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Bernanke's Helicopter Is Warming Up

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... A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices. Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers. A money-financed tax cut is essentially equivalent to Milton Friedman's famous "helicopter drop" of money

      - Ben Bernanke, Deflation: Making Sure "It" Doesn't Happen Here, November 21, 2002

 

Previously we showed that despite an unprecedented surge in developed world debt over the past decade, and especially in the last five years since the onset of the Great Financial Crisis (currently at 450% debt/GDP), there has been only a nominal increase in economic growth as measured by G7 GDP as well as CPI-measured inflation. This has happened despite (or rather due to) a historic expansion in G7 central bank balance sheets, whose bankers first launched a policy of ZIRP, and subsequently replaced it with Quantitative Easing whereby trillions in reserves were injected in the banking system offset by the purchases of Treasurys, MBS and other "high quality collateral" (which has been soaked up to such an extent, the TBAC, led by Citi's Matt King, takes every opportunity to warn and complain about it in the quarterly refunding presentations).

One direct result of such intervention has been the reflation of capital markets asset bubbles across the world, and especially in the US, where the S&P500 is trading just shy of all time highs, and yet as highlighted previously, the "wealth effect" generated by this monetary pathway has led solely to the enrichment of the wealthiest decile of the population, and to a income gap in the US that is now at record wides, and worse even than during the "roaring 20s."

While in other times it would be safe to say such a monetary framework would and could continue indefinitely, or at least until this particular bubble burst once more (or the social fabric tears with other more severe consequences), recent developments and especially a key phrase from none other than Barack Obama uttered a month ago, namely that "we have to turn the page on the bubble-and-bust mentality that created this mess" is why some believe an Obama-appointed Larry Summers could pull the punchbowl earlier than expected. After all, it is becoming increasingly more accepted even in the corridors of the status quo, that QE has failed completely at anything besides stabilizing the financial system in 2009 and then ramping equities to new highs. This fits in with the recent realization that over the next year, the Fed will "taper" its open-ended QE and ultimately bring its injection of "flow" into the capital markets to a stop.

But while QE may be ending, it certainly does not mean that the Fed is halting its effort to "boost" the economy. In fact, as Deutsche Bank's Jim Reid suggests, the end of QE may well be simply a redirection, whereby the broken monetary pathway, one which uses banks as intermediaries to stimulate inflation (supposedly a failure according to the economist mainstream), i.e., "second-round effects", is bypassed entirely and replaced with Plan Z, aka "Helicopter Money" mentioned previously as an all too real monetary policy option by none other than Milton Friedman and one Ben Bernanke. This is also known as the nuclear option.

Reid's summation on why contrary to prevailing sentiment, the Fed may proceed with Helicopter Money, in order to achieve one simple target: target Nominal GDP, inflation be damned, is as follows: "Throughout the modern history of monetary economics one policy has been put forward as a monetary “super drug” (or deadly poison depending on your view). That is “helicopter money”. It has long been seen as being too powerful to control and thus beyond the scope of contemplation. However in the past decade such policy has slowly emerged from the shadow of heterodoxy."  

If dropping interest rates to zero was Unorthodox Policy #1 and QE was Unorthodox Policy #2 then it seems very possible Helicopter Money will be Unorthodox Policy #3. Whether this new level of expansionism, with all the hopes and theoretic power it is supposed to hold, can generate growth of the red-hot rather than lukewarm kind remains to be seen.

 

However in so much as it could potentially raise nominal GDP, it may become an increasingly more attractive policy option around a global economy (especially DM) economy that faces many natural and structural growth concerns in the year ahead. Forcing the nominal economy to grow into the problems of the bubble era could be the most realistic policy choice over the remainder of the decade.

So yes: while on one hand some may perceive that the Fed's tapering is an indication that the central bank may be withdrawing from active micro management of the economy, there is a distinct possibility that as a result of the administration's displeasure with the explicit effects of QE so far which have led to the Obama-noted asset bubbles, yet which have failed to boost growth and inflation to a degree deemed acceptable, and more importantly, necessary to slowly but surely inflate away the massive G7 debt overhang (the abovementioned 450% debt/GDP), what may be lying just over the horizon with the appointment of Larry Summers, over that of Janet Yellen, is the diametric opposite of what conventional wisdom believes: instead of a hawk, Summers may well be the dove to end all doves, and unleash Bernanke's helicopters.

