems compelling, base money is not a liability. Whether or not the increase in base money is reversed in the future is a separate and very complex issue. Hence all of Fergus’s analysis of the Bank’s balance sheet is misleading.

4) He also repeats the error of thinking “permanence” matters. He is not alone, and the Vox article he references makes the same error. To cut a long story short, if a household which is strapped for cash receives a cheque in the post from the Bank of England is asked the question, “do you think this is permanent?” they will struggle to understand what that means. And they are right: it is not very meaningful. This has been discussed at length with David Beckworth. And more importantly, all the empirical evidence suggests that when households receive cash payments it boosts their spending.

As a consequence of 4) Fergus makes some odd points about “cancelling” the gilts on the Bank’s balance sheet. There is no economic significance in “cancelling” a bond which the issuer also owns. In effect the bonds are already “cancelled”, and selling them back to the market at some future date – which is a contingent possibility – is economically identical to issuing new bonds.

5) Fergus does correctly identify that the crux of any policy which involves an increase in the monetary base is what to do if at a future date if the stock of reserves is too high. But as discussed here this is easily dealt with and is not a problem unique to cash transfers, in fact it may be less of an issue than with QE if the required increase in reserves is smaller in scale.

These issues, which are largely the focus of the blog, are in fact a distraction. The substantive issue is that counter-cyclical fiscal policy has a host of problems: other than the use of automatic stabilisers, there is no consensus over what to do; fiscal policy is not timely, and it is hostage to the electoral cycle and partisan bickering and point-scoring. It is for these reasons that central banks have been given operational independence.

The real problem today – which is the heart of the matter – is that central banks lack the tools to fulfill their mandates in many plausible scenarios. Their existing tools – reducing interest rates and buying assets – may be counterproductive and destabilising. Central bank balance sheet issues are easily addressed – cash transfers can be made identical to QE in their impact in the Bank’s balance sheet – and independence is easily preserved, by granting the Bank sole control over the size and timing of any transfers, subject to its inflation-targetting mandate. Indeed, if the Bank lacks the tools to fulfil its mandate, a clear structure for helicopter drops might salvage its independence.

^[1] Milton Friedman did not really discuss policy issues in his original paper on the “Optimum quantity of money” which introduced the helicopter metaphor. His views are clearer when directly countering arguments on the ineffectiveness of monetary policy at the zero bound in his classic 1968 address. It is here where Friedman alludes to policies similar to those we advocate, which he ascribes to Haberler – and considers an intelligent version of the Pigou effect. Brad DeLong puts it in the tradition of “social credit”.