Two related confusions about helicopter money

Confusions about helicopter money is something of a generic title (although Martin Sandbu is thankfully not confused). Because a discussion of helicopter money (HM) cannot normally be found in the textbooks (which have only just caught up with central bank independence), the scope for misunderstanding is huge. Here I want to talk about two related confusions. The first is about whether HM would lead to an increase or decrease in nominal interest rates, as discussed in a recent interchange between Tony Yates and Paul Krugman. The second is whether HM is in competition with the use of fiscal policy to get us out of recessions.  

On HM money and nominal interest rates, there is of course the standard and very basic point that in a market you cannot control both quantity and price, still less move them in opposing directions. So if we want to think about a market for money, you cannot raise the supply of money and raise its price - the nominal interest rate - at the same time.

But this observation ignores what else is going on when you have HM. HM is a large fiscal expansion. Please none of this ‘but if Ricardian Equivalence (RE) holds’: we are talking real world policy here not doing thought experiments, and we have all the evidence we need that RE does not hold (for reasons that are not difficult to understand). Let's also not fall into the trap of doing IS-LM. We are in a world of inflation targeting, and anything that raises demand (as a fiscal expansion will) will tend to raise inflation, and so the monetary authorities will tend to raise nominal interest rates. Any temptation to say ‘yes but in the short run’ becomes dubious because of expectations effects. 

So it is really quite simple. Either the nominal interest rate lower bound constraint continues to bite, which means helicopter money will leave nominal interest rates unchanged (but the economy better off), or there is no constraint (or that constraint is removed), in which case rates will rise (sooner) with HM.

The second confusion is that helicopter money in some way precludes undertaking countercyclical fiscal policy. It does not. Right now, for example, governments could and should announce large increases in public sector investment (where I am using investment in the economist’s sense to include investment in human capital, rather than in a national accounts sense). This would negate any immediate need for HM. Monetary policy adapts to fiscal policy.

When people ask me which we should have, helicopters or fiscal expansion, I'm tempted to say I would love to have the choice! If I did have that choice, right now I would take additional public investment over a helicopter drop, because the micro case for investment is in many cases (and countries) very strong, interest rates are low and investment improves the supply as well as the demand side. In any future severe recession where the interest rate lower bound was likely to be hit [1] I would also advise bringing forward public investment. However I do not see this as a competition (countercyclical fiscal action vs HM) for two reasons.

First, one lesson of the Great Recession is that we cannot rely on governments to do the right thing with fiscal actions, so HM is an insurance policy in that sense. If governments do spend more or tax less as we approach the ZLB, that insurance policy may not be needed. [2] Second, even if governments do the right thing, either lack of good projects [3] or information delays may mean they do not do enough, and so the very quick action that central banks could take with HM could be a useful complement. To put it another way, helicopter money is best seen as an alternative to QE rather than as an alternative to fiscal action.

[1] Because of implementation lags, a fiscal response to an impending deep recession should not wait until nominal interest rates actually hit their lower bound. If that fiscal response involves investment, used in an economists rather than national accounts sense, then there is no great loss if the deep recession does not happen, because it is wise to invest when real interest rates and wages are relatively low.

[2] In the proposals put forward in Portes and Wren-Lewis (2015), the central bank would directly tell the government the probability of the lower bound being hit.

[3] I think the argument that the amount of public investment cannot be adjusted to match macro conditions is often overstated. We are not talking HS2 here (the proposal to build a high speed train line between London and Birmingham and beyond), but improving flood defences, repairing roads and schools etc.