In doing so four birds with one stone: i) it would alleviate the liquidity problem arising from the QE "reserve for collateral" as a result of an unprecedented surge in gross Treasury issuance to fund the fiscal component of the tax-cut, ii) it would put an end, at least initially, to the equity bubble as the bulk of the liquidity would no longer find its way directly into capital markets first and foremost, iii) it would represent a "money-financed tax cut" that would flow through to consumers much faster than the current broken Dealer-mediated indirect pathway, and iiii) it would boost the popularity of an administration that suddenly finds itself at a record low approval rating as money, quite literally, falls from the skies.

Of course, what it would also do, because it would mean inflation would suddenly "unanchor" itself from long-term expectations of a modest 2% rise, is send inflation rates soaring, thereby accelerating the Fed's centrally-managed systemic collapse into a monetary singularity that ends concurrently with the dollar's reserve status.... and a relatively straightforward impact on all "hard", non-fiat based assets.

Impossible?

Read on.

From DB's "A Nominal Problem", by Jim Reid

Are the Helicopters Coming?

What monetary policy has done so far

The old unorthodoxy is now orthodoxy. Central banks have sent interest rates to lows never seen in centuries of existence. Once they hit these zero-lower bounds central banks embarked on programmes of quantitative easing, expanding their balance sheets by multiples of their pre-GFC levels and via purchases of assets previously seen as beyond the spectrum of viable central bank assets (for example MBS and longterm government bonds). As we write the US and Japanese central banks continue to expand their balance sheets by enormous quantities, even if the former seems close to paring some of this back.

So on many historical measures monetary policy is already extremely and aggressively accommodative. However the world’s economies are not running at what is deemed to be a sufficiently high nominal rate. [I]f central banks objective frameworks are changed to allow them to be more accommodative in the face of continued economic disappointment, greater policy activism will be demanded of them.

Throughout the modern history of monetary economics one policy has been put forward as a monetary “super drug” (or deadly poison depending on your view). That is “helicopter money”. It has long been seen as being too powerful to control and thus beyond the scope of contemplation. However in the past decade such policy has slowly emerged from the shadow of heterodoxy.

So what is helicopter money? What are the dangers? And could it really be put into action, possibly as the policy to make central bank nominal GDP targets credible.

Helicopter Money

To explain what helicopter money is we first turn to two heavy-weights of the monetary policy world – Milton Friedman, a giant of 20th century economic and monetary thinking, and Fed Chairman Ben Bernanke, one of the most powerful and influential central bankers in world history.

Friedman proffered helicopter money as a once and for all change in the nominal quantity of money. He gave the policy its “helicopter” moniker through a now famous example where he asked what the impact would be if the government sent out helicopters which dropped a $1000 in bills from the sky. Given that the drop doesn’t change economic agent’s desires to hold cash, each agent will try and spend their excess real cash holdings. Given that no one wants to accept more cash at the current price level (each agent is trying to reduce their cash holdings), prices are bid up until a new equilibrium is found. The result is a jump in prices and nominal GDP.

In the early 2000s Ben Bernanke discussed how such a helicopter drop might be enacted in reality, specifically in reference to the zero-lower-bound deflation-ridden “Lost Decade” Japanese economy. Bernanke argued that the most effective policy for the Japanese economy was helicopter money, or what he called a “money financed tax cut” and suggested channels through which it could increase prices and real GDP. He argued in a 2002 speech (Deflation: Making Sure “It” Doesn’t Happen Here) that fiscal and monetary (central bank) authorities should co-ordinate through a broad-based tax cut accommodated by a programme of open market purchases to alleviate any tendency for interest rates to increase stimulating consumption and prices. Even if it didn’t help consumption it would boost asset prices as households rebalanced portfolios.

Also relevant to today is comments made by Bernanke in 2003 on the likely effectiveness of helicopter money in Japan when he stresses that with such a policy, “The health  of the banking sector is irrelevant to this means of transmitting the expansionary effect of monetary policy, addressing the concern of BOJ officials about ‘broken’ channels of monetary transmission.”

