Cassandra (who normally does Tokyo) has a diary note in which (s)he explains – in layman’s terms – why the Fed printing all that money (expanding its balance sheet) is not inflationary. The key section quotes Perry Merhling (whom shamefully I had previously not heard of). Here it is.
It seems to me that what we are seeing is simply the balance sheet consequences of the Fed's decision to take the wholesale money market onto its own balance sheet. Banks (and other entities) that used to lend to one another, are now lending and borrowing through the intermediation of the Fed. This is so not just domestically but also internationally (the huge swap line), since foreign banks used to fund dollar asset holdings in the dollar money market.In this view, inflation seems much less likely. Why not? If the original wholesale money market borrowing and lending was not inflationary, then why should its substitute be inflationary? Indeed, the real question is whether the expansion of the Fed's balance sheet is keeping pace with the contraction of money market credit more generally. If not, then the consequence may be deflationary.Posted by: Perry Mehrling at December 22, 2008 05:12 AM
This is of course correct – as far as it goes. To the extent that Fed balance sheet expansion simply offsets private balance sheet contraction there is no net increase in money and near substitutes – and so the Fed balance sheet expansion cannot be inflationary. We are – to that end – stuck in our deflationary spiral.
The situation has a name in the economic jargon - a liquidity trap. An American – not a Japanese version of a liquidity trap – but a liquidity trap nonetheless. No matter how much “money” the Fed supplies the public will want to hold it. Monetary policy is thus useless.
This is usually made out (by Krugman et al) as an excuse for massive fiscal policy. And I am not averse to that.
However there is another approach which I detailed in my lessons from shorting JGBs post. The argument: if you can’t fix the problem with increasing money supply then maybe you can fix the problem with decreasing money demand.
You need to convince people not to hold money. You need to convince them that cash is trash.
And to do that you need to convince the public that there will be inflation (the above gross leverage argument notwithstanding).
To do that the Federal Reserve has to be credibly irresponsible. It is not enough to print a couple of trillion dollars (which they have) because everyone thinks (with some justification) that they will suck back the money supply when the crisis is over.
No – you have to be more visibly reckless than that. You have to really convince people that there will be inflation.
So the suggestion in my title is literal. The Federal Reserve should hire a couple of hundred helicopters and load each one 10 million dollars in neatly bound parcels of $1000 each. Total cost $2 billion plus trivial helicopter hire.
It should fly them over 200 randomly picked American cities and throw the money out the window. It should press release this – but press coverage will be excessive. Indeed I suspect that the press coverage would give the Fed’s inflation policy greater awareness than the Coca Cola Company. (The Coca Cola Company’s annual advertising budget is $2.8 billion – so this is already cheap compared to some private sector alternatives.)
The press release should be simple. We are doing this to induce inflation. If there is no inflation as a result we will simply do it again.
Of course people will fall of roofs after searching for money that might have landed on their house. They might die. Of course people might get trampled in the crush. They might die too.
All of this increases the visible recklessness of the policy.
But the charm of this. It may actually induce mass spending of American dollars for (self-fulfilling fear of inflation)– a massive stimulus. And it will do it all for $2 billon. Obama has a stimulus package of $1.2 trillion – or about 600 times as large. This is relatively cheap.
The real case for throwing money out of helicopters is that it looks like it will work better than anything else that anyone has come up with yet.
And it will be cheap. Much cheaper than alternatives that are actually being implemented.
The secondary benefit is that most of the losses from inflation will be in the hands of the Chinese who have built huge reserves of soon-to-be-deflated US dollars.
Hey what better – lets kick start the economy and get the Chinese to pay.
I am serious. At least serious until I can get a credible explanation as to why this won't work at least as well as any of the alternatives being mooted.
John Hempton
52 comments:
You may be being a little unfair to Krugman--he is not simply pro-fiscal stimulus to the exclusion of anything else. See the very end of this essay from 1998:
http://web.mit.edu/krugman/www/japtrap.html
this is also why gold differs from fiat money. if you throw gold out of a helicopter you are bound to hurt someone.
