It is often said that generals fight the last war that they have won, even when those tactics are no longer appropriate to the war they are fighting today. The same point has been made about macroeconomic policy: policymakers cannot avoid thinking about the dangers of rising inflation, and in doing so they handicap efforts to fully recover from the Great Recession.
Another military idea is the benefit of using overwhelming force. In the case of inflation we have two legacies of the last war that are designed to prevent inflation reaching the heights of the late 1970s: inflation targets and in many countries independent central banks. Do we need both, or is just one sufficient? I think this question is relevant to the debate over helicopter money (financing deficits by printing money rather than selling debt).
Why are helicopter drops taboo in policy circles? Why is it illegal in the Eurozone? The answer is a fear that if you allow governments access to the printing presses, high inflation will surely follow at some point. Many of those who worry about helicopter money are fairly relaxed about Quantitative Easing (QE), which involves much more money creation than would be involved in a helicopter drop. (Of course some are not relaxed, and (still) think that QE is about to produce rapid inflation - I will ignore that group here.) The key reason they are more relaxed is that central banks are in control of QE, whereas governments would initiate money financing of deficits. [1]
Take the recent interchange between Tony Yates and myself on helicopter money (TY, SWL, TY), and consider the following hypothetical. The economy needs a fiscal stimulus, but for some irrational reason the government will not allow debt to rise. It therefore instructs the central bank to create money to fund a fiscal stimulus (i.e. a helicopter drop). However it also tells the central bank that this action should not compromise its inflation target (which is currently being undershot), and the central bank agrees that the helicopter drop will not compromise its ability to stop inflation exceeding the target, but instead it will help inflation rise to meet that target.
Tony’s problem with this is in the instruction. In these particular circumstances the actions are not a problem, and will do some good (given the government’s irrational fear of debt). However we have crossed a barrier - the government is telling the central bank what to so. The fact that in my hypothetical example the inflation target remains is not enough: he writes “the inflation target in the UK is a very fragile thing”. He goes on: “So I don’t view the inflation target as a cast iron protection against helicopter drops undermining monetary and fiscal policy. There’s a good reason why monetary financing is outlawed by the Treaty of Rome. Allowing yourself tightly regulated helicopter drops is not time-consistent. Once government gets a taste for it, how could it resist not helping itself to more?”
I think it is possible to take two quite different views to Tony on this. The first is that, in most OECD economies today where macroeconomic understanding is better and information more available, inflation targets are more than sufficient to prevent us experiencing the inflation rates of the 1970s again. The hypothetical to think about here is a government that has direct control over the inflation target, but asks the central bank to vary interest rates to achieve that target. Of course we do need to imagine this - it is the UK set-up. Would such a government happily raise the inflation target in order to finance a bit more spending? Such a move would be highly unpopular, because most people think higher inflation means lower real wages. In the UK no political party has even hinted that raising the inflation target might be a good idea, despite obvious fiscal incentives to do so. Suppose a government pretended repeated money creation would not breach the inflation target, even when the central bank advised otherwise. Would that government survive when inflation took off?
A second view is that we have the story of the 1960s and 1970s all wrong. We did not get high inflation in advanced economies because governments wanted to monetise their own profligacy. There were, after all, independent central banks in the US and Germany. Inflation occurred because of the combination of a number of specific factors: trade union pressure in the face of shocks that tended to reduce real wages, underestimation of the natural rate (and a poor understanding of how monetary policy should work), and placing too great a priority on achieving full employment. The latter might have been a legacy of the 1930s: policymakers were also fighting the last war, except in the 1970s the last war was about unemployment, not inflation.
I think both views are probably correct. As a result, I’m much more relaxed about money financing of deficits in the current situation. However in one crucial respect I do agree with those who say we have no need for helicopter money today, because there is no reason for governments to have a fear of rising debt if their central bank can undertake QE. However irrational fear of rising debt in a recession has similar characteristics to fighting the last war: deficit bias is a problem, but a recession is not the time to worry about it. I think this is why I am not persuaded by this article by Ken Rogoff: yes, in the grand scheme of things we should worry about inflation and debt, but right now we are worrying about them too much and therefore failing to deal with more pressing concerns.
[1] Some people imagine the central bank could itself initiate a helicopter drop, independently of government. That is simply not possible given current institutional arrangements, but as I noted in my earlier post(point 7) I think it is interesting to explore institutional changes that give the central bank some role in countercyclical fiscal policy. A simpler confusion is that helicopter money involves giving money to everyone, while tax cuts just go to taxpayers. Helicopter money is really about financing a fiscal stimulus of any kind using money: the form of that fiscal stimulus is a separate matter.
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