The message is clear – if done on an adequate scale helicopter money has the power to raise prices and nominal GDP even in the face of the severe economic headwinds and dislocations (such as a badly damaged banking system) seen post-2008. It flows naturally from Friedman’s famous statement that “inflation is always and everywhere a monetary phenomenon.” If a central bank really wants inflation-driven nominal GDP growth, it can have it. Indeed the combination of NGDPT and Helicopter Money appears to be a potent potential policy package for today’s moribund economies.

Route One Policy – Helicopter Money vs. QE

A major benefit of a policy of helicopter money over current quantitative easing policies is its greater potential directness. Quantitative Easing is reliant upon second-round effects to affect the real economy. When the Fed purchases government securities it hopes that its purchases will (a) force investors and financial institutions to rebalance their portfolios towards riskier assets (such as loans to businesses or corporate bonds) by driving treasury yields lower and (b) it will raise financial asset prices increasing wealth. It is hoped that once the Fed has lowered borrowing costs and raised financial asset prices these first round effects will feed into second round effects of greater consumer spending and business investment, only then boosting economic activity. From this two points stand out to us about QE. First its economic effects are secondary to its financial asset effects. Second it is reliant upon the financial and more specifically the banking system to act as the transmission mechanism for its economic impact. If banks, when the Fed purchases government securities off of them and credits them with reserves, simply hold onto these reserves instead of lending them out much of the impact of QE will never survive to the desired “second round” economic effects.

This is exactly what has happened. As the Fed has expanded its asset purchase programme, banks have held onto their reserves. In a much talked about paper presented by economist Robert Hall at the August 2013 Jackson Hole get together, “These countries [US and other advanced economies] have been in liquidity traps, where monetary policies that normally expand the economy by enlarging the monetary base are ineffectual. Reserves have become near-perfect substitutes for government debt, so open-market policies of funding purchases of debt with reserves have essentially no effect”. This followed from Michael Woodford’s 2012 paper, also presented at a Jackson Hole meet in 2012, that, “once the interest-rate lower bound is reached, bank reserves and other very short-term riskless claims should become essentially perfect substitutes, so that increases in reserves that come about through central-bank purchases of riskless short-term assets should have no effect.”

What these papers are saying is that at the zero-lower bound (ZLB) QE’s main effect will be to increase banks reserve holdings and so will have little actual economic effect. All of the impact of QE will be lost in the first-round financial effects. Figure 96 and Figure 97 show that this has been the case. Fed asset purchases have increased the monetary base, however most of the increase has remained stuck in excess reserves. Figure 96 shows that the rate at which the Fed’s (and other major central banks) monetary base has been turned into actual money supply through bank lending activity has collapsed (lower money multiplier) and Figure 97 shows how any increases in the money supply which have been achieved have had an incredibly dampened effect on actual nominal activity (lower money velocity).

From these charts it seems fair to argue that much of the impact of QE has indeed been lost in the financial and banking system, distorted as it is by postcrisis balance sheet rebuilding, adaptation to new regulations and rates at the zero lower bound and so never making it to the actual economy.

For helicopter money on the other hand, as we’ve already highlighted via Ben Bernanke’s own words, “the health of the banking sector is irrelevant to this means of transmitting the expansionary effect of monetary policy.” The reason is simple – helicopter money bypasses the banking system and puts money straight into consumers’ and businesses’ pockets. Where the first round effects of quantitative easing hit the financial system and then through the financial system the second round effects reach consumers and businesses, helicopter money first hits consumers/businesses and then through them the financial system.

Helicopter money achieves this direct impact by directly increasing the cash of consumers and businesses through (say) a money-financed tax cut.

Importantly this money has very high “economic power” as it is very likely it will be spent (on consumption or investment) because the central bank has purchased permanently the debt created to finance the tax cut meaning no current or future debt liability has been incurred and so higher taxes in the future shouldn’t be expected. As Bernanke stated in 2003, after a helicopter money policy, “essentially, monetary and fiscal policies together have increased the nominal wealth of the household sector, which will increase nominal spending and hence prices.” All of this is achieved without any involvement of the banking sector, which is “irrelevant”.

All the data we have points to the developed world’s financial and banking system unable and/or unwilling to put their grown central bank reserves to work in the real economy. All unconventional monetary policy to date has fallen foul of this fact. Helicopter money won’t.

