Don't Trust Ben Bernanke On Helicopter Money
http://www.forbes.com/sites/stevekeen/2016/04/12/dont-trust-ben-bernanke-on-helicopter-money/
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Ben Bernanke earned the sobriquet “Helicopter Ben” for his observations in a 2002 speech
that “the U.S. government has a technology, called a printing press
(or, today, its electronic equivalent), that allows it to produce as
many U.S. dollars as it wishes at essentially no cost”, that the
existence of this technology means that “sufficient injections of money
will ultimately always reverse a deflation”, and that using this
technology to finance a tax cut is “essentially equivalent to Milton
Friedman’s famous “helicopter drop” of money.” But just because he’s
called “Helicopter Ben” doesn’t mean that he knows how “Helicopter
Money” would actually work.
His column “What tools does the Fed have left? Part 3: Helicopter money” discusses both the nuts and bolts of actually implementing a “Helicopter Drop” (or as he more accurately describes it, “an expansionary fiscal policy—an increase in public spending or a tax cut—financed by a permanent increase in the money stock”) and also discusses how such a policy might affect the real economy. While his discussion of the nuts and bolts is realistic, his discussion of how it would work is fantasy.
The nuts and bolts are straightforward (and Bernanke has a good
practical suggestion for how to implement it too, which I’ll discuss at
the end of this post). “Helicopter money” (or as he excitingly renames
it, “a Money-Financed Fiscal Program, or MFFP”) is a direct injection of
money from the government into people’s bank accounts, which is
financed by a loan from the Federal Reserve to the Treasury. This
differs from the standard way that Government spending is financed,
which is by issuing Treasury Bonds that are then bought by the public.
The standard method doesn’t put additional money into circulation in the economy, because the increase in some private sector bank accounts caused by the government spending—a tax rebate, for example—is completely offset by the fall in other private sector bank accounts as they buy the Treasury Bonds that financed the tax rebate.
But with “MFFP”, the tax rebate is financed by new money created by the Federal Reserve “at essentially no cost”. It thus directly increases the money supply, and this is where Friedman’s “Helicopter” analogy comes from. In the private sector economy, the money supply is increased when private banks lend to the public. Money created by private bank lending also goes by the nickname of “inside money”, since it is created by institutions that are “inside” the private sector—private banks.
His column “What tools does the Fed have left? Part 3: Helicopter money” discusses both the nuts and bolts of actually implementing a “Helicopter Drop” (or as he more accurately describes it, “an expansionary fiscal policy—an increase in public spending or a tax cut—financed by a permanent increase in the money stock”) and also discusses how such a policy might affect the real economy. While his discussion of the nuts and bolts is realistic, his discussion of how it would work is fantasy.
Former Federal Reserve Chair Ben Bernanke
(L), and former Chair Paul Volcker look on during a panel discussion at
the International House in New York on April 7, 2016. / AFP / POOL /
Andrew Renneisen (Photo credit should read ANDREW RENNEISEN/AFP/Getty
Images)
The standard method doesn’t put additional money into circulation in the economy, because the increase in some private sector bank accounts caused by the government spending—a tax rebate, for example—is completely offset by the fall in other private sector bank accounts as they buy the Treasury Bonds that financed the tax rebate.
But with “MFFP”, the tax rebate is financed by new money created by the Federal Reserve “at essentially no cost”. It thus directly increases the money supply, and this is where Friedman’s “Helicopter” analogy comes from. In the private sector economy, the money supply is increased when private banks lend to the public. Money created by private bank lending also goes by the nickname of “inside money”, since it is created by institutions that are “inside” the private sector—private banks.
So how does “Helicopter Money” differ in impact from the standard way of financing government spending? Here’s where Bernanke passes from the practical nuts and bolts to the fantasy world of mainstream economics. According to Ben, the Helicopter flies, so to speak, because it causes “a temporary increase in expected inflation,” and because it “does not increase future tax burdens.”
Huh? Doesn’t Helicopter Money mainly work because the increase in the money supply directly causes an increase in spending too? That’s what you might think if you hadn’t done a PhD in Economics, as Ben Bernanke has done. But if you have done a PhD in Economics, you know that it’s more complicated than that, because in your model of the economy, whether people will actually spend that money depends on two other factors.