When the money is spent. Then what?
unfortunately most people are horribly overlevered... inflation won't lead to higher salaries any time soon. Many people are actually afraid of losing their jobs. In the face of this depression to come, i wouldn't spend my helicopter present.
Hi,
It would therefore seem that Benanke is going to turn out as good as P Volker......his prognosis from years ago.....has anticipated the solution.
No, seriously, what's your suggestion?
This scenario was actually a scene from J.P. Donleavy's, "A Singular Man", where the protagonist, a Mr. George Smith, showers (from above) the population with 'federal reserve notes.
The event is fancifully dubbed, "Next Turdsday", and is commenced to the recorded sound of an adult male breaking wind.
The entire tableau is almost reminiscent of your plan. Even the fart.
a far more effective suggestion would be to give the population a year long break from paying taxes, and have the Fed fund the budget deficit.
A helicopter drop would certainly be credibly irresponsible, and would likely discourage the Chinese (who are probably starting to figure out what their role in all this is likely to be) from buying more Treasurys. A spike in real US interest rates is not likely to be inflationary.
As you have pointed out in earlier posts the US is in a difficult situation since it doesn't save enough. Anything which scares off foreign creditors, therefore increasing real interest rates, is probably not a great idea.
John Haskell is wrong here.
This works PRECISELY because it is so irresponsible. The Federal budget is over 2 trillion. Sure - not funding that will be inflationary - but only in the sense that it is currently inflationary.
What we want is something with true shock value... which will convince the population that the Fed will do ANYTHING to induce inflation so you better start spending your dollars before they turn to confetti.
Funding 1.5 trillion or 2 trillion of deficit - old - and proven not to work.
We need to be utterly irresponsible here - and John Haskell's solution simply does not cut it. Too responsible.
J
The gist of your suggestion has merit, assuming that inflation is the best way out of the excess indebtedness. What about accelerating the extinguishment or write-down or forced conversion of bad debt, and then capitalizing what is left of the financial system with a combination of public and private capital. At the very least, it seems fairer to those who took risk responsibly.
Glad to see I'm not the only nut suggesting a "real helicopter plan". I think it's much fairer and more "capitalist" than giving money to the same people who created the mess.
http://www.unknownliberal.org/blog/?p=216
@ Bizquirk
Curious that you should mention JP Donleavy, because I was reminded of his contemporary, Terry Southern and his The Magic Christian.
This time the protagonist is Guy Grand, quite the opposite of a grand guy, you understand, who has placed a gigantic vat in downtown Chicago, filled with cash ... and manure, urine, and blood. He arranges for signs to be put up in the vicinity--FREE $ HERE--and before heading out of town, turns on gas burners arranged just below the vat.
That'll make it hot for them, Grand muses out loud ... and then dashes for a plane back to NYC.
there is no real money to spend, credit has been the currency for some time
There are enough right wing nut cases in the US that will blow up Bernanke and the Fed using trucks full of fertilizer if he ever attempts something like this. Seriously, it would rip the US apart.
You only give something away when you think it is worthless and what you get is of greater worth. While seeing the riots after Bens helicopters came past I surely want buy a new car.
howsabout the fed just repays everyone's mortgages.
There's something here which I'm just not getting.
Money is just another form of value. Chairs are value, so are pots and pans.
People aren't hoarding chairs. So why hoard money?
The only thing I can think of is that there are peverse effects coming into play because things like loans, once made, are not updated with regard to inflation.
I don't understand why that is so. Why are things like debt *not* inflation linked? retail prices can instantly change when significant changes in the value of currency occurs. Why not currency denominated debt and assets?
Why not print a 1 million dollar note for every adult hand them out?
Your question is “why this won't work at least as well as any of the alternatives being mooted”.