Indeed to our eyes this debate gets to the heart of what central banks fundamentally can and cannot do, chiefly that they seem to have the ability to control only one economic variable at a time. During the 1970s central banks successfully supported high nominal growth at the cost of runaway inflation. In the 1980s they successfully strangled inflation at the cost of sharp falls in real economic activity. In the Great Moderation of the 1990s and early 2000s they kept a lid on inflation and inflation expectations at the expense of a series of asset bubbles. Post-2009 central banks have successfully avoided deflation and kept inflation around their targeted levels, but allowed continuing slack and unemployment in their economies. Maybe helicopter money and a combined nominal GDP target might allow for stable, slack eliminating, nominal GDP growth. Of course there is a question of what it might leave uncontrolled…

A double-edged sword?

In spite of the theoretical power of helicopter money it has and continues to face strong opposition. Indeed, fast-forward 9 years from 2002’s Professor Bernanke to 2011’s Chairman Bernanke and we see the quote, “monetary policy can be a powerful tool, but it is not a panacea for the problems currently faced by the US economy.” This reasoning can be seen as coming straight out of a 2003 Fed Policy Paper presented to the FOMC (which by then included Bernanke among its numbers) by Vincent Reinhart which concluded on money-financed tax cuts and other “extreme” policy measures that, “You can see why I put this list last. These options would change how we are viewed in financial markets, involve credit judgments of a form we are not used to, perhaps smack of desperation, and pulls us into a tighter relationship with other parts of the government.”

The message is simple – helicopter money is a step too far for central bank policy. It risks creating unintended consequences (“change how we are viewed in financial markets”) and asset market mispricing (“involve credit judgments of a form we are not used to”) as well as possibility abandoning the independence of the Fed (“a tighter relationship with other parts of the government”).

As with all economic decisions, there is a trade-off. And as with all trade-offs, priorities and preferences change. There is an argument that helicopter money could put the world’s economies back on a stronger nominal GDP growth track, boost spending, increase confidence and reduce debt burdens. But it could well do so at the risk of financial market mispricing (i.e. asset bubbles) and letting the inflation genie out of its bottle after three decades ensuring it stayed in it.

NGDPT and Helicopter Money pose Deeper Questions then Any Framework and Policy Yet Used

In a world which, to our eyes, continues to be weighed down by uneroded debt burdens; nominal GDP targeting and helicopter money could be the logical next step in today’s monetary-stimulus heavy economies. More than that, it could be successful in a way that its less radical predecessors have not been.

However the decision to go down the path of helicopter money would pose deeper questions and possibly far greater risks then any policy enacted so far. It is still our view that aggressive expansionary monetary policy post-2008 put “capitalism on hold”, saving the economy from undergoing the type of creative destruction debt liquidation and businesses failure Schumpeter pointed out as being at the very core of capitalism. In turn this has prevented the type of rejuvenation that might have been expected “post-crisis”. Maybe the scale of the GFC meant such activism was a necessary and unavoidable response as the alternative would likely have been a socially divisive depression.

With so much previously unforeseen unorthodox monetary policy conducted since 2008, it’s impossible to rule out NGDP targeting or even helicopter money. Perhaps the closest thing we have to this at the moment is in Japan. Perhaps this will be a test case for such policy that might herald its global adoption or consignment to the economic graveyard.

Monetary policy and growth

It is an open question whether pushing monetary policy aggression to a whole new stratosphere can generate sustainable real growth. The evidence from Japanese monetary policy in the 1990s and 2000s and US/UK/EA policy post-2008 certainly points to aggressive monetary policy putting capitalism on hold and embedding deep-set structural problems, and not generating growth. If dropping interest rates to zero was Unorthodox Policy #1 and QE was Unorthodox Policy #2 then it seems very possible Helicopter Money will be Unorthodox Policy #3. Whether this new level of expansionism, with all the hopes and theoretic power it is supposed to hold, can generate growth of the red-hot rather than lukewarm kind remains to be seen.

However in so much as it could potentially raise nominal GDP, it may become an increasingly more attractive policy option around a global economy (especially DM) economy that faces many natural and structural growth concerns in the year ahead. Forcing the nominal economy to grow into the problems of the bubble era could be the most realistic policy choice over the remainder of the decade.

 


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