Every so often a Keynesian commenter will ask me about “helicopter drops.” This term refers to money-financed deficit spending. People will usually say something to the effect that “everyone agrees” a helicopter drop would boost aggregate demand. In fact, not everyone does agree. More specifically Paul Krugman and I don’t agree. At least we don’t believe that helicopter drops solve any fundamental problems created by “expectations traps.” Thus the Bank of Japan ran large deficits in the 1990s and early 2000s, much of which were financed by printing money. But the Japanese public did not expect the monetary injections to be permanent, mostly because the BOJ promised to avoid inflation, and they could only do so by (implicitly) promising to pull the excess money out of circulation when the economy started to recover. Sure enough, the BOJ reduced the monetary base in Japan by 20% in 2006 (when the Japanese economy was showing signs of recovery.) A couple years later deflation returned.
Paul Krugman recently expressed the same view:
And what about money-financed deficits? This sounds at first like something you can just do, not a commitment issue. But here’s what you should ask: how do you know whether a deficit is money-financed? As long as you’re in a liquidity trap, it doesn’t matter at all what it says on the zero-interest pieces of paper you issue; they may say that they’re dollar bills or they may say that they’re T-bills, but they’re completely fungible at the margin. What matters is what happens after you emerge from the liquidity trap, and that depends on how the central bank acts: does it withdraw the monetary base it created when the economy was depressed, or does it let it stay out there and cause some inflation?
In other words, you don’t know whether a deficit was really money-financed or not until the zero bound is no longer binding, and hence the effectiveness of allegedly money-financed spending depends on expectations — again.
The only area where we disagree is the plausibility of expectations traps. I don’t think they are at all likely to occur in the real world. If a central bank promised to inflate, it would be believed. Krugman thinks expectations traps could be a problem, although he also argues that this is no reason not to try monetary stimulus:
You can see where I’m going here. Menu B is, if you like, safer for the Fed than Menu A, because it is defined in terms of actions rather than results; the Fed can point to what it is doing, rather than announce a target for long-term rates or inflation that it might fail to hit. So Menu B serves institutional objectives better. Unfortunately, it doesn’t do the job for the economy. To be fair, we don’t know that Menu A would, in fact, be sufficient. But Bernanke the Younger — BB before he was assimilated by the Fedborg — would have said that this was no reason not to try.
This is like a Greek tragedy. Most economists are clueless about what needs to be done. Bernanke probably does understand, but (as the recent Fed minutes showed) cannot persuade his colleagues. And so he watches all this unfold with what must be a horrible feeling in the pit of his stomach.