Again, Unconventional Wins Out
byWho would have expected extreme thinking from central bankers? That is the theme of some coverage in the financial press over the past few weeks. For example, the Financial Times takes note that “a growing chorus of economists is saying central banks should take more radical steps, including buying assets other than government bonds.”
Some, if not all, of these steps are not so radical from a broad historical perspective. Following the recent bankers’ brainstorming session in Jackson Hole, Wyoming, Fed Chairman Ben Bernanke was said to be pondering various possibilities including (1) QE (quantitative easing) 3, (2) a lowering of the interest rate paid on banks’ reserve accounts at the Fed, (3) an extension until 2015 of the Fed’s low-interest-rate precommitment, and perhaps in the longer term, (4) adopting nominal GDP targeting, as endorsed, for example, by George Soros in a recent opinion piece on the eurozone and Germany in particular.
Today, the Fed announced that it would adopt options (1) and (3), purchasing $40 billion in mortgage-backed debt each month for an indefinite period and predicting that the federal funds rate would remain near zero through mid-2015 (see news article for more details).
Most of the measures being contemplated are portrayed as more radical than they actually are, in my view. For example, most of the actions being pondered by the Fed could not match the impact of the approximately $500 billion “fiscal cliff” due in January, or even the “fiscal clifflet,” the Economist’s phrase for the portion of the cliff that actually winds up going into effect, once the current Congress gets its last chance to pass legislation. As a blog at that publication’s site puts it,
Even if the Bush tax cuts are extended and the sequester delayed, a huge amount of fiscal drag remains in place. They include the expiration of the payroll tax cut, the expiration of extended unemployment insurance benefits, imposition of a new 3.8% Medicare investment tax on the wealthy, and the bite to discretionary spending embedded in the Budget Control Act and prior continuing resolutions.
One novel and potentially effective Fed approach would be the monetary “helicopter drop” recently discussed in the full-page FT article and a recent column in the same newspaper. The idea would be for the central bank (the Fed in the US case) to send money to individuals, through direct deposits in Americans’ bank accounts or by distributing currency via the banking system. Of course, the US central bank currently cannot transfer money to the public in this way except as directed by the President and Congress. Ironically, the term “helicopter drop” is associated with Milton Friedman, who often implied that all expansionary monetary policy actions were merely helicopter drops, and hence could not change output in the long run, only wages, prices, etc. In fact, the modern Fed generally purchases financial assets or lends against solid collateral, rather than simply giving away cash. But the financial-sector bailouts since 2009 have already challenged these traditional, but somewhat arbitrary, bounds on Fed actions.
Aside from breaking political deadlock with anti-Keynesian politicians, a helicopter drop might help quell complaints that the Fed has unfairly focused its help on big financial institutions. This sentiment is often centered on concerns that Fed decisions are inherently somewhat undemocratic, since they are made by the Fed’s policy making committee, not elected officials. On the other hand, the Fed is greatly restricted in its use of cash compared to Congress and the president. It uses newly created money in its role as a banker for the federal government and the private banks, and not as it chooses.
Unprecedented actions seem realistic in the US context, given the seeming desperation of most central bankers to get the economy and job-creation going. As Alan Blinder, ex Fed vice chairman, recently put it, “At this point, I’m willing to support almost anything that would give the economy a little more oomph.” (Bloomberg news article )
Why a helicopter drop, instead of some other form of policy action, in the US? First, Friedman is trusted as an authority by many pundits and decision makers who harbor somewhat irrational doubts about the effectiveness of stimulus bills, even as stimuli to private consumption. The approach also fits in with Friedman’s argument that the government should distribute cash rather than in-kind benefits to the poor, to allow people to be freely-choosing consumers to the greatest extent possible. Finally, it would permit a fairly rapid injection of funds at a critical time (with the ending of emergency unemployment benefits and the rest of the cliff), overcoming political gridlock in Washington.
On the other hand, in its net effects on private-sector balance sheets, the imagined Fed “helicopter drop” would be virtually indistinguishable from a more typical stimulus plan, in which, say, the Treasury Department sells bonds to banks or investors to “pay for” the plan, since the Fed would presumably perform open-market operations in either case as needed to keep the interest rate at its publicly announced target level.* So, with Congress’s approval, the President could probably achieve essentially the same effect as the “unconventional” money helicopter, especially given the Fed’s current commitment to stick to near-zero interest rates until 2015.
At least hypothetically, the money could be sent out to taxpayers, people who receive government benefits already, or some other broad group of individuals. This would enable policymakers to directly reach nonborrowers, as well as less-wealthy Americans, who are often in great need and are almost certain to spend most of the new money. In related news, at Reuters, David Cay Johnston reports on some interesting preliminary research supporting this common-sense notion, i.e., that the macroeconomic effects of stimulus are larger when it goes to less-wealthy recipients.
*Note, September 14, about 8:50 am ET: Second paragraph from bottom revised somewhat to remove potentially confusing language about government spending. The details of how the Fed and the Treasury work together to keep interest rates on target when spending is increased can be found on various MMT sites, and, presumably, in Randy Wray’s brand new textbook, Modern Money Theory: A Primer on Macroeconomics for Sovereign Monetary Systems (Amazon link with free excerpt download). – G.H.