These two factors are “inflationary expectations” and the tax implications of government spending. In the mainstream economic model that Bernanke believes actually describes the real world, real people base their spending decisions today on their beliefs about what’s going to happen to inflation and future tax burdens.
In Bernanke’s model, if people believe that some policy will cause inflation, then inflation will indeed occur—because people will immediately charge more for what they sell (business owners will put up prices, workers will demand higher wages). In other words, the belief itself—that inflation will be caused by the policy—actually causes the inflation. People do this because they all use the same model for predicting the future course of the economy, and in this model there is a direct relationship between changes in the money supply and increases in prices.
Equally, if people believe that some government policy now will cause higher taxes in the future, then they will spend less now so that they can save money so that they—or their descendants—will have the money to pay higher taxes in the future. People do this because they know that government deficit today (if it’s financed by borrowing) must be matched by an offsetting government surplus in the future, so they put aside money today so that in future they, or perhaps their great-great grandchildren, will have the money needed to those future taxes.
If you feel like your head is spinning like the rotor of a helicopter after reading those two paragraphs, then good: they describe a nonsense view of the real world, the fantasy model which left mainstream economists like Bernanke completely unawares as the greatest economic crisis since the Great Depression loomed in 2007.
This mainstream model was dreamed up—and that’s an accurate way of describing its development—precisely because its developers wanted to “prove” that government policy was ineffective. So they happily made absurd assumptions to reach this conclusion.
The “logic” behind the idea that people will save now in order to pay taxes in the future is even more transparently nonsense. When it was pointed out to its developer Robert Barro that people wouldn’t necessarily save today to pay taxes in the future if they thought that future tax burden would not affect them but future generations, Barro had a simple riposte—when you go shopping, you do so planning for the infinite future of your personal dynasty:
The argument fails if the typical person is already giving to his or her children out of altruism. In this case people react … with a compensating increase in voluntary transfers… The main idea is that a network of intergenerational transfers makes the typical person a part of an extended family that goes on indefinitely. In this setting, households capitalize the entire array of expected future taxes, and thereby plan effectively with an infinite horizon. (Barro, “The Ricardian Approach to Budget Deficits”, 1984)As a victim of a conventional education in Economics, Ben Bernanke fell for all this guff as an explanation for why government policy should generally be “hands off the economy”, and therefore why really huge crises like the Great Depression couldn’t be the fault of the private sector, but must be due to bad government policy. Clearly, the experience of the Great Recession hasn’t caused him to question this delusional model of reality. Now, in the aftermath of this crisis that he and the mainstream had no idea was coming, he continues to try to use this model to explain how, maybe, government policy might just work.
So the model says that a government deficit will just cause inflation; but hey, we want some inflation now, so let’s do that. There’s one problem solved.
But the model says that, if people expect a tax rise in future to compensate for a rise in government spending today. So how do we get around that? Ah, let’s finance the spending by direct money creation rather than taxes. That’s problem two solved, so “Helicopter Money” will actually work in our model. Therefore that’s how it will work in the real world too.
Bollocks. The mechanism is much more straightforward than in Bernanke’s tortured logic, and the less you have learnt of mainstream economics, the better you are equipped to understand it. I’ll cover that in my next post.
For this one I’ll finish with support for Bernanke’s proposal for a mechanism that would make “Helicopter Money” possible:
Ask Congress to create, by statute, a special Treasury account at the Fed, and to give the Fed (specifically, the Federal Open Market Committee) the sole authority to “fill” the account, perhaps up to some prespecified limit. At almost all times, the account would be empty; the Fed would use its authority to add funds to the account only when the FOMC assessed that an MFFP of specified size was needed to achieve the Fed’s employment and inflation goals.That’s a sensible way to make it possible for the government to implement “Helicopter Money” at times when the economy gets caught in a debt-deflationary crisis, as it is now. But I’d prefer to see it implement what I call a “Modern Debt Jubilee”, as I’ll explain in my next post.
Should the Fed act, under this proposal, the next step would be for the Congress and the Administration—through the usual, but possibly expedited, legislative process—to determine how to spend the funds (for example, on a tax rebate or on public works). Importantly, the Congress and Administration would have the option to leave the funds unspent. If the funds were not used within a specified time, the Fed would be empowered to withdraw them.
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