Steve Waldman has a post discussing the problems involved in making monetary stimulus effective. He ends up by claiming that “helicopter drops” would certainly work, but the Fed isn’t authorized to do them:
To the degree that our problem is on the demand-side and stems from private-debt-overhang-induced risk aversion or a desire to hoard money, we know the solution. That problem, if it exists, will go away if we give everyone money. But giving everyone money is not conventional, authorized, monetary policy. It requires new law.
In macroeconomics the term “helicopter drop” refers to combined fiscal and monetary stimulus, essentially have the Fed print money to finance a budget deficit. In recent years the phrase “print money” has become slightly misleading, as the Fed has turned bank reserves into interest-bearing debt. But with or without interest on reserves, a “helicopter drop” is not a foolproof escape from a liquidity trap. To see why, consider why conventional monetary policy is often ineffective.
In the early 2000s the BOJ printed lots of money, and the Japanese government issued lots of debt. That should have been inflationary, if helicopter drops really worked. But it wasn’t, because the BOJ also hinted that they’d eventually pull the money back out of circulation, to prevent prices from rising. And in 2006 they did just that, and prices didn’t rise.
Many people assume this “expectations trap” (popularized by Krugman) applies only to conventional monetary stimulus. Actually, it also applies to a combined fiscal and monetary stimulus, as we saw in Japan. Temporary monetary stimulus won’t be effective. It won’t work if rates are zero. It won’t work if rates are positive. It won’t work if combined with fiscal stimulus. It simply won’t work, if temporary.
The Fed has also promised their monetary injections will be temporary, and hence they haven’t worked, just as in Japan. You might argue “what else could they do, if they promised the tripling of the base was permanent, we could end up with hyperinflation.” Yes, they can’t say it’s all permanent, but they could tell us how much. But Steve Waldman says they won’t do that. In that case there is no reason to expect any stimulus from more money, helicopter drop or not.
And yet, the market reaction to hints of QE2 suggests that open market purchases can be successful, even at the zero bound. The most likely explanation is that the markets weren’t reacting so much to the action itself, but rather to the implied signal it sent about Fed determination to prevent deflation. And the Fed action succeeded (so far) in preventing Japanese-style deflation.
And now for the perplexing title of this post. When I put “helicopter drop” in quotation marks, I mean money financed deficits. When I don’t use quotation marks, I mean real cash and real helicopters. An elite macroeconomist would tell you it makes no difference, and in a purely technical sense that’s true. But in terms of expectations it makes all the difference in the world. An actual helicopter drop, Ben flying across America dumping hundred dollar bills out of a helicopter, would almost certainly raise inflation expectations sharply. Especially if he dressed up like Peter Pan and kept announcing through a megaphone “if you believe you can inflate.” The imagery would be powerful and evocative. Indeed so much so that it would probably require only a tiny amount of actual $100 bills–just make sure the news cameras were there. Better yet, do it over minority neighborhoods, to triggers subliminal concerns among Fox News viewers.
Of course all this would be crazy, and I am not advocating it. But these thought experiments illustrate that we’d be much better off if the Fed simply told us where it wanted to go, and how it was going to get us there. I get frustrated when Waldman says the only reasonable policy is a non-starter, because it’s not what the Fed wants to do:
The Fed is not going to target NGDP or a price level path over any relevant time frame without a change in governance structure or mandate. People on the left and right and especially the technocratic center who like to see the Fed as a loophole through a dysfunctional Congress are kidding themselves. The Fed is a political creature, not some haven for philosopher-economists in togas who will openly consider your ideas. Get over it and get your hands dirty.
Look, we’ve already established that what the Fed “wants to do” won’t work, it will fail. It’s our job as pundits to suggest policies that actually will work. If our society is suicidal then there’s nothing we pundits can do about it. If we are told that every single suggestion that will work is politically unacceptable, there is nothing we can do about it. Except keep trying to educate people.
Now I have to go iron my toga for a party tomorrow night.
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