A more refined question is “why this won't work at least as well as sending out cheques to everybody”.
The second question is relevant because the fiscal effect of a helicopter drop is the same as monetizing government debt through the Fed and mailing out cheques in the same amount. If there’s any notion that the helicopter drop has some sort of unique monetary effect, it’s an illusion. It’s a fiscal expenditure that’s monetized through the central bank, the same as the cheque. Both currency and cheques are equal cost and equivalent to some sort of flat tax rebate, refundable flat tax credit, or negative flat tax.
Given that the monetary effect isn’t unique, the re-refinement of the question becomes “why won’t the behavioural effect of a random currency drop instead of randomly mailed cheques work least as well”.
Perhaps the helicopter drop and the ensuing bloodbath upon retrieval are more irresponsible.
Drop wins.
$1 million for each person would be 250,000,000.000.000 - over two hundred trillion - and a rather big increase on the money supply which is closer 2 trillion. That would produce Zimbabwe.
All we need to do is have the credible threat of 5-10% inflation. That would kick start.
Paying off everyone's mortgage - whilst not quite of the same scale - is closer to the Zimbabwe process.
What I am trying to achieve here is something modest (a mere couple of billion) but with a huge psychological impact.
OK, say your plan works. I want to save but you now think the US Fed is irrational and will try to induce inflation. What do you do? I would shift my investment mix to a number of well-publicized and easily-available foreign security funds or precious metals. Though there is home-country bias, the marginal effects of such a shift by a substantial number of US investors in investment would mitigate the effect of your program.
Yep. It is reckless. It is irresponsible. The trust in the FED would be shattered.
There are costs to this - one of which is the loss of reserve status.
Maybe responsibility could be re-attained. But I doubt it. The idea is to do something so mind-bendingly irresponsible the liquidity trap is shattered.
I can't think of anything more irresponsible than throwing money out of helicopters - but I am willing to entertain outlandish ideas.
Ideas about giving money to everyone in some disciplined fashion - well I don't think they cut it.
I guess to really do it well Ben Bernanke should be announcing the policy whilst saying that he is spending his share on prostitutes...
Oh dear... that image doesn't bear reapeating.
J
I think you answered your own question when you said that people would get hurt. That's why Coca Cola doesn't do this trick. Similar PR tricks are done sometimes and invariably result in injuries.
Here's a better way. Have a national lottery, where two thousand people win a million dollars each. Or twenty thousand people win a hundred thousand dollars each. No entry fee.
This all reminds me of Keynes' idea of putting money in mines so people would dig it out. Just a fancy way of getting money in the hands of the middle class. I think it is a much better idea than having a stimulus plan where most of the money goes to already-rich contractors who buy materials and supplies from China and pay crappy wages to illegal aliens who do the actual hard work.
Anyone who wants to read the entire last will and testicle of George Smith, including the part where he directs his executor to shower a properly armed and equipped populace with cash, can do so at Google books search, starting at page 128.
See http://books.google.com/books?pg=PA129&lpg=PA129&dq=Next+Turdsday&sig=5LAvdYnTlYIICUirezWgnoCVBpI&ct=result&id=LjO2h8dd9BUC&ots=YonaNnvAsu#PPA128,M1
Mish's "Fiscal Insanity Virus" strikes John Hempton with a vengeance.
"Right wing nuts" are the ones who are crazy, for being opposed to this kind of nonsense. Riiiiigght ....
Perhaps the only way out for over indebited households is for Governments to write off part of their mortgage debt or take a stake in their property. In exchange for this help perhaps everyone will need to to accept the introduction of mechanisms to make house price bubbles harder in the future.
Is it any wonder gold is $900/oz with idiotic suggestions like this running around?
This crisis is one of mis-allocated resources. For decades we have punished savers via artifically low short rates and understated inflation. At the same time we have massively rewarded those who "own" assets on leverage and those who help provision credit. As a result we have an unproductive economy and a massively wider income disparity. The average person no longer believes that working hard will make you rich; rather, they believe that if you can just catch the next bubble or get employed in a "too big to fail" industry you will get rich.
