A Quick Note on “Helicopter Drops”

by Steve Randy Waldman, Interfluidity.com

So, David Beckworth has a fantastic piece arguing that, in service of an NGDP target, the Fed might sometimes coordinate with the treasury to arrange “helicopter drops”, which Beckworth defines as “a government program that gives money directly to households”.

Scott Sumner quibbles, noting that:

No country has been doing more “helicopter dropping” over the past 20 years than Japan. They’ve massively boosted both their national debt and their monetary base (which is what “helicopter drops” mean to economists.) And their NGDP is lower than 20 years ago. Not good.

Sumner is right that economists often use the phrase “helicopter drop” to refer to any sort of money-financed stimulus, that is, any government spending funded by bonds that are sold (directly or indirectly) to the central bank. That convention is unfortunate, as it obscures the clear intention of Milton Friedman’s original thought experiment, which involved helicopters and dollar bills and no government spending at all. Friedman’s musings concerned the notion of simply distributing money to humans, with no selection of worthies from unworthies or cronies from schlubs, and no government-directed flow of real resources.

Japan has been the king of “helicopter drops” under the money-financed government spending definition, but has never undertaken the sort of direct-to-household, unconditional transfers that Beckworth proposes. Beckworth is very clear that he supports heli drops precisely because:

“[f]iscal policy geared toward large government spending programs is likely to be rife with corruption, inefficient government planning, future distortionary taxes, and a ratcheting up of government intervention in the economy.”

Direct, unconditional, uniform transfers to households are nearly immune to corruption and involve no increase in the degree to which government directs the use of real economic resources. (See this excellent piece by Matt Bruenig.) Japan’s fiscal policy, on the other hand, has been notorious for cronyism, and has directed oceans of sweat and concrete into infrastructure.

Sumner and Beckworth are simply using different definitions of “helicopter drop”. Sumner’s objections are less persuasive if we do Beckworth the courtesy of accepting his definition for the purpose of evaluating his proposal. Perhaps we should insist Beckworth use a less ambiguous phrase, or perhaps we should reject the conventional but unfortunate generalization of Friedman’s evocative thought experiment. But that semantic quarrel shouldn’t be allowed to seep into a substantative controversy.

Readers should note that I am not neutral in this argument: my position is very close to Beckworth’s. Although it’s not perfect, I’ve been persuaded (largely by Sumner!) that the best macro- policy we can hope for in the medium term is targeting an NGDP level path. Like both Sumner and Beckworth, I believe there are circumstances under which conventional monetary policy (defined as central-bank sales and purchases of obligations issued or guaranteed by the US Treasury) might not be sufficient to maintain that target. Sumner argues that we augment conventional monetary policy with negative 2% IOR (effectively a tax on bank reserves), and then no fiscal supplement would ever be necessary. He suggests that negative IOR would be preferable to direct-to-household transfers. Beckworth may or may not agree with that, but he is clearly open to the possibility of using transfers rather than negative IOR to supplement conventional policy, perhaps because he thinks transfers would be better policy, or perhaps as a concession to the political and institutional barriers that would have to be overcome before the Federal Reserve would impose negative rates. My view is that all tools have their place, but direct-to-household transfers are often preferable even to conventional monetary policy (while traditional fiscal policy — outright government spending — in general is not). Beckworth and I might quarrel a bit, but our disagreements would be over the magnitudes of various costs and benefits associated with direct-to-household transfers vs interest-rate policy and other interventions usually described as “monetary”.

It is something of a cliché, I hate to belabor the point, since everybody understands that Scott Sumner and Paul Krugman are practically twins in the blogosphere. But it does become tiresome to constantly read views that are nearly indistinguishable. When Sumner writes:

Helicopter drops must be reversed in the long run, at the cost of distortionary taxation. Better to cut distortionary taxes today.

He assumes, as Krugman has, that eventually the monetary base will not be interest-bearing, or at least that there will someday be a significant opportunity cost associated with holding reserves. I think that assumption is mistaken. For the indefinite future, I believe the Federal Reserve will pay interest-on-reserves very close to or above the short-term Treasury rate, so that there will be no opportunity cost to holding bank reserves. (This is the so-called “floor system“.) If I am right, then there will never be a need to reverse transfers via “distortionary” taxation. Instead, in a better economy, the transfers will be sterilized by raising interest on reserves. That doesn’t mean the transfers are costless. In “ordinary” times, we assume (without much evidence) that the macroeconomic cost of government spending is high interest rates, which hinder growth-enhancing private investment. In an economy which has recovered after Beckworth-esque helicopter drops (and which has not reversed the transfers via taxation), an inflation- or NGDP-targeting central bank might need to impose interest rates higher than they would have imposed absent the expansion of the monetary base. Higher interest rates would exact a toll. But that toll would be no more “distortionary” than conventional interest rate policy by central banks.

