This is a post about why the taboo against helicopter money or money financed fiscal stimulus is irrational once we have Quantitative Easing, but might nevertheless be in the interest of some groups.
Many macroeconomists have argued that we shouldn’t think about central banks in the same way as private banks. A central bank can never be insolvent, at least as long as people use the currency it issues. It can cover losses by creating more money. All that matters, from a macroeconomic point of view, is whether it has the ability to do its job, which is to control inflation.
I do not want to talk about controlling inflation here. Instead I want to talk about these losses, and in particular who gains when these losses are made. Macroeconomists tend to focus on the controlling inflation point, so let me avoid that by imagining a really simple world. There is a constant price level target, and base money velocity (nominal GDP/money) is constant in the long run, so base money must return to some constant value in the long run to meet the target. In the short run velocity is not constant and we can have recessions due to demand deficiency in the usual way.
Think about Quantitative Easing (QE). [4] The central bank creates money to buy government debt in the market at a time when that debt is expensive, because it only does QE when interest rates are low. [1] Suppose it just so happened that all this government debt that the central bank buys comes from pension funds. These funds sell their debt, take the money and keep it as money. After some time, the economy recovers, interest rates rise and the price of this government debt falls. The central bank no longer needs the debt, and it wants to reduce the money stock to get to the price level target, so it sells the debt back to the market, or more specifically to the same pension funds it bought it from. As the price of these assets has fallen, the central bank makes a loss. The pension funds gets back the debt they originally sold, but they have some money left. They have gained.
Good for them you might say - why should I care? Well the central bank is concerned that it has not got all its money back (it made a loss), and to control inflation it needs to take more money out of the system. It asks the government to recapitalise it, which the government does by raising taxes. What has in effect happened is that money has passed from the taxpayer to the pension fund.
My purpose in pointing this out is not to make some distributional point. Instead it is to note that QE in this case involves the central bank giving money away to pension funds. So why is this considered kosher, but the central bank giving the same amount of money (its loss on QE) directly to the public is considered deeply problematic? [2] Why would it be thought completely wrong for the central bank to voluntarily give the same amount of money to the government so that they could help stimulate the economy by some fiscal means (a money financed fiscal stimulus)? [3]
If you think that my assumption about price level targets and constant long run velocity was somehow critical here, imagine the case where to meet its inflation target the money newly created in the long run (the loss on QE) did not need to be taken out of the system. The pension funds gain but no one seems to lose. But if the expansion of money had been via a helicopter, then every citizen would gain instead. So why is acceptable to create new money and give it to pension funds (through losses on QE), but not create money to give to ordinary people or the government? The former is called monetary policy and is OK for a central bank to do, but the latter is called fiscal policy and this the central bank cannot do.
Why does this matter, apart from the distributional point? Because as a means of stimulating the economy in the short run the effectiveness of QE is highly uncertain compared to the effectiveness of direct transfers to citizens or public works. We seem to be stuck with an ineffective form of stimulus, because something more effective is taboo, or goes by a different name. To repeat it in a simple but more provocative way: a central bank giving money to people or governments is out of the question, but a central bank giving money to parts of the financial sector is just fine. That is a very convenient taboo for some.
[1] Suppose this is government debt issued many years ago, when interest rates were 5%. So debt with a nominal value of £100 pays 5% interest. If interest rates are now 2.5%, then this debt is more valuable than its nominal value - indeed someone would pay you something near £200 for it if it had a long maturity. However if interest rates go back to 5%, the value of the debt would fall back to £100.
[2] Assume Ricardian Equivalence does not hold, so giving money away now is expansionary even though that money has to eventually come back when the central bank is recapitalised.
[3] If the money financed fiscal stimulus was in the form of additional but temporary government spending, and when the central bank was recapitalised the Treasury paid for this by temporarily reducing government spending, we get what I call a ‘pure’ money financed spending stimulus. I know of no theory which says that would not be expansionary.
[4] If you want to be topical, you could think about creating money to buy foreign currency instead.
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