Monday, 15 August 2016

Prof John Kay tries to debunk helicopter money.

That’s in a recent article of his entitled “Essays on modern monetary policy….”.

Kay starts by claiming (para starting “Bookkeeping by double entry..") that double entry bookkeeping is a good system and under that system it is impossible to create a financial asset without at the same time creating a liability, ergo helicopter money, which seems to be an asset of the private sector, but not a liability of the public sector must be a nonsense.

Well there’s an obvious flaw in that argument, namely that double entry is not the only possible form of financial record keeping. Double entry did not exist in Europe till the 13th century, and wasn’t introduced to Britain till about 300 years ago. Plus even today, it is often not used by very small firms.

So do we take it that helicopter money is possible in a country which employs some system other than double entry, but not possible in a country which does? That argument is clearly absurd.


Next (para starting “But notes and coins..”), Kay cites the argument put by Randall Wray, namely that since helicopter money, or base money to give it its more normal name, can be used to pay taxes to government, such money must be a liability of government. Well there are several problems with that argument, as follows.

1. What about someone who has a stock of base money, but will never have to pay taxes, for example because they’re a pensioner on a low income? In what sense is that stock of base money a liability of the state? None that I can see.

2. There is no obligation to pay your taxes using base money. Certainly in the UK, the tax authorities (out of the kindness of their hearts) are very cooperative and flexible when it comes to paying taxes: they’ll accept jewellery, antique furniture, valuable paintings, land, you name it in settlement of tax debts.

Of course when they do that, they try to make sure that the relevant jewellery etc is worth more than the amount of tax owed. But that’s their business. The important point is that the tax debt is extinguished when the jewellery is handed over.

So…to the extent that people settle tax debts in the latter way, base money just isn't a liability of the state. Indeed, numerous countries thru history have collected taxes in the form of agricultural produce (e.g. in Roman Britain). It would be perfectly possible to have a system under which ALL TAXES were paid that way, with the state still issuing a form of money. In that case, it is very hard to see in what sense that state issued money would be a liability of the state.

Of course the latter arrangement wouldn’t make much sense: half the point of introducing state issued money thru history has been to make the collection of taxes more efficient. But the important point is that having the state issue a form of money, while taxes were paid with agricultural produce would be perfectly possible.

3. Even to the extent that base money really is a liability of the state, what of it? The IMPORTANT point here is: does helicoptering work? If so (and assuming it’s a good way of imparting stimulus) then we should go ahead with it.

Indeed, and still assuming that base money really is a liability of the state, the reason helicoptering works is that when the private sector’s paper assets rise in value, the private sector spends more. And that helps cure recessions. End of story.

The fact that some of those paper assets could be construed as a liability of the state is irrelevant because that liability does not REDUCE spending by the state.

An example of helicoptering.

Kay then runs thru a hypothetical example of helicoptering (para starting “Let us suppose now…).

He points out (correctly) that given a helicopter drop, the notes concerned will end up back in the vaults of the central bank, which in turn increases commercial banks’ reserves, which Kay claims to be a liability of the central bank or the state.

Well we’ve already dealt with that point above. Just exactly what does a central bank owe a commercial bank where the latter has $X of reserves? The only obligation is to supply the commercial bank with reserves (i.e. base money) in a slightly different form, that is, in PAPER form (dollar bills, pound notes etc) if that’s what the commercial bank and its customers want. And dollar bills are inherently worthless bits of paper. It costs central banks next to nothing to produce them. It’s a bit difficult to see in what sense there is any sort of REAL LIABILITY there.

At any rate, once the latter paper notes have been deposited at the central bank, Kay claims “And within a few days the banks would have used these deposits with the Central Bank to buy other assets – either from government or with payments which the Central Bank would have to honour.”

Well commercial banks might well TRY TO DO THAT. But they face a problem, namely that on the “all else equal” assumption, the stock of government debt is fixed, as is the stock of other financial assets.

