Why are helicopter drops off limits for modern central banks and governments? Why do central banks and governments prefer to buy assets from banks and the rich rather than send money to the masses? There are three major reasons:

  1. If the central bank simply prints money out of thin air and credits it to the people, then it suffers a loss. If the helicopter drop is sufficiently large, then the central bank may even become technically insolvent. Although this has very few technical implications for the functioning of a central bank, the political implications are significant. Opponents of the stimulus will latch on to the losses as a sign of monetary irresponsibility. The political implications and fear of loss of central banking independence may even have a negative impact on the economy. Understandably, central banks prefer to avoid such a situation. By buying financial assets, central bank governors can at least postpone losses for long enough that it becomes the next governor’s headache.
  2. If the helicopter drop is financed by a bond issuance by the government, then many market participants fear that the government debt will increase to unsustainable levels that cannot be paid back.
  3. If the helicopter drop is financed by a bond issued by the government and bought by the central bank, then some commentators fear that we will have crossed the rubicon into the dangerous world of monetised fiscal deficits.

I have written in the past on how these concerns are largely mistaken. But perceptions matter, not least because markets are reflexive. So the question is: How can we design a systematic program of helicopter drops that tackles the above concerns? The below is one possible solution:

  • The helicopter drop should be financed by a perpetual bond issued by the government and bought by the central bank. The perpetual bond pays an overnight floating interest rate equivalent to the Federal Funds rate.

The perpetual nature of the bond means that the government will never have to pay it back. The floating rate paid on the bond means that interest rate risk on the central bank’s balance sheet is negligible and it can hold the bond at par value on its balance sheet. The central bank’s inflation target is left unchanged which means that fiscal deficits cannot be monetised without limit.

Comments

Diego Espinosa

Ashwin, At the ZLB, I'm not sure I understand what is accomplished by the Fed buying the bond. Couldn't Treasury just issue it to the private sector at a zero yield? It is, after all, the exact equivalent of IOR-paying reserves.

Ashwin

Diego - but what when rates go up from zero in the future? The Treasury can't issue a perp at zero even today and if its just a floating rate 3-m t-bill, then we're again left to the criticism, however irrational, that the bond needs to be refinanced at regular intervals.

Diego Espinosa

Ashwin, If rates rise, it doesn't matter if the Fed or pvt sector owns the bond: the fiscal impact is the same. You could argue the Fed can delay recognition of the fiscal impact with deferred loss accounting. I think the RE folks would probably argue the pvt sector would see through that eventually. Reserves are truly liquid: they can always be used for payment. This is why you don't hear banks complaining about owning gobs of a perpetual FRN. I think if Treasury issued a PFRN, this instrument would also have the same use as reserves (it would be used for payments and be truly liquid).

Rajiv Sethi

Ashwin, under this proposal monetary policy will directly raise the federal debt, and can be held hostage by Congress simply refusing to raise the debt limit. I would prefer the following: (i) create an account at the Fed for every US citizen with a valid social security number, including minors, (ii) stop transferring profits on Fed assets directly to the Treasury, (iii) credit all accounts in equal measure to dissipate all profits, (iv) restrict withdrawals from these accounts to tighten monetary policy, and remove restrictions to ease, (v) continue open market operations as necessary, especially in a liquidity crisis, lending at high rates against good collateral to solvent institutions in accordance with the Bagehot rule. This last policy should result in windfall gains after a crisis. The direct transfers to account holders will boost aggregate demand when most needed.

joe bongiovanni

Sorry, I just do not get it. Why does 'bonding' almost always enter a 'helicopter drop' discussion these days? Friedman's original view was for printed money to enter the banking system as deposits, and the essentially critical aspect was that 100 percent of the money issued enter the national income stream for full effectiveness. Today, Lord Adair Turner is proposing an exact copy as that of Friedman, both in terms of effort and effectiveness. http://www.youtube.com/watch?v=ZhrY_coLK_k His Overt Permanent Money Finance(OPMF) proposal is based on Friedman's earlier Fiscal and Monetary Framework for Economic Stability. IF the implication of 'helicopter drop' money is demand-producing circulating media in the hands of the consumers, then let's first of all agree that it matters not which agency is piloting the helicopter, and also that the entire effort CAN take place without debt-burden considerations, which is what makes Turner's proposal "Permanent Money". Thanks.