So, in ordinary times, helicopter drops might not be a free lunch. But at present they almost certainly would be. Sumner may argue that our current problems result from a lack of determination or nerve at the monetary authority, and perhaps he is right. But whether due to economic law or human foible, moments where zero is an insufficiently low interest rate to achieve a desirable NGDP path without supplementary policy seem… irksome. People lose jobs, suicide rates spike, things get double-plus ungood. An intervention whose “cost” was to raise the “natural” rate of interest above zero would be welcome in practice, even though it would render uneconomic some real investments that would be profitable at very low hurdle rates. The “cost” of fiscal policy under a floor system — higher future interest rates — becomes a benefit, all things considered, if it pushes us into a more comfortable, prudence-rewarding, positive-interest-rate world. General fiscal may be undesirable for fear of corruption and misuse of real resources, but Beckworth’s heli drops avoid all that. [1]

This conversation was provoked by an excellent Cardiff Garcia article, with whose spirit I very strongly agree. It’s all very fun to draw lines and spit across them. But letting differences divide “monetarists” and “fiscalists” is letting divergent conceptions of perfect become the enemy of the good. In a market monetarist’s perfect world, the fiscal multiplier is zero, but we all agree that’s not necessarily the case here in purgatory. In a fiscalist’s perfect world, a sluggish economy is an opportunity to produce valuable public goods costlessly, but in practice our political system may be too broken or corrupt to deliver. I applaud Beckworth for offering a plan we could implement without assuming the can opener of institutions much better than those we actually have.

Notes:

[1] If the distribution of market income is sufficiently concentrated, I worry that “helicopter drops” might fail to create conditions that allow a target-disciplined central bank to raise interest rates. In narrow fiscal terms a certain sense, that would render permanent heli drops a free lunch, so yay. However, permanent heli drops that are broadly distributed but accumulate to a narrow class might lead to expanding inequality, financial instability, and social mayhem, unless countered by the “T”-word that economists find so distortionary.

Update: Reading through the comments, I think it worth distinguishing between “a fiscal cost” and the “cost of fiscal policy”. Helicopter drops are most certainly fiscal policy (thanks JKH), and they have a fiscal cost in an accounting sense. If helicopter drops are arranged as Beckworth suggests, via an Fed/Treasury coordination, then public debt explicitly rises. If they are implemented as direct transfers from the central bank, then the obligations of the central bank increase, which is a cost to the Treasury as the beneficial owner of the central bank’s cash flows. (The US Fed’s “private shareholders” lay claim to only a small, fixed dividend.) Helicopter drops are fiscal policy.

However, this piece is mostly concerned not with fiscal costs in an accounting sense, but the real cost of fiscal policy. Suppose, as I fear in the footnote, that helicopter drops put no durable pressure on inflation or NGDP, so that an inflation- or NGDP-targeting central bank is not compelled to raise interest rates in response. The helicopter drops are still fiscal policy, they still have some kind of accounting cost to the Treasury or the central bank or both. (This cost may or may not be offset in the accounts by some intangible asset, but let’s leave that aside for now.) However, if this “fiscal cost” does not affect prices or interest rates, it has no real cost to the economy in the sense of displacing or “crowding out” private sector investment.

Let’s imagine heli drops implemented qua Beckworth, via Fed/Treasury coordination, because it simplifies the accounting. Suppose the helicopters fly, everybody receives some cash, but they deposit the funds, in banks or mattresses, with no effect on actual expenditures. NGDP is then unaffected. Public debt to GDP rises. But there is no real-resource cost to the program, no displacement of investment by consumption, nothing that prevents the helicopter drops from continuing uselessly but indefinitely without harming the economy (except for fear of arbitrary debt-to-GDP thresholds). Alternatively, suppose everybody takes the money and spends it on goods, and the recipients of those expenditures are also inclined to spend, etc so that there is a large multiplier: one dollars of helicopter drops leads to many dollars of actual exchange. Real resources remain constrained, so an inflation- or NGDP-targeting central bank would be forced to raise interest rates to persuade some people to hold rather than spend the new money rather than bid-up prices or expand NGDP past the target. High interest rates mean high hurdle rates for real investment projects. Investment expenditures are effectively curtailed to make room for the additional consumption enabled by the heli drops. That displacement is the real cost of the policy. When the central bank’s target binds, fiscal spending today (heli drop or otherwise) has a cost in future production and therefore growth.

In general, this is the nature of a currency-issuing government’s budget constraint. A government can spend what it likes, there is no limit to the quantity of obligations it can issue. The cost of the issuance is paid either in inflation or high interest rates, both of which are thought to exact a toll on the quality and growth of the real economy. Fiscal policy that does not put pressure on nominal expenditures and so force an inflation/interest-rate tradeoff is still fiscal policy, still “costly” in a government accounting sense, but has no real cost in terms of diminishing resources deployed for future growth. It might still have more subtle costs in terms of distribution and financial stability, which is why I describe this “costless” scenario as something to be feared more than hoped-for in the footnote.