In a recent post I said that the Fed doesn’t have a helicopter in the current environment. That is, political and realistic constraints mean that the Fed won’t implement anything close to what we think of as a helicopter drop. My thinking is more complex than this, but here’s the short story:
- When the Central Bank “monetizes” debt it is acting in an ex-post manner that responds to fiscal policy. That is, it can only monetize what the Treasury has issued or decides will be excess of tax receipts. Therefore, the entity controlling the flow of “monetization” is the Treasury as it determines the quantity of net financial asset issuance.
- When the Central Bank “monetizes” debt is it swapping assets by taking one asset from the private sector and swapping it with another. In the case of QE it’s bonds for deposits. It’s like switching a savings account for a checking account. The private sector doesn’t have more net financial assets and actually has lower income so I’ve asserted that QE could be marginally deflationary in the long-run. Intuitive and empirical evidence seem to verify this.
Martin Sandbu and Eric Lonergan have written some very good comments expanding on these ideas. For instance, they note that the Central Bank can pay more in interest than it remits to its Treasury. This would result in more income to the private sector than QE takes out (as is currently implemented). This would very much resemble fiscal policy and could properly be called a helicopter drop. However, in the case of the USA the Fed would have to pay about 4.5% on excess reserves in order to offset the 2.3% rate it earns on its balance sheet at present. In other words, it would have to meaningfully invert the yield curve in order to achieve a helicopter drop. This would also result in a $100B+ subsidy to the banking system. I don’t find this remotely plausible given the economic and political environment.
The other option is a change in laws. The Fed, for instance, could be given the ability to purchase bags of dirt from people in exchange for cash notes. This would be an explicit helicopter drop as it would directly contribute net financial assets to the private sector. This would be explicit fiscal policy. And it will never happen. So, the bottom line is, monetary policy is the wrong tool to get us out of this weak economic environment because it simply doesn’t do what so many economic theorists think it can actually achieve….
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