Ashwin

Rajiv - Thanks. Your point is valid especially in the United States. My idea may still work in the UK for example where the debt limit is not a consideration. The motivation for this post was to find a way to implement the helicopter drop without making the central bank insolvent and to avoid the government having to refinance the debt either. I completely agree with your proposal. My only concern would be that it would limit the amount of money that could be disbursed as a helicopter drop especially in the midst of the crisis.

Rajiv Sethi

Ashwin, it would limit the amount initially, but over time a buffer of frozen deposits would accumulate that could be released as needed.

Ashwin

joe - I agree with the idea of simply printing money and disbursing it. But this necessarily involves a significant loss incurred by the central bank which is the situation that I am trying to avoid with my proposal.

Ashwin

Rajiv - fair point. You should write this up in a post. I agree entirely.

Diego Espinosa

Ashwin, It would be useful to clarify how a drop adds value. For instance, below is a "taxonomy" where value is added by: 1) issuing IOR-paying reserves 2) Treasury increasing net fiscal spending 3) Fed increasing net fiscal spending (Rajiv's above) FWIW, -I think 1) adds no value. -2) can add value. -Whether 3) adds value is a political, not economic question. As a matter of political debate, it is DOA

joe bongiovanni

I wish I understood that. I see no reason whatsoever for the CB to incur any 'losses' on transactions such as proposed by Turner. His slides indicate it not being a problem. Turner's proposal is funding the policy initiative through 'permanent money', as, once issued, it would remain in circulation in perpetuity, as money. The CB books the permanent money created by Lincoln howsoever it chooses. Same for OMF. I think the problem is the inside the box thinking about reserves and debt. Issuing real money into existence - and it would be an exogenous MA issuance, even though the transmission mechanism is fiscal - obviates any need for any reserve backing, and there is no debt issuance involved. The CB can incur $Billions in losses when it re-markets its MBS holdings tomorrow. Those losses would affect the inter-governmental transfer from CB back to Tsy, resulting in increased borrowing requirements of the state, in exactly the same way as implementing a payroll tax holiday would do. All of that seems quite avoidable with a helicopter drop of permanent money issuance. Thanks.

T. Greer

Ashwin, a question- Cannot all of these objections be raised against sending the money to the banks/rich instead of the masses? How does replacing the words "helicopter drop" with the word "bail out" change the implications of your sentence: "If the helicopter drop is financed by a bond issuance by the government, then many market participants fear that the government debt will increase to unsustainable levels that cannot be paid back." ?

Ashwin

T. Greer - Well, not really. Quantitative easing doesn't increase the government debt outstanding by itself. If the QE is deemed 'temporary', then the charge of monetising deficits is also countered. And the CB by buying assets at least postpones any potential loss on its balance sheet. The bailout is not explicit in QE - the CB can always say that it is buying assets at market price, that its actions are not reducing the yield on government bonds. But every CB apart from the Fed admits that QE reduces government bond yields, real interest rates and therefore increases asset prices.

Nigel B

All keep trying to avoid a political decision while changing the thinking and operation of monetary policy. At the end of day I don't think it can be avoided and must be confronted. That is why I think the Trillion Dollar Coin makes sense. It directly confronts the issue of "whose money is it?". Each individual can decide for himself.

Floccina

Aren't the following all in combination with the central bank buying bond in effect helicopter drops: Unemployment checks FICA tax reductions TANF SNAP

Ashwin

Floccina - When I talk about helicopter drops, I only refer to equal transfers to every citizen. All the above are of course fiscal transfers but to select groups.

Why Should Banks be the Only Ones with Accounts at the Fed? « naked capitalism

[...] in providing the Fed with a vastly superior monetary transmission mechanism. In a brief comment on Macroeconomic Resilience a few months ago, I proposed that an account be created at the Fed [...]