So I had the following dream last night:
Me: Honey, I decided not to teach summer classes this year.
Honey: Oh Scott, you’ll just spend the time out on the golf course
(I grab a shotgun and shoot off one of my feet)
Honey: Why did you do that?
Me: To convince you that I won’t go golfing this summer.
Honey: Um, you could have just promised not to go golfing.
Me: But I thought you won’t believe me.
Honey: But you never even tried to convince me. I might have believed you.
Honey: I never realized how weird you are.
(Just then my friend Paul walks in to the room)
Paul: You’re not going to believe him are you? He could put on a peg-leg and hobble around the golf course.
Honey: And your friends are even weirder than you are.
If your brain is as twisted as mine, you see the obvious connection to helicopter drops of cash. To me, there is a sort of surreal quality to discussions of liquidity traps. The discussion starts with the premise that it is hard to expand aggregate demand when nominal rates are close to zero. (Which is false.) Then there is a discussion of all sorts of crackpot schemes like negative interest rates on $20 bills. Or dropping cash out of helicopters. Then the liquidity trap proponents come up with ever more far-fetched reasons why this wouldn’t work.
In fact, these discussions are flawed from the very beginning, as they assume there is some sort of “trap” that prevents central banks from boosting AD. Central banks operating under floating exchange rate fiat regimes can always increase AD if they want to; in all of recorded history there are no failures. But people think otherwise because they see central banks do things that look expansionary when rates hit zero, and in many cases AD does not increase.
Krugman’s right that a helicopter drop is not necessarily inflationary. Suppose the government dropped 50 $100 bills for every US citizen out of an airplane. If the public expected the government to institute a $5,000 per capita tax in the very near future, and retire all that cash from circulation, it would have no effect. But of course that would be a really, really stupid thing to do. Taxes have deadweight losses, so the net effect of the money drop plus tax would be simply the destruction of wealth, that is all. It would be like me shooting off my foot to convince my wife that I wouldn’t play golf, but then putting on a peg leg and going out golfing anyway. Sure that’s theoretically possible, but why would I do it? If the government behaves like a bunch of reckless lunatics hell-bent on hyperinflation, it is a good bet that they are a bunch of reckless lunatics hell-bent on hyperinflation.[You might argue that fiscal authorities do nutty things like this. Yes, but they don’t have the alternative of using the printing press.]
So I think a big helicopter cash drop would almost certainly boost AD. But it would still be a terrible idea. Here’s why. If the Fed did this without an explicit inflation or NGDP target, then it would likely result in hyperinflation. The public would be frightened, and I can’t say I’d blame them. But if the Fed did accompany the drop with an explicit price level target, then the optimal helicopter drop would be less than zero. Indeed if the Fed committed to say 4% inflation, the public would not want to hold even the current $2 trillion in base money (unless they were paid to do so with an interest on reserve program.) So to summarize:
1. Helicopter drops might not work, but almost certainly would.
2. Helicopter drops are a really stupid idea, especially if the central bank did not first try to inflate using traditional tools. There are numerous recent statements by Fed officials to the effect that they have the tools they need, it’s just that they don’t think the economy needs more AD. Why pull the nuclear option without first doing something simple, LIKE SAYING YOU’D LIKE TO HAVE HIGHER INFLATION?
3. The helicopter drop might result in hyperinflation, which would be worse than what we have now.
4. Even if an explicit 4% inflation target prevented hyperinflation expectations, the Fed would probably have to reduce the base to hit the target. I.e., no helicopter drop.
Just to be clear, it isn’t just a really silly idea for the real world because it might overshoot to hyperinflation. It is really bad to even discuss it as a hypothetical, because it feeds into the view that the Fed, ECB, and BOJ want faster inflation, but just don’t know how to get it. And that’s false. They don’t want faster inflation, and they know perfectly well how to get it if they change their minds.
PS. I agree with Tyler Cowen’s take on this issue. My only problem with his analysis is that he shows too much respect to the idea itself, and the hypothesis that a helicopter drop might not boost inflation expectations. Cowen’s right, but as soon as you start trying to defend these ideas in a serious way, you play right into the hands of sort of people who think it is sensible to consider a scenario where someone shoots off their foot with a shotgun, and then installs a peg-leg so they can play golf.
When the day arrives where the BOJ says they want 2% inflation but can’t achieve it, come back to me and we can start talking about shooting off feet with shotguns. Until then I see no point in having this conversation. It’s like arguing with 9/11 conspiracy nuts.
And I hate golf.
PPS. After I wrote this it occurred to me that people might think I was talking about the “drop” of commercial bank deposits at the Fed. It’s cash to the public I have in mind. Reserves are too esoteric, and too much like T-bills these days—so they might not affect inflation expectations very much. I am talking about actual helicopter drops, not tax cuts/open market purchases.