On Monday at 6PM, Felix Nugee and Jonathon Hazell are presenting their paper on ‘helicopter money’, proposing to reform macroeconomic policy. We have discussants Ryan Avent of the Economist and their Free Exchange blog, and Martin Weale of the Monetary Policy Committee. Felix and Jonathon blog about why we need their proposal, below.
Update: The draft copy of the paper can now be found here https://wilberforcesocietyblog.files.wordpress.com/2014/01/helicopter-money.pdf
In 2008, we saw a massive financial crisis in the UK, and then a steep fall in spending across the economy. The result was a deep recession and a sluggish recovery at best. The combined action of the Bank of England and the Treasury wasn’t enough to change this. We put together a paper for TWS to try and answer two questions – what prevented the government response from being stronger; and, bearing in mind these issues, what an optimal stimulus policy would look like. The UK economy is finally growing again, and maybe further stimulus is finally no longer needed. But beyond this we want to look at how to prevent Britain’s worst economic performance in a century from happening again:
It’s not all that unlikely that we could face the same problems in the future. Therefore we need a set of institutional reforms, to put in a framework to deal with any repeat of the last five years. This is ultimately the goal of our paper, designing a proposal called ‘helicopter money’. We propose to give the Bank of England the power to make lump sum cash payments to British households during a slump, so that consumers would go out and spend the money, boosting demand and ending recessions. The Bank would figuratively drop bundles of cash from a helicopter, so that people would use them to buy goods and services.
Our proposal is not quite new. In one form or another, top commentators at the Financial Times, the Daily Telegraph and the Economist have all mooted the idea. A few leading policymakers, in particular Lord Adair Turner are enthusiastic. However, to our knowledge there is not yet a piece of work that takes the wealth of important, rapidly-evolving academic ideas relating to helicopter money, and brings them together into an accessible proposal which more people can understand. Nor, we feel, is there a work that fully sketches out the political economy of helicopter money – only in this way can we understand what the optimal institutional design is, an issue which many discussants puzzle over or pass by. If we want a genuinely forward-looking reform to deal with future crises, this last step is necessary.
Failure of the alternatives
Of course to figure out why we need reform, the first step must be to discover why the status quo isn’t working. Before 2007, central banks steered the aggregate economy through varying the short-term interest rate, thereby affecting consumption, investment, and future growth and inflation expectations. The Bank of England was a “Flexible Inflation Targeter”, a role it performed very successfully – growth was high, unemployment and inflation low, from the 1990s to the eve of the financial crisis. However, when interest rates reach their zero lower bound (ZLB), theory and common sense indicate that the power of monetary policy to stimulate is constrained. This is because central banks cannot cut interest rates below zero, stopping their ability to add stimulus through that channel. This is the famous ‘liquidity trap’ phenomenon, where interest rate policy is powerless, like ‘pushing on a string’. A good demonstration of how problematic this is comes from recent work by economists Cynthia Wu and Dora Xia. They try to calculate what the MPC would have cut rates to, had the ZLB on interest rates not been an issue. The results aren’t pretty:
The ‘shadow rate’ estimates the level of rate cuts then would be preferred by the MPC in the absence of the ZLB
Clearly, then, the ZLB is a major problem – and stops standard monetary policy from eliminating the kinds of problems we’ve seen in recent years. So where do we turn when trying to fight recessions? Fiscal policy – cutting taxes or raising government expenditure to boost spending – is the other obvious option. But it is also quite problematic. We cover several reasons in the paper, but above all the problem is politicisation. Ideologically driven decisions to alter the size of the state can be flown under the flag of fiscal policy. Take the Bush era tax cuts – passed after the collapsing of the dotcom bubble ostensibly as a recession-fighting measure and pilloried by economists, they have now mostly been made permanent and totally restructured the American tax burden. Closer to home, the obvious example is austerity. This is not the place to retread the argument, but to our minds (and that of the OBR), austerity has been a total disaster for growth. And David Cameron himself admits to using austerity to shape the British state for the long run:
“We are sticking to the task [of austerity]. But that doesn’t just mean making difficult decisions on public spending. It also means something more profound. It means building a leaner, more efficient state. We need to do more with less. Not just now, but permanently.”
Obviously when these sorts of explicitly political decisions have such a high cost, we can’t rely on politicians and fiscal policy to dig us out of any future economic mess.
What about unconventional monetary policy? The response by the Bank of England to the ZLB was to develop Quantitative Easing (QE) and forward guidance. The jury is out on how effective these have been – we try to take a look the costs and benefits in our paper. All we would say in this post is that the impact has almost certainty been small, and the costs far from trivial. But tellingly, almost no one argues that the sort unconventional monetary policy used by the Bank constitutes an ideal framework for the long run.
So clearly we need some new macroeconomic tools. Enter our proposal, helicopter money. Abstractly, a sum of money, chosen by the Bank to provide the right amount of stimulus, is dropped by helicopter to every household in the country. In reality, of course, the Bank would simply credit every household with the given amount. In very simple terms, helicopter money is like a big lump sum tax cut by the government, financed by money instead of bonds – in each case, the policy move is a cash rebate to households. Clearly, then, it would be a powerful way of boosting overall spending in the economy, and stopping recessions. The post is running long, and we don’t want to give away exactly why we like it so much as a policy. But in our paper and seminar, we defend the idea that this is a roughly optimal way to prevent recessions. Come along to find out why!