Tue Jul 12th, 2016 at 10:07:28 PM EST
Is "Helicopter Money" About to Rain Upon the World? Guest Post by David Llewellyn-Smith in Naked Capitalism
Ever since the BOJ announced a new negative interest rate policy earlier this year (NIRP) the yen has stopped falling and reversed upwards. That is, despite weak Japanese growth, despite an inverted yield curve and deeply negative long bond, and despite still weak inflation, markets have bet on spectacularly easy monetary policy generating even more of all four. This is what is know as "quantitative failure", the notion that negative interest rates will not expand the monetary base owing to such phenomenon as crushed bank margins and the hoarding of cash under mattresses, so the currency is therefore going to rise.
Frontpaged - Frank Schnittger
Meanwhile, in an effort to calm potential concerns about the integrity of the fiscal budget central bankers implementing such a future monetisation of infrastructure spending will doubtless be at pains to describe the process as a "one off" though, as the ever theoretical Bernanke stated in his blog: "To have its full effect, the increase in the money supply must be perceived as permanent by the public."
...a policy of "helicopter money" is only likely to work if it is done on an ongoing basis and in continuing and growing amounts. But at that point the risk of a policy mistake grows exponentially, in terms of a potentially destabilising pickup in inflation expectations and a related pickup in velocity.
There is some other movement around the place to support a renewed Japanese monetary experiment. Ben Bernanke will visit the BOJ and Prime Minster Shinzo Abe this week....As well, Larry Summers wrote late last week in the Washington Post:(behind a subscription wall)
I believe these developments all reflect a growing awareness of the importance of the secular stagnation risks I have highlighted over the last several years. There is a growing sense that the world is demand-short -- that the real interest rates necessary to equate investment and saving at full employment are very low and often may be unattainable given the bounds on nominal interest rate reductions. The result is very low long-term real rates, sluggish growth expectations, concerns about the ability even over the fairly long term to get inflation to average 2 percent, and a sense that the Fed and the world's major central banks will not be able to normalize financial conditions in the foreseeable future.
Having the right worldview is essential if there is to be a chance of making the right decisions. Here are the necessary adjustments:
First, with differences between countries, neutral real interest rates are likely close to zero going forward. Think about the U.S., where growth has been relatively robust by recent standards. Growth has averaged little more than potential for the last one, three or five years while the real Federal funds rate has been about -1 percent. There is no good reason to think given sluggish investment expectations that the neutral rate will rise to be significantly positive in the foreseeable future. The situation is worse in other countries with more structural issues and slower labor-force growth. Substantial continued reductions in Fed estimates of the real neutral rate lie ahead.
So, 'traditional' QE won't work. What now?
Second, as counterintuitive as it is to central bankers who came of age when the inflation of the 1970s defined the central banking challenge, our problem today is insufficient inflation. In the U.S., Europe and Japan, markets are now expecting inflation that is below target even with full employment over the next 10 years. This is despite a 70 percent rise in the price of oil. Evidence from markets and some surveys suggests that inflation expectations are becoming unhinged to the downside. The policy challenge with respect to credibility is exactly the opposite of what it has been historically -- it is to convince people that prices will rise at target rates in the future. This is likely to require some combination of very tight markets and mechanisms that give confidence that during the best times, inflation will be allowed to exceed target levels so that over the long term, they can average target levels.
The challenge "is to convince people that prices will rise at target rates in the future." This makes sense and will certainly be more fun than continuing to obsess about debt. It is good to see it in print from Larry. And all without having to invoke MMT. Maybe some will now consider these options.
Third, in a world where interest rates over horizons of more than a generation are far lower than even pessimistic projections of growth, traditional thinking about debt sustainability needs to be discarded. In the U.S., the U.K., the Euro area and Japan, the real cost of even 30-year debt will be negative or negligible if inflation targets are achieved. Indeed, the conditions Brad DeLong and I set out in 2012 for expansionary fiscal policy to pay for itself are much more easily satisfied today than they were at that time.
Fourth, the traditional suite of structural policies to promote flexibility are not especially likely to be successful in the current environment, though some structural policy approaches such as removal of restrictions on investment are still desirable. Indeed, in the presence of chronic excess supply, structural reform has the risk of spurring disinflation rather than contributing to a necessary increase in inflation. There is, in fact, a case for strengthening entitlement benefits so as to promote current demand.
"Strengthening entitlement benefits!, expansionary fiscal policy! How many times have heterodox economists made those same arguments in the last six years? Was it, perhaps, their failure to use the magic words 'the cost of long term debt will be negative' that kept this message from getting through?
Back to David Llewellyn-Smith:
These are the monetary titans of our times shifting radically towards various new forms of stimulus. Resistance to them is likely still to be strong on Western economic institutions but it is Japan that has led the world into the deflationary era and it is in Japan that the next phase of monetary innovation is likely to be pioneered.
This is hopeful in that Larry Summers is an adviser to Hillary Clinton and will likely be tapped for a major position, perhaps Secretary of Treasury. Try the measures first in Japan, then, as Larry said, in the EMU "if the Germans can get over themsleves." and then in the UK and US. With the largest economies all coordinating efforts the negatives would be reduced and smaller economies could join the process. Now that he is pointed in the right direction he could do some real good for the economy. Before it is too late.