It’s all about the Benjamins

A few years back I did a post entitled:

Helicopter drops would work, but “helicopter drops” might well fail

A “helicopter drop” is economist lingo for a combined fiscal/monetary stimulus.  Trillion dollar deficits combined with trillion dollar QE.  We’ve done that (as has Japan), and although it “worked” in the very limited sense of slightly boosting NGDP, it did not “work” in the sense of sharply boosting inflation, as the naive quantity theory would predict.  The reason is obvious; the injections are not expected to be permanent.

A helicopter drop without the scare quotes refers to an actual drop of green pieces of paper out of black helicopters.  Lots of them—trillions of dollars worth.  This would work in a Krugmanesque “promise to be irresponsible” sense; the public would correctly see them as a desperate move to debase the currency.

That’s also the distinction between increasing reserves and currency.  At the margin the distinction is not very important, and several people pointed out in comments on yesterday’s post that most models treat cash and reserves as being equivalent.  But that misses the symbolic value of wheelbarrows full of currency. A zero IOR would be seen as business as usual.  But a significantly negative IOR would be seen (correctly) as a desperate move to debase the currency.  A “WTF?” moment in Fed history.   As trillions of ERs got converted into pictures of Ben Franklin, the public would see visual symbols of Germany/Zimbabwe.  Thus it would “work” in the sense of producing the sort of inflation predicted by the QTM.  Especially if there were no Fed promises to prevent inflation.  Of course hyperinflation is a bad policy, which is why the Fed won’t do it.  Thus we’ll probably never know whether I was right or not.

PS.  I cheated a bit at the beginning, as a “helicopter drop” should be zero interest reserves.  So the US did not (quite) do that.  But Japan did, so my point stands.


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33 Responses to “It’s all about the Benjamins”

  1. Gravatar of JP Koning JP Koning
    20. November 2013 at 13:10

    “As trillions of ERs got converted into pictures of Ben Franklin, the public would see visual symbols of Germany/Zimbabwe.”

    Ok, I see where you’re coming from. Seems to me to be a behavioral point that you’re making. Rational people should see no difference between cash and reserves on the margin, but the symbolics means they do. If people do act that way, however, then aren’t markets somewhat inefficient?

  2. Gravatar of ssumner ssumner
    20. November 2013 at 13:18

    JP, Not at all. People would be perfectly rational in assuming the Fed wanted to inflate. Why would the Fed do something so zany if they didn’t want to inflate?

  3. Gravatar of ssumner ssumner
    20. November 2013 at 13:19

    BTW, it was not a pure behavioral argument—there was the 50 basis point drop in rates, which markets would have loved.

    In any case, monetary policy is 99% behavioral (short run) all the time, even when rates are positive

  4. Gravatar of Cory Cory
    20. November 2013 at 13:38

    Professor Sumner,

    Can there every truly be a permanent injection of money so long as the government taxes and therefore debits reserve accounts when it does so, deleting X amount of base money?

    So, let’s say the FED stops paying interest on reserves, does lots of OMO’s to increase the amount of base money but the government still charges an income tax which is effectuated by debiting the different the checking accounts of the different taxpayers accepting and using these newly injected dollars throughout the economy and ultimately debiting their bank’s reserve account when all is said in done.

    Given that taxes drain bank reserves, and that taxes are unlikely to go away any time soon, is there even, really such a thing as a truly permanent increase in the monetary base?

    Maybe I’m way off but it seems to me like Congress would ultimately have to be complicit in order for the central bank to be able to credibly create the impression of a permanent monetary injection.

  5. Gravatar of Philippe Philippe
    20. November 2013 at 13:42

    “As trillions of ERs got converted into pictures of Ben Franklin, the public would see visual symbols of Germany/Zimbabwe”

    No they wouldn’t, because most people don’t own millions or billions or trillions of dollars, so they won’t be pushing around wheelbarrows full of cash. If most people were to withdraw their bank deposits as cash they could probably fit the notes in a bag or suitcase, or even just a wallet.

  6. Gravatar of Philippe Philippe
    20. November 2013 at 13:43

    depending on the denomination of the notes.

  7. Gravatar of Gregor Bush Gregor Bush
    20. November 2013 at 13:56

    Sweden implemented negative IOR in July 2009 on the back of support from Svensson and the rate stayed negative until September of 2010. It appeared to weaken the SEK boosted stock prices. But there was no hyperinflationary panic. Although the base expanded by more than 300% from 2008 to 2010, currency in circulation actually fell – there were no wheelbarrows full of SEK. I think you did several posts on this.

    Why would things be materially different in the US? I suppose what you’re saying is that Sweden’s -0.25% rate wasn’t “materially” negative. But if the Fed is looking to neutralize the impact of taper, and it seems like they are, why not move to -0.25% on excess reserves and signal a willingness to go even more negative if NGDP disappoints? If your intution in the above post is correct, the IOR rate should be a powerful tool for influencing E(NGDP) when teh base is large.

  8. Gravatar of Philippe Philippe
    20. November 2013 at 13:59

    you would only see people pushing around wheelbarrows of cash if the currency had already hyperinflated and become worthless.

    No one would bother to rob you if your wheelbarrow of money was only worth a loaf of bread.

