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Wednesday, June 8, 2016

A stealth helicopter drop?

As growth in developed markets has remained lackluster, increasing attention has focused on monetary financing, with high-profile proponents including Willem Buiter and Aidar Turner.

Apart from the economic effectiveness of a helicopter drop, an important issue is whether the means for accomplishing the monetary financing are permissible in various jurisdictions. For example, writing in his Brookings blog, Bernanke offers that a People's QE "would certainly be illegal in most or all jurisdictions." And it's well-established that monetary financing is prohibited by EMU members states by Article 123 of the Treaty for the Functioning of the European Union. (See my earlier blog entry of 13-Nov-11 for more on this point.)

But in this respect, it's useful to consider the effect of a permanent increase in the money supply used to finance purchases of sovereign debt. From a 2013 interview, Michael Woodford addresses the relation between the helicopter drop and permanent QE:
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 service 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. Under the quantitative easing policy, the central bank acquires assets, but it rebates the interest paid on the government bonds back to the Treasury, so that the budgets of all parties are the same as if no government bonds were actually acquired, as is explicitly the case with helicopter money.
Woodford goes on to explain the critical role of public expectations:
The effects could be different if, in practice, the consequences for future policy were not perceived the same way by the public. Under quantitative easing, people might not expect the increase in the monetary base to be permanent – after all, it was not in the case of Japan’s quantitative easing policy in the period 2001-2006, and US and UK policymakers insist that the expansions of those central banks’ balance sheets won’t be permanent, either – and in that case, there is no reason for demand to increase. Perhaps in the case of helicopter money, it would be more likely that the intention to maintain a permanently higher monetary base would be believed. Also, in this case, the fact people get an immediate transfer should lead them to believe that they can afford to spend more, even if they don’t think about or understand the consequences of the change for future conditions, which is not true in the case of quantitative easing.
If the key criterion determining observational equivalence between helicopter money and quantitative easing is the perceived permanence of the latter, then the stage appears set for monetary financing to become a fait accompli merely by affecting public perceptions. And this could happen in one of two ways.

First, in permitted jurisdictions, central bankers could simply announce that principal and interest payments on sovereign holdings will be rolled over continually. In that case, taxpayers would perceive no budget constraint associated with the additional spending financed with printed money, and the proposition of Ricardian equivalence under rational expectations would no longer hold.

But there is a second way in which these public perceptions might change -- namely, taxpayers might simply adapt their expectations as central bankers reinforce the precedent of rolling over these bond purchases year after year. Already, the eventual reduction of the central bank balance sheet appears no longer to be on the agenda in many jurisdictions. Fiscal authorities, market participants, and financial journalists appear to have become inured to the prospect of elevated central bank balance sheets persisting indefinitely. And now that the Fed pays interest on reserves, it has severed the link between the supply of money market funds, the demand for such funds, and the price of these funds. The FOMC now can run a balance sheet policy independent of its rate policy, as has been the case with other central banks, such as the Bank of England and the ECB.

My sense is that it's rather unlikely that western central bankers will announce that their purchases of sovereign debt should be considered permanent, given the sensitivities involved. For example, in a speech earlier today before the German Institute for Economic Research in Berlin, French Central Bank Governor Fran├žois Villeroy de Galhau noted [emphasis his]:
I think that so-called “helicopter money” would bring more harm than good: we do not need it and it is not on the table.
However, it wouldn't surprise me if current large-scale, sovereign debt purchases remained on the balance sheets of the Federal Reserve, the Bank of England, the ECB, the Bank of Japan, the Riksbank, etc for a sufficiently long period for taxpayer expectations to adjust so as to consider the status quo as the new norm. In fact, it wouldn't surprise me if central bankers responded to the next downturn in the economic cycle by purchasing still more sovereign debt, in the name of fulfilling existing mandates.

The growing interest in helicopter money may become moot at some point, if central bank watchers come to view continual reinvestment of principal and interest as a permanent feature, In that case, there will be no need to fire up the metaphorical helicopters; central bankers would have achieved via stealth the monetary financing that otherwise would have involved a fractious debate -- and very likely a violation of legal protections in various jurisdictions.