Helicopter money: Too confused to be helpful

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.

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?

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.

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.

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.

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.

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.


Debt and savings in the euro area: An update (and how net exports have been keeping the EA afloat so far)

This is an updated chart of the flow of financial savings and debt in the euro area (EA).

EA balances

For each quarter, the red bars (when positive) measure the flow of financial savings to resident households (dark red) and financial corporations (light red).

The flow of financial savings has been consistently positive throughout the period, reflecting the quarterly addition to the stock of private savings. Notice the recent decline of financial savings of financial corporations.

The green bars (when negative) measure the source of private savings internal to the EA, i.e., the net spending by resident non-financial corporations (light green) and the net spending by all 19 consolidated EA governments (dark green).

The flow of debt originating from net government spending in the EA economy (dark green) has been persistently declining since 2010, consistently with the policy of containing government deficits and debts in the EA (aka “austerity”).

The net spending by private non-financial corporations (light green) is evident in the first and in the middle part of the period considered, when business investment was generating a flow of financial savings to other sectors.

Since 2009, however, the private business sector (producing the output of the EA) has been saving, instead of spending on investment and productive capacity. This is displayed by the the light green bar turning positive, reflecting the fact that since 2009 private manufacturers have demanded savings rather than contributing to make savings possible through their net spending.

How did the EA manage to stay afloat with both households and firms trying to save their income while governments are less and less willing to support savings through their net spending?

The answer lies with the yellow bars. When positive, they indicate that foreigners acquire a fraction of the savings generated in the EA by net selling their output to the EA. This is when the EA net imports from abroad.

Since 2010, however, and increasingly so in the past three years, the yellow bar has turned negative (and bigger in size than governments’ net spending), reflecting foreigners’ contribution to the desired savings in the EA. This happens when the EA acquires net claims abroad in exchange for output produced in the EA and to be consumed by foreigners (i.e., the EA is selling abroad more than it imports).

The current combination of sectoral balances makes the EA highly vulnerable. If private corporations remain net savers in a weak economy, and if governments consider their current deficit levels just about good enough to meet their fiscal rules, any turbulence originating from a rising value of the euro in the foreign exchange markets or from a further slowdown in the U.S. would leave private savings with no support and set the conditions for another recession.

What would happen if the Fed decided to send a $1000 check to every adult American?

Here is my answer on Quora:

This would simply be equivalent to a tax cut. At the end of the day, every adult American would find $1,000 more in her pocket.

If the Fed does it directly, this would not be counted as government “debt”.

Some people call this “helicopter money”. It is a form of fiscal policy in disguise.

A tax cut would be a good idea today in the U.S.

Also, here is Joerg Bibow’s letter to the Financial Times on helicopter money.

A T-shirt model of savings, debt, and private spending

As long as the Euro area enforces balanced budget constraints at ALL levels of government, the Euro area will not be sustainable.

I have summarized here the argument behind the statement above.

What follows is a simple model that shows the logic of the argument.

1. In a monetary economy where the private sector demands financial assets as a vehicle to store wealth (aka ‘financial savings’), spending (by the private sector) can be assumed to depend on saving desires. Specifically, in any given period of reference, the change in total spending (ΔE) is a function (α) of the difference between the available stock of financial assets (FA) and the desired stock of financial savings (FAd):


The intuition is that if the value of available financial assets exceeds the desired stock, spending will increase, and vice versa.

2. In this simple model, FA(= the desired stock of financial savings) is taken as a given:


3. The nominal value of available financial assets to private residents must equal the sum of all liabilities outstanding, including those issued by the private resident sector (DP), the domestic public sector (DG), and the foreign sector (DF). DP is the outstanding value of private debt. Dis the oustanding value of public debt. DF is the net position with foreigners (when positive, it is the value of residents’ claims on foreign entities). This means:eq3

4. This model explains spending with saving desires (FAd) and the available stock of financial assets (FA) which depends on the existing liabilities issued by private, public, and foreign entities.

