Monday, August 16, 2010

Helicopter Money

Here's a very good suggestion by Steve Randy Waldman on his blog Interfluidity for a way to prevent future financial meltdowns. This builds on the suggestion of "Helicopter Ben" when he addressed the limits of financial techniques to manage a deflationary economy:
Here’s my proposal. We should try to arrange things so that the marginal unit of CPI is purchased with “helicopter drop” money. That is, rather than trying to fine-tune wages, asset prices, or credit, central banks should be in the business of fine tuning a rate of transfers from the bank to the public. During depressions and disinflations, the Fed should be depositing funds directly in bank accounts at a fast clip. During booms, the rate of transfers should slow to a trickle. We could reach the “zero bound”, but a different zero bound than today’s zero interest rate bugaboo. At the point at which the Fed is making no transfers yet inflation still threatens, the central bank would have to coordinate with Congress to do “fiscal policy” in the form of negative transfers, a.k.a. taxes. However, this zero bound would be reached quite rarely if we allow transfers to displace credit expansion as the driver of money growth in the economy. In other words, at the same time as we expand the use of “helicopter money” in monetary policy, we should regulate and simplify banks, impose steep capital requirements, and relish complaints that this will “reduce credit availability”. The idea is to replace the macroeconomic role of bank credit with freshly issued cash.

Of course we will still need investors. But all that transfered money will become somebody’s savings, and having reduced the profitability of leveraged financial intermediaries, much of that will find its way to some form of equity investing.

There are details to consider. Won’t this proposal render central banks almost immediately insolvent? After all, conventionally, currency is a liability of a central bank that must be offset by some asset, or the balance sheet will show a gigantic hole where the bank’s equity ought to be. But that’s easy to remedy. Central banks can just adopt an old accounting fudge and claim that policy-motivated transfers purchase an intangible asset called “goodwill”. But, you may object, fudging the accounts doesn’t alter economic realities. Quite so! But what are the economic realities here? Balance sheet insolvency is nothing more or less than a predictor of illiquidity. No firm goes out of business because it’s shareholder equity goes negative. Firms die when they are presented with a bill that they cannot cover. But a central bank with liabilities in its own notes can never be illiquid, since it can produce cash at will to satisfy any obligation. It is book insolvency, not intangible goodwill, that would misrepresent the economic condition of the bank. If the central bank does not pay interest on reserves (which it should not), currency’s status as a “liability” is entirely formal. Central bank accounts should be defined by economic substance, not by blind analogy to the accounts of other firms. The purpose of a central bank’s balance sheet is to present a snapshot of its cumulative interventions, not to measure solvency. Consistent with that objective, a placeholder asset that offsets the formal liability incurred from past transfers would render transparent the cumulative stock and net flow of policy-motivated transfers. [1]

Then there are more interesting problems, like how routinizing transfers from the central bank to citizens might reshape society. “Free money” would certainly carry consequences, both good and bad, foreseeable and unforeseeable. My suggestion would be that the central banks should make equal transfers to all adult citizens irrespective of income, job, or tax status. That would be simple to understand and administer, and it is “fair” on face. It has other good points. To the degree that transfers are motivated by wasteful idleness of real resources (e.g. unemployment), flat transfers are guaranteed to put money in the hands of cash-constrained people who will spend it. Flat transfers are much more effective stimulus than income tax cuts (much of which are saved), and more effective even than payroll tax cuts (because people with jobs are more likely to save an extra dollar than people without). Further, because such transfers would be broadly distributed, the information contained in the spending patterns provoked by such transfers is more likely to be representative of sustainable demand than other means of stimulus. Status quo monetary policy, in obvious and direct ways, distorts economic activity towards the financial assets and debt-financed durable goods. I hope it’s obvious by now why that’s bad. Transfers to the already wealthy (e.g. income tax cuts) amplify the influence of a relatively small group of people whose desires are already overrepresented in shaping patterns of demand.


Still, it is possible that too many people would choose to “live off the dole”, or that people would come to depend upon income from the central bank, limiting the bank’s flexibility to reduce transfers when economic conditions called for that. So here’s a variation. Rather than distributing cash directly, the central bank could make transfers by giving out free lottery tickets. The winnings from these lottery tickets would constitute transfers from the central bank to the public. But the odds that any individual would win in a given month could be made small, in order to prevent people from growing dependent on a regular paycheck from government. Plus, it would be easier for the central bank to reduce the “jackpot” offered in its free lottery than to scale back payments that people have come to expect. If you buy the thesis that poor people experience increasing marginal utility to wealth, paying out large sums occasionally rather than modest sums frequently might be ideal.
Go read the whole post.

I'm surprised at how stodgy and resistant to innovative thinking the central banks around the world have shown themselves to be. It's as if they think we are still inhabiting the 19th century and not the 21st. I'm depressed by how little economists have learned. In fact, this financial crisis shows that almost half have un-learned the key lessons of the Great Depression and the insights of Keynes. Despite their claims of having achieved a neo-Keynesian synthesis, this crisis proves they've mostly forgotten Keynes.

One reason I like Waldman's suggestion is that it reminds me of the one area in which Nixon -- that Republican president I despise for having lied his way into winning the presidency by claiming to have a "secret plan" to end the Vietnam war -- was in fact a social progressive: Nixon favoured a negative income tax. Something like helicopter money or a negative income tax is needed to solve what I see as the Monopoly board game problem: over time a segment of the population gains control over most of the assets and income of a society. Their death grips takes down everybody, themselves included. To keep them from euthanizing the entire society, you need a mechanism to recirculate the wealth to keep the game going.

By the way... all this re-thinking reminds me of the alternative economics thrown up during the Great Depression. Near and dear to my heart is the Social Credit movement with its "national dividend" as a share-the-wealth scheme. Sadly, in Canada this political group morphed into a right wing party that ignored its roots. Gee... that reminds me of the Republican Party in the US that started out as an socially-oriented abolitionist party and has now ended up as a cryptic racist, rabidly anti-government, right wing, loony bin party.

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