The print money solution would exacerbate every one of these issues. Harm the prudent, reward the wreckless, further convince people that working hard is no way to get ahead.
Sure, if you narrowly define the crisis as one of goods deflation (why are we so focused on the price of TVs, etc?) then MAYBE printing money will help. However, that is just simply no why this crisis exists.
After we erode the confidence in the American economic system we will probably erode confidence in the currency. Just imagine if everyone began to worry just a little bit tomorrow that the currency would become worthless paper. There would be a massive rush into physical goods thus triggering a self-reinforcing hyper-inflation. This is a game of trust; not of analyzing measures of monetary aggregates.
John,
Your comment is so 20th century, plus not terrible green -- think about what the helicopter does to our CO2 footprint.
No, its best to make it illegal for people not to have a Paypal account. Then, all you need is a push of a button and, presto, you've got mail!
Take it one step further. Issue debit cards from the Paypal balances, and confiscate any balances not spent before the next credit is made. Then, make the credits on an irregular basis: sometimes a day later, sometimes a month. Also make them in irregular amounts that vary by person -- make them even "fluky", lottery-like, for some people.
Oh heck, why not just appoint an Argentine to be the next Fed Chairman? No sense letting boys keep trying to do the work of men, right?
babar wins teh Internets -- lol!!
The Economist made the same argument on October 30, 2008.
http://www.economist.com/displaystory.cfm?story_id=12510859
They could announce a new way of raising money for the government: selling monopoly board games; only these are of course filled with real money. Every $30 board game gives you 40x $1, $5 and $10 bills, 50x$20, 30x$50, 20x $100 and $500 bills.
Brings people to the mall to spend more as well!
Do not confuse the real and the nominal worlds. Yes, you can inflate prices and make holding cash unrewarding, but will that create real demand, or even more important, real supply? Inflation is ultimately a tax as is much of government spending irrespective of how it is financed. Businesses and investors are unlikely to respond to higher future taxes with greater investment and output. One is simply transferring wealth from creditors to debtors. You have to believe in an extreme form of the monetary illusion for your idea to have lasting impact.
Do not confuse the real and the nominal worlds. Yes, you can inflate prices and make holding cash unrewarding, but will that create real demand, or even more important, real supply? Inflation is ultimately a tax as is much of government spending irrespective of how it is financed. Businesses and investors are unlikely to respond to higher future taxes with greater investment and output. One is simply transferring wealth from creditors to debtors. You have to believe in an extreme form of the monetary illusion for your idea to have lasting impact.
Cute, but I would try this first: eliminate pennies, and replace *all* paper one-dollar and five-dollar notes with coins.
I strongly suspect that this would result in people getting suspicious of coming inflation; spending more money as "it's just pocket change"; and would save real tax dollars as making and circulating pennies and dollar bills is expensive.
This could be empirically tested, to a certain extent, by behavioral economists.
More in the spirit of your suggestion, we could give managers of the biggest failed financial institutions access to vast amounts of taxpayer money. That seems adequately reckless and irresponsible, and the money saved on helicopter rentals could be put toward outfitting their $50-million French-made private jets with $1400 parchment waste cans.
Regardless of its efficacy, its totally unethical. I realize quaint notions of property rights are out the window now that we have an "emergency," but this situation where we're the pawns of good-hearted economists is totally unacceptable.
The government is the enemy. And this post perfectly illustrates why. In the name of "the system," they don't give a damn about my savings and are happy to expropriate it for the sake of the common good.
Welcome to the land of the free.
It's recklessly naïve to think that this program would induce Americans to start spending and that our foreign creditors, such as the Chinese and Japanese, and domestic holders of the Federal debt would not start dumping their Treasury obligations. The net result would be a spike in interest rates that would immediately kill off any nascent economic recovery.
