Much Excitement—and Lots of Confusion—about “Helicopter Money” of Late

Wolfgang Münchau is one of those rare sensible voices in the international media reporting on the euro crisis. He has been consistently right in his gloomy assessments of euro crisis management in recent years. He is also correct in pointing out that the observed deflationary trend in the eurozone is not primarily due to any recent oil price shock but mainly driven by the chosen deflationary intra-area “rebalancing” path: with German wage-price inflation well below the 2-percent stability norm, everybody else is forced into deflation to restore their competitiveness. (See here: “Beware what you wish for when it comes to ECB measures”)

But Münchau got it pretty wrong in his FT column this week suggesting that so-called helicopter drops of money would constitute monetary policy. Milton Friedman famously used the helicopter analogy in pushing his monetarist mantra, but he forgot to mention that central banks are not in the business of running money-dropping helicopters. Friedman’s story went like this:

“In our hypothetical world in which paper money is the only medium of circulation, consider first a stationary situation in which the quantity of money has been constant for a long time, and so have other conditions. Individual members of the community are subject to enough uncertainty that they find cash balances useful to cope with unanticipated discrepancies between receipts and expenditures. … 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. … Let us suppose, then, that one day a helicopter flies over our hypothetical long- stationary community and drops additional money from the sky equal to the amount already in circulation. … The money will, of course, be hastily collected by members of the community. … If everyone simply decided to hold on to the extra cash, nothing more would happen. … But people do not behave in that way. … It is easy to see what the final position will be. People‘s attempts to spend more than they receive will be frustrated, but in the process these attempts will bid up the nominal value of goods and services. The additional pieces of paper do not alter the basic conditions of the community. They make no additional productive capacity available. … Hence, the final equilibrium will be a nominal income [that has doubled] … with precisely the same flow of real goods and services as before” (Friedman 1969, p. 4).

However, as Keynes acutely observed, a central bank is a “dealer in money and debts.” A central bank issues its monetary liabilities by buying debts and/or making loans. Handing out banknotes or making transfers into deposits to the public for free constitutes not monetary policy, not even unconventional monetary policy, but plain and simple fiscal policy. And who would want unelected central bankers to be in charge of taking such a decision; even if it may well be the right one?

Of course, the eurozone fiscal authorities may in principle agree on a fiscal expansion – if they somehow manage to overcome both the legal hurdles they have set themselves and, probably more important, successfully crawl out of the intellectual hole they have dug for themselves. Similarly, under today’s outright deflationary conditions, it has, at last, become conceivable that even the ECB might embark on a “largish”-scale purchase of government debts purely with its monetary policy mandate of maintaining price stability in view; which is crucial for legal reasons, as Wednesday’s preliminary ruling by the European Court of Justice reminded us.

Fiscal expansion paired with QE may seem equivalent to a helicopter drop. But it is not. First of all because it is critical to acknowledge that there are two parties involved, making two very different kinds of decisions; one clearly political, the other supposedly purely technical. Furthermore, there is an important intertemporal issue not to be overlooked either. If the ECB buys ten-year government bonds today yielding 2 percent while the short-term rate is zero, the measure will expand its balance sheet and boost seigniorage income. If in five years time conditions are back to normal with a short-term rate of 3 percent, the ECB will be issuing its own debt certificates to mop up excess liquidity at a cost that exceeds the return on the ten-year paper purchased today. In other words, today’s measures would be eating into future seigniorage.

Monetary policy always and everywhere has seigniorage and other fiscal implications, but that still does not make helicopter drops an act of monetary policy. Associating helicopter drops with monetary policy reflects primitive quantity theoretic monetary thought and related muddles.

When in actual fact, Friedman’s helicopter analogy shares a close family relationship with Keynes’s much-maligned remarks on “digging holes in the ground to fill them up again,” which deserve to be quoted in full here:

“If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing” (Keynes 1936, p. 129).

A couple of points are noteworthy here. First, Keynes refers to the Treasury rather than the central bank in providing the stimulus to economic activity. Second, and philosophically rather interesting, while Friedman refers to “money for nothing” raining from the sky, Keynes refers to private enterprise and of laissez-faire in his analogy. Third, and contrary to all the nonsense written by ideologues and other foolhardy folks, Keynes did indeed perceive of much better ways of creating employment by means of a fiscal stimulus than digging holes in the ground and filling them up again.

Who is the real fool then? Answer: All those smart, austere politicians (“madmen in authority who hear voices in the air”) who today even get paid for borrowing on behalf of the public, either actually so (Germany) or nearly so (U.S.), to undertake infrastructure investment to better their societies and prosper the fortunes of our grandchildren, but still refuse to do the right thing.

P.S. Referring to “common sense” (read: absence of sense) and monetary orthodoxy with its permanent love affair with the “barbarous relic,” Keynes observed on the same occasion: “the form of digging holes in the ground known as gold-mining, which not only adds nothing whatever to the real wealth of the world but involves the disutility of labor, is the most acceptable of all solutions.” Today’s most acceptable of all solutions? Cutting taxes of the super-rich and allow them to own politicians, making sure to always do the smart, austere stuff; while also buying up the media as a means of keeping the public conveniently stupid.