Wednesday, 5 August 2015

OMG: BoE blog post on helicoptering invokes Ricardian Equivalence.

“QE for the people” is a hot topic in the UK at the moment, so this recent BoE blog post is currently of relevance.  The article is by Fergus Cumming and it makes claims which are debatable, to put it politely.

First, he attaches importance to Ricardian equivalence (RE). RE is basically as follows.

Governments have to incur debt so to fund stimulus, so at some point they’ll have to repay that debt via extra tax – extra tax on households for example. Thus households will not spend additional income that comes their way as a result of stimulus because they allegedly think they’ll have to pay extra tax to fund that repayment at some point.

If you think RE is an idea straight out of la-la land, you’re not alone. As Jospeh Stiglitz, the economics Nobel Laureate put it, “Ricardian equivalence is taught in every graduate school in the country. It is also sheer nonsense.”

Second, and as to actual REASONS why RE is nonsense, do you really think the average household spends time looking at the figures for stimulus, and working out how much extra tax they might have to pay several years hence? It’s hilarious: about 97% of households (at a guess) haven’t the faintest idea where to find relevant figures.

Third, the ACTUAL EVIDENCE is that RE is nonsense: that is, the evidence is that when government implements stimulus (e.g. puts tax cuts into effect) households actually spend a significant proportion of that additional after tax income.

Helicoptering is not reversible?

Next, the BoE article claims that conventional QE is reversible (in that the central bank can always sell the bonds it has bought back into the market) whereas helicoptering (aka QE for the people) is allegedly not reversible. Complete nonsense.

If the state prints money and distributes it via tax cuts or extra public spending, it can subsequently very easily reverse that process. First, it can raise taxes and “unprint” the money collected. Secondly, it can wade into the market and offer to borrow any amount it likes simply by offering an interest rate slightly above the going rate.

Actually doing that might require a change in the rules governing the central bank, but that’s just a technicality.

And finally  towards the end of  the BoE article it is claimed that:

“A successful helicopter money injection is difficult to achieve in principle because it requires people to believe that the government and central bank want to relinquish control of future inflation.”


The exact reason for that bizarre claim are not well set out, but presumably the argument is that helicoptering is irreversible, ergo it will lead to excess inflation. Well as I just explained above, helicoptering IS REVERSABLE!!!!


  1. You may have seen this?

    Thanks to B. Mitchell.
    “It was opportune that about that time the US Congress gave out large tax cuts (in August 1981) and this provided the first real world experiment possible of the Barro conjecture. The US was mired in recession and it was decided to introduce a stimulus. The tax cuts were legislated to be operational over 1982-84 to provide such a stimulus to aggregate demand.
    Barro’s adherents, consistent with the Ricardian Equivalence models, all predicted there would be no change in consumption and saving should have risen to “pay for the future tax burden” which was implied by the rise in public debt at the time.
    What happened? If you examine the US data you will see categorically that the personal saving rate fell between 1982-84 (from 7.5 per cent in 1981 to an average of 5.7 per cent in 1982-84).
    In other words, Ricardian Equivalence models got it exactly wrong. There was no predictive capacity irrespective of the problem with the assumptions.”

    1. Yes: that was one of the studies I had in mind when I referred above to the "actual evidence".

      It really is staggering that we need to do studies into the question as to whether households, when they come by extra money, actually spend a significant proportion of that money...:-)


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