>> There are enough right wing nut cases in the US that will blow up Bernanke and the Fed using trucks full of fertilizer if he ever attempts something like this. Seriously, it would rip the US apart.
The right-wing is angry over giving the money to the ELITES and the INCOMPETENT.
Giving it away to everyone equally? They'll be quite happy with that.
Every worry I've read about this plan is ALREADY a worry and an EVENTUALITY under our current circumstances.
We must either default or inflate. You can do that either by giving the money to the rich or by giving the money to the poor (or just everyone equally, for simplicity). Once you decide on a bailout, THAT is your main choice. Everything else is window-dressing.
Please look at the advantages.
http://www.unknownliberal.org/blog/?p=216
Mr. Hempton,
By the way, sorry for my use of the term "nut" in my late night post last night. I'm just "relieved" to read someone else out there (i.e., you, a "real" econoblogger) is at least entertaining the idea.
I'd like to see the government run some form of "National Game Show" or "National Lottery" instead of just offering bailouts to all these companies.
For instance, they could buy 10,000 cars from GM and the other auto companies, then give away X number to the public every week. Ditto with all these excess houses and condos. Maybe they could throw in a few billion fiat dollars too.
They could make the National Game Show/Lottery only open to US citizens who make less than $150,000 a year. It should be a television show running two hours at night.
I don't know about throwing money out of the air, but if you could somehow get memebers of the entire Federal Reserve unto a jumbo jet and crash it, then you may see some improvement.
The trick is to not induce inflation, but induce inflationary expectations, with no resultant increase in inflation. The fed needs to trick the public.
This is difficult because expectations are often self fulfilling. With workers expecting price increases they will demand higher wages and fuel the cycle. This would nullify the benefits of increased spending because real wages would fall.
The money would still not be spent. If you have individuals with blown out balance sheets and no consequences (can always get a credit card or Home equity line) they will spend extra money. Once individuals with bad balance sheets realize there are actual consequences they will not spend until their balance sheets are repaired.
periods of excess credit and illiquidity are always followed by periods of contraction and liquidity.
I find it amusing that so many smart people spend hours devising ways to get around something that can't be shortcut.
John,
I like the part about the hookers. :)
However I think the problem is that like deflation, it's counter intuitive. Most ordinary people, just do not appreciate how weird economics can get at the zero bound.
I'm with you on the idea, I just think it needs to be tried. not pontificated over.
I must confess I didn't "get it" because I skimmed the article late at night while on cold medicine. (Yes, I'm using a weak variation of the Oxycontin defense.) I didn't realize you entertained the helicopter part literally. Even though you used the word "literally" in the headline, I still interpreted it as a rhetorical flourish.
My bailout plan recommendation was/is to simply give everyone an equal amount of money per capita (tax credit or check) rather than to give it to failed banks (TARP). And to keep giving until Americans' private and public debts become slightly more servicable again.
Why any bailout at all? I believe we'll eventually default (either a huge number of people individually and/or as a nation) in the absence of significant inflation. I expect most of the US will become like Detroit unless we do something. I would rather relive the 1970s than the 1930s, which I think is the choice we have to make.
---
If you don't mind, I'll post this on the original thread and the "Reaction" thread.
John,
the greatest folly in your suggestion is: people have money.
this simply is not true. 99% of household wealth is already invested in homes, cars, stocks, bonds and anything else you can name. then some more is already owed. have you heard in-debt-to-the-eyeballs? it is impossible for the people to spend money that they do not have. 2bn in new money (on top of 800bn money stock) will hardly do anything.
go chill out in Hemptown.
I agree with the above advocates of helicopter drops. The idea that people will for some strange reason hold on to infinitely large sums of money (if this is what a “liquidity trap” is) is just bunk.
Granted the tax rebate, or whatever it was that the US government handed out in recent months was not very effective. But the size of this rebate was minute compared to what people have lost on the value of their houses, not to mention their credit card debts.
