A debate on helicopter money was held at the London Business School in April 2013 involving Lord Adair Turner and Professor Michael Woodford. An account of that important debate is included in an article ‘Helicopter money as a policy option’, at VoxEU.org, dated 20 May. In that debate the ‘Helicopter Money Financing model’ was compared with what I would label the ‘Quantitative Easing/Fiscal Financing model’. The purpose of this short article is to question some aspects of the logic deployed in the debate by Professor Woodford and his conclusion.
Professor Woodford’s Assertion
In his presentation, Professor Woodford makes the following statement:
‘It is possible for exactly the same equilibrium to be supported by a policy of either sort. On the one hand (traditional quantitative easing) one might increase the monetary base through a purchase of government bonds by the central bank, and commit to maintain the monetary base permanently at the higher level. On the other (‘helicopter money’), one might print new base money to finance a transfer to the public, and commit never to retire the newly issued money. Suppose that, in either case, the path of government purchases is the same, and taxes are raised to the extent necessary to finance those purchases and to finance the outstanding government debt, after transfers of the central bank’s seignorage income to the Treasury. Assuming the same size of permanent increase in the monetary base, the perfect foresight equilibrium is the same in both cases. Note that the fiscal consequences of the two policies are actually the same.’
On certain assumptions, where central banks create the new money referred to, and in the very long-run (perpetuity), it may possibly turn out that way, but there are some issues that might arise in anything but the very long-run to bring this supposed equivalence — widely claimed to be true by central bankers — into question.
Comparison of Two Models
To succinctly illustrate the issues, let us consider the case where the Treasury (not the central bank) creates the new money (called, say, ‘new US dollars’) to finance a transfer to the public under the Helicopter Money Financing model. There are at least three ways to implement this model: i) the Treasury could use its newly created ‘new dollars’ currency to directly finance the budget deficit. Alternatively, ii) the Treasury could create ‘new dollars’ and the central bank could create an equivalent value of existing currency (‘old dollars’): these two currencies tranches could then be swapped immediately so that the Treasury could then finance the budget deficit directly using ‘old dollars’. Finally iii) the Treasury could take back control and responsibility for the issuance of the currency. Under ii) and iii) two currencies do not need to be in circulation simultaneously, as would be the case under i).
Under i), ii) and iii) there is no increase in public debt, as the creation of new fiat money creates no liability to the issuer (see Willem Buiter, ‘Helicopter Money: Irredeemable Fiat Money and the Liquidity Trap’, NBER Working Paper, No. 10163, December 2003). This is made clear by the inscription printed on the UK Pound Note.
As a footnote, one should add that under the Helicopter Money model it is not necessary to impose a requirement — imposed by Professor Woodford — that the monetary base must be maintained at a higher level permanently. The sole purpose of the monetisation of the deficit (Helicopter Money Financing Model) is to finance the initial stimulus expenditure (outlays or tax cuts). Once that is achieved the new money could be withdrawn (sterilised) at any time if, or when, liquidity became excessive. This could happen as full capacity is approached, and then the associated higher interest rates (due to sterilisation) would be desirable. (It is also not obvious to the author why Professor Woodford imposes this requirement on his own preferred model).
Under Professor Woodford’s preferred model the new money created is used to lower interest rates through asset purchases (quantitative easing), leaving the deficit (the ‘government purchases’) to be financed by either the issuance of new government bonds or by taxation. It follows, therefore, that the fiscal consequences of the two models (so far described) do differ. Either:
a) the level of public debt is increased under the Quantitative Easing/Fiscal Financing model, but there is no increase in public debt under the Helicopter Money Financing model, and/or
b) the level of taxation is increased under the Quantitative Easing/Fiscal Financing model, but there is no increase in taxation under the Helicopter Money Financing model.
Note that public debt is increased under the Quantitative Easing/Fiscal Financing model (if taxation is not raised as the sole method of financing) as new government bonds are sold to the private sector and/or to the central bank. Such bonds held by the central bank are counted as part of general government debt, the main measure of public debt used by credit rating agencies. Presumably, the credit rating agencies ‘see through’ and recognise that new government bonds held by the central bank could be sold to the public at any time.
Could the Quantitative Easing/Fiscal Financing Model still be Superior?
There is, nonetheless, one particular case where Professor Woodford’s model might appear, at first blush, to be effectively equivalent to the Helicopter Money Financing model. That would arise if the financing of the deficit is achieved by issuing ‘non-transferable’ government bonds to the central bank, and if credit rating agencies took this into account. In that case effective public debt would not rise. The two models look to have the same effects on public finance. Then, however, the choice between the two policy models depends on which of the two models has the stronger favourable effects on the economy, and which has the more serious adverse side effects.
As further quantitative easing (asset purchases) is designed to push-up asset prices and further lower longer-term interest rates then the adoption of that policy risks the creation of serious credit and asset price bubbles, unwarranted and destabilising capital flows, exchange rate wars, the distortion of risk assumption throughout the economy, and the distortion of central bank balance sheets. Further quantitative easing is like pushing on an already elongated string: it is not sufficiently raising aggregate demand or stopping deflationary tendencies, and its effectiveness is ever decreasing. In the author’s view, the latest Japanese enterprise — unprecedented in scale though it may be — is most unlikely to return consumer price inflation to 2 per cent on an on-going basis, as hoped for, as its principal impact is on asset prices (including global equity and credit markets) not consumer prices. That said, there may well be relatively short-lived favourable expectations effects which may increase inflationary expectations, given the sheer magnitude of the expansion in the monetary base.
Under the Helicopter Financing model there are no obvious or significant adverse side effects, and the new money would flow to those with the largest marginal propensities to consume (not to banks, speculators and financial institutions as under the Quantitative Easing/Fiscal Financing model; that is, agents that do not purchase ordinary goods and services).
Consequently, it is not obvious that Professor Woodford’s claim that ‘the perfect foresight equilibrium is the same in both cases’ is correct.
Conclusion and Policy Implication
In conclusion, then, Professor Woodford’s logic and conclusion seem questionable on the basis of the above analysis. If this is so, the case for Helicopter Money Financing model is very substantial indeed, and stronger than the current approach (Quantitative Easing/Fiscal Financing model), particularly for countries experiencing low growth/recession/depression and high and rising public debt.
This finding suggests that policy makers in afflicted countries, in the European Union and at the IMF may need to re-think their macroeconomic policy strategies, abandon fiscal austerity and quantitative easing monetary policies, and consider new ways to achieve much greater coordination between monetary and fiscal policies. The Helicopter Financing model appears to represent one option that should be seriously considered to replace current monetary and fiscal policy orthodoxy in the new era of high public debt and insufficient private demand.
Further details can be found at Wood. R, Solving the European Economic Crisis: Challenging orthodoxy and creating new policy paradigms, Amazon Books, 2012 and various recent articles by the author on EconoMonitor and Vox Economics websites.
Richard has published papers on wages policy, the taxation of financial arrangements and macroeconomic issues in Pacific Island countries. Views expressed in these articles are his own and may not be shared by his employer.