Sunday, 22 March 2020

Professional economist says helicopter drops don’t work. Dear oh dear.


The “economist” is Kevin Dowd, who actually teaches part time at the my local university, two miles from where I live. In this article, entitled “Against Helicopter Money”, he says “The success or otherwise of helicopter money operations depends, therefore, on their purpose. If their purpose is to stimulate output, they would likely only have some short‐term success.”

Well perhaps I can explain why helicopter drops actually do work, and not just in the “short term”  - something that the average intelligent fifteen year old has probably worked out.

First, peoples’ weekly spending tends to vary (gasps of amazement) with how much money they have in the bank. Just to clarify, when people win a lottery (more gasps of amazement) their weekly spending tends to rise, as indeed the empirical evidence shows. So the INITIAL effect of a heli drop is pretty obvious.

Next, a heli drop puts more central bank issued money, i.e. “base money”, into the hands of households, and to repeat, households will tend to spend that money. But it’s important to note that when households spend that money, the money does not disappear: that is, if one household spends that money it simply ends up in the pocket of another household. In fact it is impossible for the private sector to dispose of base money! The only way to make the stuff disappear is for the state (i.e. government and central bank) to raise taxes and confiscate some of that money from the private sector, and then extinguish the money.

That is unlike private bank issued money. That money disappears whenever the non-bank private sector repays debts to banks. Thus in contrast to base money, the private non-bank sector CAN CHOOSE to dispose of private bank issued money. 

To summarise so far, a heli drop results in a PERMANENT rise in the private sector’s stock of money, and that will result in a PERMANENT rise in demand, all else equal, as everyone tries desperately to dispose of what they regard as their excess stock of money. That effect is sometimes called the “hot potato” effect.

And just in case anyone wants to raise the objection that base money (physical cash apart) is held only by private banks, not households or the non-bank private sector generally, the answer to that is that a household EFFECTIVELY has ownership and control of a tranche of base money even though they have no direct access to it. To illustrate, if the state credits everyone’s bank account with £X, private banks will immediately deposit that money at the central bank, while of course crediting the accounts that everyone has at private banks. So in EFFECT, household do actually have ownership and control over a tranche of base money: it’s just that private banks act as intermediaries between households and the central bank which actually stores the money.

Having said that, there is actually a sense in which Kevin Dowd is right, which is that inflation gradually whittles away the real value of the nation’s stock of base money. Thus if a heli drop is done in year one, and no more base money is created in years two, three, four etc, then gradually the stock would decline in real terms to its pre-drop value. However, that does not seem to be what Dowd had in mind.

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