Open market operations vs. helicopter drops

Great stuff!

I like the thought experiment of committing to a 4% inflation target for TIP spreads, buying $40 billion of bonds the first week, then buying $80 billion of bonds the second week, then buying $160 billion bonds the third week…..

In that scenario, what would happen first: 4% TIPs spreads or the purchase of $160 billion? Almost certainly the former.

If only Bernanke had used that thought experiment instead! 🙂

“The government prints money, and buys roads, bridges, the bearing of duration risk, biomedical research, human capital for twelve-year olds–whatever. This is helicopter money.”

There’s DeLong’s mistake. True helicopter money is given away, not used to acquire new assets. If the Fed prints $100 and buys $100 worth of bonds or farmland, then the Fed’s assets rise in step with its issue of money, and the Fed is fully capable of using its new assets to buy back the $100 it issued. But if the $100 is dropped out of a helicopter, the Fed gains no assets, its net worth drops $100, and the Fed no longer has enough assets to buy back the money it has issued (assuming it does not have a big cushions of other assets).

I’m not sure I agree with “An actual helicopter drop worsens the fiscal authority’s consolidated balance sheet. It is deficit spending. It leads to higher (distortionary) taxes in the future. An open market operation has no effect, on average, on the country’s fiscal situation.”.

With govt-issued money all increases in the money supply must in the long term be funded by deficits. This is easy to see if the govt funds part of its deficit with newly printed money (or the CB buys bonds back after the govt has sold them). But its also true if the CB increases the money supply by buying private assets – in the long term these will bring in interest revenue that will be passed onto the govt and allow it to spend more or tax less than otherwise.

Therefor “It leads to higher (distortionary) taxes in the future” is not correct IMO. If the authorities wish to withdraw money that was introduced by helicopter drops it will have total control over if it increases taxes a lot in the short term, or it spreads the tax increases over a longer period by bond-policy.

Like wise “An open market operation has no effect, on average, on the country’s fiscal situation.” is incorrect IMO once the long term flows of interest payments from OMO are factored into future taxation requirements.

It seems to me that helicopter money just bypasses the whole reserves/Fed balance sheet part. The Fed just opens an account for the Treasury and gives them “printed” X amount. The Fed can never get those dollars back unless it uses alternative means to shrink the money supply.

Scott, you rightly distinguish monetary and fiscal policy by stating that the latter leads to more taxation in the future. But you wrongly conclude from this, that helicopter drops are fiscal spending, while in truth this is only the case if the government (treasury + central bank) does not want the additional money lead to more inflation!

In reality, the government can always decide if some action involving monetary spending (either from the central bank or from other parts of the government) should be paid for by inflation “tax” or by more “conventional” taxes in the future. A helicopter drop with the willingness to pay for it with an inflation “tax” is therefore not fiscal policy according to your own definition.

Does the above description make any sense?

Thinking further about this, even conventional monetary policy actions like buying very short term government bonds can be classified as fiscal policy instead of monetary policy if the FED is not willing to cause inflation with it. Instead, these purchases of bonds will then be paid for by conventional taxes (because the FED gives smaller seigniorage checks to the treasury).
Note how performing the bond purchases like this (i.e.: with fiscal policy) really leads to redistribution from tax payers to bond holders (i.e.: exactly what some critics wronlgy accuse “real” monetary policy to cause).

Dr. Sumner,

Many writers on this subject conflat a Helicopter Drop with a conventional Keynesian or Fiscal Stimulus. The latter is an effort of extended length of increased spending by a central government to increase employment, capital expenditures, and to increase aggregate spending. Dr. Keynes argued that such a project should be funded by tax reductions and deficit spending. This is a task enacted by a legislature and carried out by an executive office. A central banks role is this at best minimal being to ensure that there is sufficient money to

A Helicopter Drop is not this at all. The concept of the Helicopter Drop was developed by Dr. Milton Friedman in 1969 in his paper “The Optimum Quantity of Money”.

In this paper Dr. Friedman constructs and artificial community of whose numbers do not change as they are both immortal and sterile. Similarly capital is immortal is it never wears out and requires no maintenance. Neither physical nor financial capital can be bought or sold, lending and borrowing is prohibited. Further money is all paper and the volume of that money is fixed at 1,000 separate dollar bills. Only goods and services may be purchased with these 1,000 dollar bills.