I.e. make the drop big enough, and it should work.
This means there is no need to convince anyone to be irresponsible e.g. by telling people that “cash is trash”. I.e. print and distribute exactly the right amount of money (difficult to do, I agree) and ideally demand would rise to the point where full employment returned. The additional monetary base could well prove inflationary once confidence returns, but the government – central bank machine has numerous ways of clamping down on demand.
Re John Haskell’s point about scaring off foreign creditors, if most countries do more or less the same thing (e.g. a bit of Q.E., plus a bit of helicopter dropping), the problem is solved: creditors are not drawn to one country any more than any other. And I get the impression that this is roughly speaking what is happening: e.g. both the US and UK are doing some Q.E. with the UK two or three months behind the US. Plus China is expanding its money supply.
The original post is absolutely clear and correct. I cannot comprehend why the mainstream media in covering the economic crisis simply isn’t connecting the current devastation to deflation and the contracting money supply.
When debt owed to institutions is traded and sold freely, it becomes a form of money, no less than checking account deposits. Over 60 trillion dollars of credit default swaps alone existed at their peak, and now both their nominal value and trading value are evaporating.
The Fed would thus have to print and circulate trillions of dollars of new money before any inflation could be generated.
Right now, a couple of years of 10% inflation would do wonders to correct the real estate crisis. Nominal prices could simply hold flat or rise a little, while mortgage balances hold flat. Most people would be re-employed under the monetary stimulus, and able to pay their mortgages, supporting the banking sector in their crisis.
So yes, the Fed should buy more and more treasury bills, drive down the long-term interest rates, and send significant checks to everyone equally.
There’s no such thing as an unstoppable deflationary spiral, but actions of necessary vigor boggle the minds of orthodox thinkers.
I think policies should be also more innovative and learn from the financial sector. As I'm from a small country pretty hit by the crises and especially by the weakening of our currency I think the national bank should not spend that much money for defending the country. It is cheaper and more effective to beat up and black mail traders and force them to start to buy our currency. It sounds shocking but honestly, would it not be as much effective? - ignoring moral hazard.
"The Federal Reserve should hire a couple of hundred helicopters and load each one 10 million dollars in neatly bound parcels of $1000 each. Total cost $2 billion plus trivial helicopter hire."
As a shop owner, I would immediately close down. When I re-open, I would do barter only. You have the demand - but where is the supply?
But you are kidding, because you know the Fed would never do such a thing. However, this paper suggests another, and a real way, that the Fed might act - and should act.
http://www.newyorkfed.org/research/staff_reports/sr404.html
It is by Mike Woodford, a cautious man and also the best expert there is on central bank policy. And he proposes something very similar - pages 31-36. That the Fed should set a price level target and then stick to it. He proves that this is a much better policy than a forward looking inflation rate target - because with only an inflation target the past deflation in the price level is backed in and never removed.
Woodford is well known to Bernanke - they have co-authored various things - and he is entirely serious.
The plan is very similar to the one proposed for a long time by this blog:
http://blogsandwikis.bentley.edu/themoneyillusion/
Take a look.
There are 2 ways to get people to spend.
1)Wipe out their debts(writedown)
2)Wipe out their debts (inflation)
Option (1) will kill the debtowners. Rich bankers and bondholders (Hempton being in this category).
Option (1) will bring down asset values. Again, this will disproportionately hit the "asset" rich. Because the average guy will gain as much or more from debt writedown as they lose from asset drops.
Option (1) will more or less screw the same people who gained the most from the bubble.
Option (2) will do all the same things, but spread the pain much far wider and much more arbitrarily. The pigmen will still lose, but much less. Because the average guy will be sharing more of the pigmen's loss. Nominally, debts get written down, but so does their earning power over many years.
Option (2) is subtle theft from the masses. No surprise Hempton is gunning for it.
Option(2) will screw over once again the people who already got screwed over by the bubble
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