Thus to some extent commercial banks would FAIL in the latter attempt. Indeed, in the most recent attempt by the Bank of England to do more QE, it FAILED because (much to everyone’s surprise), the normal sellers of government debt refused to sell!  But to the extent that commercial banks SUCCEEDED in buying other assets, the above mentioned base money would be paid to sellers of those other assets, who in turn would deposit that money back at the central bank (in some cases using a commercial bank as an intermediary).

Thus all the central bank would do is shift money, in its own books from the accounts of commercial banks A,B and C to the accounts of banks X,Y and Z. Bit difficult to see where the “liability” for the central bank is there!

Three points of clarification.

Next comes a section in Kay’s article entitled “Three points of clarification”, which is split into three sub-sections.

In the first two of those, Kay argues that helicopter money has little effect on the private sector’s stock of physical money ($100 bills etc) because physical money is becoming increasingly unpopular due to the fact that it’s largely criminals who use physical cash. Strangely, Kay does not mention the decline in demand for physical cash caused by the increased use of plastic cards, but never mind.

And the conclusion he draws from those two points, to quote, is that, “The implication of points one and two is that there is no reason to think that ‘helicopter money’, in any quantity, would have any material effect on either the volume of currency held outside the banking system or the level of transaction reserves held by commercial banks.”

So what’s the relevance of that? Kay doesn’t explain.

In particular, given the decline in the use of physical cash to which Kay refers, what does it matter if there is no increased usage of physical cash? The important point is that households and firms DO HAVE an increased stock of money held in bookkeeping or electronic form at their bank. And that will induce them to spend more.

Bank assets and liabilities.

The third of Kay’s above mentioned three sub-sections is far from clear, but it reads thus.

“Third, measures of money other than fiat currency – including sight deposits and other entries on bank balance sheets – are manifestly assets which are fully matched by liabilities. Each penny of customer deposit corresponds to a penny of bank obligation. The claim that banks ‘create money’, while true in a certain sense, does not repeal the law that there is a financial liability corresponding to every financial asset. Everything that has been said above about fiat money is true a fortiori of broader money.”

By “fiat currency” I assume Kay refers to central bank issued money, i.e. base money. That being the case, he is right to say that as regards the other main form of money, i.e. commercial bank created money, assets are “fully matched by liabilities”. That’s because that form of money comes into existence when a commercial bank makes a loan (as pointed out in the opening sentences of this Bank of England article – article title, “Money Creation in the Modern Economy” by M.McLeay & Co).

But it is precisely that form of money which is NOT under discussion here. That is, Kay’s article is concerned with CENTRAL bank created money, not COMMERCIAL bank created money.

Then in the second half of the above quoted paragraph, Kay tries to argue that because in the case of COMMERCIAL bank created money there’s a liability to match each pound or dollar of asset, that therefore the same applies to what he calls “broader money” (which I take to mean CENTRAL bank money as well).

Well I’m not falling for that sleight of hand. As explained at length in the above paragraphs, there are big differences between central bank and commercial bank created money.

There is no free lunch.

The final section of Kay’s article is entitled “There is no free lunch”. It starts with this claim: “Helicopter money is simply another mechanism of fiscal stimulus funded by government borrowing.”

Complete nonsense! Let’s run thru this very slowly.

Suppose the state does a helicopter drop, i.e. prints and spends $X of new money. Where’s the borrowing? The borrowing to which Kay refers is a figment of his imagination.
There is of course the argument already dealt with above that base money can at a stretch be regarded as a liability of the state in that such money can be used to pay taxes. But on the “all else equal” assumption, i.e. assuming taxes remain constant, there is no $X increase in that “tax liability” to match the $X increase in base money.

Ergo - roll of drums – that $X is an asset as viewed by the private sector without there being any $X liability that corresponds to it.


P.S. (15th August 2016).  Another paper just out which takes a more positive view of helicopter money is by William Buiter: “The Simple Analytics of Helicopter Money: Why It Works – Always.”

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