Wednesday, 1 June 2016

Odd ideas from Andrea Terzi on helicoptering.

Terzi sets out some ideas on helicoptering in this article. I’ve reproduced the article below with my comments interspersed (in green italics).

In his piece on helicopter money, Lord Adair Turner seemed to argue that:

1) The money multiplier provides the needed boost to expansionary fiscal policy, yet this boost could generate inflation.

2) The risk of inflation could be managed by raising reserve requirements as needed.

Both statements are incorrect.

So why exactly would raising reserve requirements not succeed in raising interest rates? An explanation is needed. After all, it’s widely accepted that central banks can keep interest rates up PRECISELY by keeping commercial banks short of reserves.

And this is the slightly expanded version of my Letter to the Financial Times (FT.COM published an abridged version)

In ‘The helicopter money drop demands balance’ (May 22), Lord Adair Turner defends the notion that bigger fiscal deficits are needed to end the current stagnation, but leaves one question unanswered: Why should a money-financed deficit be more powerful than a traditional debt-financed deficit?

...Because money (base money to be exact) is a bit more liquid than government debt!

Money-financed fiscal deficit is one particular form of government spending (in excess of taxes) that is funded by the central bank directly crediting the recipient banks with central bank money. In a traditional debt-financed fiscal deficit, banks are ultimately credited with government securities.

No. In a “traditional debt-financed fiscal deficit”, the entities “credited with government securities” are (surprise, surprise) those which buy those securities, which for the most part are not commercial banks. In fact commercial banks in the US and UK hold only 5% (very roughly) of government debt. The vast majority is held by pension funds, insurance companies, foreigners, you name it.

The expansionary effect of the two options must then be equivalent, as private sector’s disposable income increases by precisely the same amount, the only difference being that banks hold a bigger balance with the central bank in one case and a bigger credit balance with the government in the other case.

Yes, obviously the INITIAL expansionary effect is the same, but there are SECONDARY effects, like the above mentioned liquidity difference.

Indeed, large-scale purchases of government debt by central banks (a.k.a. QE) are a form of ‘helicopter money’ for a given fiscal stance, as they substitute central bank money for government debt, and their dismal results are evidence that funding public debt with central bank money provides no special boost.

To say there is “no special boost” is going too far. QE does have a FINITE effect, but clearly not a big one.

The belief that an increase in bank reserves would boost an expansion of bank credit has been convincingly refuted by all central banks’ experts on monetary operations. The money multiplier is inapplicable to a floating currency, and the only reason for having reserve requirements is to limit the volatility of money market rates under current liquidity management arrangements.

Turner recommends helicopter money as a way to manage fiscal deficits without creating more public debt. However, central bank money is another form of debt, and any narrative that begins by assuming that government debt is bad won’t go very far by proposing an increase of debt in a different form.

“Central bank money is another form of debt”? Well it’s a strange form of debt. Reason is that government has the right to grab any amount of money it wants off the private sector via taxation. That’s the equivalent of me having the right to break into the bank that granted me my mortgage and grab wads of £10 notes with a view to paying down my debt to the bank. You can call that a debt owed by me to the bank, but like I say, it would a strange sort of debt.

Also, who says “government debt is bad”? One of the basic bits of logic behind money financed deficits is that the lower is interest on government debt, the nearer do base money and government debt become the same thing (as pointed out by Martin Wolf). Thus if an economy in need of stimulus continues to refuse to react to interest rate cuts, there must come a point at which debt financed deficits become pointless and one is FORCED to switch to money financed deficits. Strictly speaking that point is when interest on government debt is zero, but clearly when interest on the debt is say 0.1% there probably won’t be any takers. So one might as well make the switch when the rate is 0.5% or so.

A better version of Turner’s important point that fiscal deficits are needed is to question current debt limits. Designed to check governments’ spending power, they have caused collateral damage by leaving the support of growth entirely to private debt. And private debt is critically pro-cyclical.

And finally there is something fundamentally illogical about debt financed deficits, which is that the basic objective is STIMULUS, but borrowing is “anti-stimulatory”: that is, it has a DEFLATIONARY effect. So debt financed deficits are a bit like chucking dirt over your car before washing it.

Moreover, debt is attractive to foreigners, for example China, Japan, etc hold a large stock of US government debt. I don’t see anything desperately clever about getting into debt to foreigners, not that doing so is necessarily a disaster.

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