by ChrisCook
Mon Sep 6th, 2010 at 11:30:25 AM EST
This post by Ricardo Caballero - which suggests a 'Helicopter Drop' approach by cutting taxes, funded by 'printing money' (ie Fed money creation) - is cross-posted from VoxEU.
A helicopter drop for the US Treasury | vox - Research-based policy analysis and commentary from leading economists
The US may be near a liquidity trap. This column argues that the ineffectiveness of monetary policy can be turned on its head by using money creation to finance fiscal policy stimulus - such as a large but temporary cut in sales taxes. To avoid future problems, the Treasury could commit to transfer resources back to the Fed when the economy is back to full employment. This would be a helicopter drop with a drainage contingency.
(snip)
Cutting taxes without raising public debt
Instead, what we need is a fiscal expansion (e.g. a temporary and large cut of sales taxes) that does not raise public debt in equal amount. This can be done with a "helicopter drop" targeted at the Treasury. That is, a monetary gift from the Fed to the Treasury.
Critics may argue that this is simply voodoo accounting, as it is still the case that the consolidated balance sheet of the government, which includes the Fed, has incurred a liability. But this argument misses the point that the economy is in liquidity-trap range, and once this happens the system becomes willing to absorb unlimited amounts of money. In this context, by changing the composition of the liabilities of the consolidated public sector in the direction of money, the government gets a sort of "free lunch."
Critics can also argue that even if the above logic holds during a liquidity trap, things can get quickly out of control once we are out of it. I counter that this can be solved by having Fed mechanisms ready for a quick drainage once the economy is out the woods (the Fed has already been working on the design of these mechanisms) and by adding a contingency to the helicopter gift. For example, the Treasury could commit to transfer resources back to the Fed once the economy returns to full employment.
From the point of view of public debt stability, the scenario to be concerned with is a combination of large fiscal deficits with stagnation. By making public debt contingent on the end of stagnation, this dreaded scenario is averted. And by having this contingent debt being held by the Fed, there is the added benefit that the ineffectiveness of monetary policy in the neighbourhood of a liquidity trap is turned on its head by acting instead as fiscal policy.
On the Gang 8 'Creditary Economics' List Caballero's post drew the following response from the astute Dutch economist, Dirk Bezemer.
Let's go through it.
- The Treasury forgoes tax income => the public's account balances with government increase.
- The Fed 'gives' the same amount to the Treasury = > it creates a liability on itself as the Treasury's account balances with the Fed are credited. True credit creation, as there is no balancing asset in the
Fed's accounts.
(In the case of QE as normally practised, that corresponding asset is a treasury bill. Here the Fed does not give money, but buys Treasuries.)
The corresponding asset in the economy is the public's increased account balances with government, which they can 'draw down' to spend (i.e. the money otherwise spent on taxes is now supposedly spent on goods and
services).
And here is the catch: 'the money' does not exist - money is not a thing but a relationship (thanks, Geoffrey). Therefore the ' helicopter drop' will weaken bank balance sheets, unless the Fed accommodates.
Why? The tax relief will increase money in deposit accounts, which is a liability to banks. Normally that money has been created by the banks as loans, so they have those loans as the corresponding asset - if they are short of money, they can always buy it in the interbank market (what used to be the clearing house system).
But in this case, where do they find the assets to balance the increased liabilities? Not in the
interbank market, so they will need to obtain it from the Fed, i.e. banks' account balances with the Fed will have to be drawn down and thereby decrease.
Now the bookkeeping circle is closed: the Fed has obtained its balancing asset to the money initially given to the Treasury, in the form of increased claims (or reduced liabilities) to the banks. But the banks
are left holding the bag.
The upshot is that the Treasury swaps liabilities from the public for liabilities from the Fed. The Fed increases liabilities to the Treasury and decreases liabilities to the banks. The banks increase liabilities to the public, which is financed by increasing liabilities to the Fed. Banks' balance sheets therefore become more fragile.
Two other things.
As a byproduct, banks are forced to increase their deposit holdings beyond what they had chosen to hold initially. So their balance sheet composition is changed by policy. With unchanged preferences for balance sheet composition, they will try to redress this by reducing deposit creation, that is, new lending.
This counteracts the intended increase in spending: Goodhart's Law in action.
Also, why would the public spend the additional money on goods and services, as assumed? They might as well precautionarily choose to invest it. In this case the operation just leads to asset price inflation, not economic growth.
For similar argumentation on 'QE', see our paper Innocent frauds meet Goodhart's Law in monetary policy
So in a nutshell, this policy would not even be neutral - it would be counter-productive.
In fact, its even worse than Dirk is saying, and for two reasons.
Firstly, tax cuts only go to people who pay tax, and an increasing number do not, and many probably never will again. These are the people most likely to spend money into circulation, but they are specifically excluded.
Secondly, before the recipients of this largesse even think about the 'precautionary investment' mentioned by Dirk - and I agree with him that this would be their approach - they will be de-leveraging by paying off debt as fast as they can.
In my view the solution is massive - and I do mean massive, in the trillions of dollars - spending on productive assets funded by QE.
This spending would be under the professional management of service providers with a stake in the outcome, and accountably supervised by a Monetary Authority.
Such QE-financed spending would be in both the public and private sectors, and would cover infrastructure; affordable housing; massive investment in renewable energy and energy savings; and most of all, in increasing the skills and capacity of the domestic population to implement this transformational investment.
Once the new generation of productive assets are complete, they may be re-financed with existing pension investment/ sovereign wealth fund money and so on - looking for safe long term real returns - and the QE would then be retired and recycled.
Likewise, the taxation paid by the freshly re-skilled workforce in productive domestic employment would also be used to retire and recycle the QE which created it.