Thus, an increase in spending requires that:eq4

Taking the desired stock of financial savings (FAd) as given, when the private sector is unwilling to expand its debt (DP), an increase in spending can only be the outcome of an increase in net exports (DF), or an increase in government deficit (DG). While an increase in DG is financially viable as long as the ECB supports it, and it is also economically desirable as long as unemployment remains high, an increase in DF can hardly be large enough to restore nominal income growth, entails rising risk on foreign assets, makes the euro area dependent on foreign demand conditions, and is not economically desirable as net exports reduce the output per capita below what the economy can produce.

European fiscal rules violate the savings-debt constraint

In a forthcoming article (‘A T-shirt model of savings, debt, and private spending: lessons for the euro area’, European Journal of Economics and Economic Policies: Intervention, Vol. 13 No. 1, 2016, pp. 39–56), I have discussed the relevance of the savings-debt constraint in macroeconomics, and have argued that EU policies violate the savings–debt constraint. As long as this continues, the euro area will continue to live dangerously and will remain vulnerable to political disintegration.

The EU has always stressed that euro area’s national government budget must be consistent with the budget constraint set by fiscal rules, while offering no other channel for fiscal flexibility at the euro area level. This approach is inconsistent with a key constraint in macroeconomics that I call the savings-debt constraint.

In a nutshell, the savings-debt constraint says that any policy that inhibits debt also inhibits financial savings, spending, and jobs. Evidence that the EU policy framework is inconsistent with the savings-debt constraint is offered by the first priority in the list offered online by Jean-Claude Juncker, President of the European Commission: ‘Creating jobs and boosting growth – without creating new debt.’ As long as EU policymakers believe or assert this principle, the euro is in unsafe political hands.

A more detailed discussion of the savings-debt constraint can be found in my article cited above. This is a short summary of what the savings-debt constraint is about.

1. In any monetary economy, the savings–debt identity defines a fundamental financial constraint: any increase in financial assets must correspond to (or ‘be validated by’) an equivalent amount of new liabilities coming into existence. When we hold currency, or bank deposits, or government securities, or corporate debt, we hold a liability issued by the central bank, a commercial bank, the government, or a private business, respectively.

2. A number of entities of the private sector have a desire to accumulate and hold financial assets (i.e., financial savings), with an important share sitting in institutional portfolios, such as pension funds. For this desire to be fulfilled, it must be matched by an equivalent amount of private and public liabilities.

3. To adequately validate the demand for savings, however, debt must be sustainable, and this is where the difference between private and public debt matters.

4. Private debt is only as good as the borrower’s ability to make contractual payments when they come due, and this ultimately depends on the borrower’s income. So private debt may become unsustainable, or grow above the debtor’s target level of indebtedness, or the lenders’ risk perceptions may ratchet higher.

5. Public debt is always sustainable provided it is denominated in domestic units and the central bank is authorized to use its floating currency to purchase securities issued by governments in unlimited amounts, unconditionally. It only becomes unsustainable under specific institutional arrangements. Notice that since 2012 the European Central Bank (through the introduction of the Outright Monetary Transactions program) has made national government’s debt that meets EU conditions sustainable. Essentially, by placing a cap on public debt, the EU is defining politically what is a tolerable, ‘sustainable’ debt of national governments.

6. If private debt becomes unsustainable, the private sector begins deleveraging, cutting spending to pay off debt. With an increasing number of entities competing for existing financial assets, and fewer entities willing to issue new debt, the disparity between actual and desired savings grows quickly, with a potentially disruptive impact on spending. The savings-debt constraint generates a powerful contractionary effect.

7. By offering no other channel for fiscal flexibility, the EU effectively removes the most powerful remedy to the contractionary effects of deleveraging. And it effectively leaves open only one channel, namely a current account surplus.

8. This means that the EU is handing over its responsibility of providing an internal policy response to the recession. Counting on the support provided by debt issued by foreigners is no solution: a) In a serious stagnation, even a large current account surplus may not be sufficient to help support desired savings; b) The current account surplus depends on foreigners issuing debt and makes the euro area dependent on foreign policies; c) An appreciation of the euro may reduce the size of the current account surplus; d) Net exports tend to be correlated with an increasingly uneven income distribution; e) Net exports lower output per capita.

Economic prosperity depends on government policy dealing effectively with a decline in demand caused by a disparity between desired savings and sustainable indebtedness. Stressing fiscal rules at all levels of the EU means violating the savings-debt constraint. The required ammunitions to restore prosperity are well in the hands of the EU.