Using the Fisher Equation; MV = Py where M is the money supply, V was the velocity at which money changes hands, P was the average price of goods and services, and y was the total quantity of goods and services, Dr. Friedman has set M and y as constant. While P and V are not legally fixed, given the theoretical constraints, neither would ever change.

Dr. Friedman then conducts a thought experiment, he writes:

“Let us suppose now that one day a helicopter flies over this community and drops an additional $1,000 in bills from the sky, which is, of course, hastily collected by members of the community. Let us suppose further that everyone is convinced that this is a unique event which will never be repeated.”

“Under those circumstances, it is clear that the price level is determined by how much money there is—how many pieces of paper of various denominations. If the quantity of money had settled at half the assumed level, every dollar price would be halved; at double the assumed level, every price would be doubled.”

“Hence, the final equilibrium will be a nominal income [that has doubled] … with precisely the same flow of real goods and services as before.”

“The additional pieces of paper do not alter the basic conditions of the community. They make no additional productive capacity available. …”

Expressed mathematically, in this world, if M doubles, P doubles but capital remains fixed. The point is that in Dr. Friedman’s thought experiment, economic growth, capital formation, was impossible. His interest was on the impact of how changes in the quantity of money impact prices.

Dr. Ben Bernanke is commonly associated with the concept of Helicopter Drops since he famously quoted Dr. Friedman on the subject in 2002. He was speaking about how to combat deflation, i.e. how to stimulate inflation. He wrote:

“Each of the policy options I have discussed so far involves the Fed’s acting on its own. In practice, the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities. A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices. Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers. A money-financed tax cut is essentially equivalent to Milton Friedman’s famous ‘helicopter drop’ of money.”[1]

Like Dr. Friedman, Dr. Bernanke was not focusing on actions which would stimulate economic growth per se but rather how to cause inflation.

When Japan first began to experience deflationary pressures, the Japanese government actually implemented an actual Helicopter Drop. In the spring of 1999 the Japanese government distributed shopping coupons worth 20,000 yen (about 200 dollars) to families with children under the age of 15 and to more than half of the elderly population. In total, 620 billion yen (about 6 billion dollars) worth of coupons were distributed to 31 million people. The coupons had to be spent in the recipient’s local community and expired within six months[2]

Of particular note, the Bank of Japan played little or no role in this practical expertise in a Helicopter Drop. The point here is that central banks cannot execute a Helicopter Drop by arbitrarily transferring money into banking accounts of random consumers but must be achieved by governments in a way that will strongly encourage immediate spending. Central banks lack any actual mechanism to conduct a Helicopter Drop, it is, of necessity, a programme to be executed by a government. If you like, central banks do not own helicopters, only government do.

However, with that noted, nothing was built, no one was employed, it was simply a give away of gift cards for people to spend as they saw fit locally and within a short period of time, almost exactly as described by Dr. Friedman 30 years earlier. This programme did not aim at creating economic growth and none was achieved but inflationary pressures were generated.

Suffice it to say, a Helicopter Drop is not a Keynesian Fiscal Stimulus nor can it be Monetary Stimulus executed by a central bank. It is, in it original sense and in the only practical sense, a Helicopter Drop monetary policy conducted by governments instead of central banks.

[1] http://www.federalreserve.gov/boarddocs/Speeches/2002/20021121/default.htm

[2] http://faculty.chicagobooth.edu/chang-tai.hsieh/research/coupon.pdf

[Shortened URLs change to full URLs–Econlib Ed.]

What do you mean a central bank can’t run out of ammo? If a central bank devalues a currency so much that people resort to currency substitution, then the central bank is effectively out of ammunition. Of course by the time that happens, the central bank will have caused a great deal of misery to the people it is supposed to be helping. I suppose to some that may be acceptable collateral damage in the quest to hit a nominal target.

If the BOJ wanted to buy all the world’s financial assets they would have to pay acquisition prices rather than the share price found in normal citcumstances, first converting Yen to the currency that those assets normally trade in. The acquisition premium and FX rates would prevent the ROI from being “lavish.”