  9. Gravatar of jknarr jknarr
    20. November 2013 at 14:32

    What about the marginal utility of the two forms of base money? Reserves are only good for clearing banks, while currency ultimately clears the actual economy. Surely, this is a significant difference.

    As long as reserves are not tradable in the real economy, it is unclear why a surplus of reserves affect nominal prices. At zero rates, there is very little supply- and demand- for borrowing, so that vector fails.

    Currency is also a more permanent form of base money than reserves. Reserves could be handed an attractive interest rate to stay put with IOR, while currency could turn into a quickly-circulating bad penny:

    Bottom line, circulating currency need never have nexus with a bank ever again, let alone get re-absorbed into reserves. It’s effectively permanent in a way that reserves are not, if you want to take that argument.

    Otherwise, the question could hinge on problems of marginal demand (creation) for currency. In this sense, reserves are simply currency that has not been demanded yet. When demand for currency accelerates, this is the inflationary impulse — and currency formation the only the symptom.

    If that is the case, we do also need to consider the drugs-and-terror limits on currency withdrawals, from nearly 1/2 median annual income to 1/5 currently. There are very practical currency formation bottlenecks.

    Scott, finally, currency is cheaper than you think. Fees and the ZLB make demand deposits more utility-destroying than currency. Interest paid is the incentive to place your money with a (leveraged, counterparty-prone, won’t-give-you-your-money-on-demand) bank.

    Cash is the competition, which is why they need to kill currency formation vectors if they are to keep tight money and install negative short rates.

  10. Gravatar of Steve Steve
    20. November 2013 at 14:57

    “A “WTF?” moment in Fed history.”

    WTF = What The Fiat???

  11. Gravatar of ssumner ssumner
    20. November 2013 at 20:01

    Cory, No, the Treasury has no impact on the base.

    Philippe, They would have lots of cash if there was negative IOR.

    Gregor, I’m told the Swedish system had a loophole, so that they didn’t have to pay it.

    Steve, Yes, that’s what I meant. 🙂

  12. Gravatar of Saturos Saturos
    20. November 2013 at 21:09

    Pretty sure you previously did a post called, “It’s all about the Benjamins” as well…

  13. Gravatar of Saturos Saturos
    20. November 2013 at 21:10

    Random Scott Sumner post title generator, anyone?

  14. Gravatar of Saturos Saturos
    21. November 2013 at 01:45

    This Rajiv Sethi post (and Nick Rowe in the comments) is highly relevant: http://rajivsethi.blogspot.co.uk/2013/11/the-payments-system-and-monetary.html

  15. Gravatar of Florian Florian
    21. November 2013 at 04:22

    The hoarding of Benjamin’s argument is certainly correct in theory, but I’m not sure about it’s practical relevance.

    As an example for Europe, as of September 2013 there were roughly €900 Billion in currency in circulation, with €4.5 trillion of overnight deposits at the ECB. It would seem physically impossible to make up the difference overnight, so quite a bit of that money might really start moving into other places than just cash, simply because the creation of cash might face what one might call “supply constraints”.

  16. Gravatar of ssumner ssumner
    21. November 2013 at 07:06

    Saturos, I’m not a fan of that sort of monetary/fiscal hybrid. It’s not needed, and it raises all sorts of political problems. K.I.S.S.

    Florian, Of course it would never happen, but if the government did intend to do this they’d first have to print up all the money. Small denominations would be better, as they are more costly to store.

  17. Gravatar of Ralph Musgrave Ralph Musgrave
    21. November 2013 at 07:48

    Jknarr,

    Contrary to your suggestions, reserves CAN BE traded in the real economy. E.g. if get a check for $X from the Fed in exchange for my Treasuries (say as part of the QE operation), I then deposit the check at my commercial bank, and the latter gets the Fed to credit its account in the books of the Fed.

    In effect I then have $X of reserves which I can use or dispose of any way I like (though obviously I can only move my money / reserves employing my commercial bank as an agent).

  18. Gravatar of Philippe Philippe
    21. November 2013 at 07:49

    Scott,

    “No, the Treasury has no impact on the base”

    Taxes do drain reserves from the banking system, but the Fed and Treasury normally (i.e. pre-financial crisis) take offsetting measures to ensure there is no impact on the Fed Funds rate:

    “Flows of funds between the TGA and private depository
    institutions were important prior to the crisis because the TGA is maintained on the books of the Federal Reserve; increases in TGA balances stemming from Treasury net receipts drained reserves from the banking system and, in the absence of offsetting actions, put upward pressure on the federal funds rate. Conversely, decreases in TGA balances resulting from Treasury net expenditures added reserves to the banking system and, absent offsetting actions, put downward pressure on the funds rate. This dynamic created an important interface between Treasury and Federal Reserve operations. The sections that follow describe first how Treasury and Federal Reserve officials cooperated to manage the interface before the crisis, and then how the interface has changed since the onset of the crisis and the expansion of the Fed’s balance sheet.”

    http://www.newyorkfed.org/research/current_issues/ci18-3.pdf

    Since QE, the Treasury has stopped depositing excess TGA balances into Tax & Loan accounts within the banking system, and as a result there have been large swings in the size of the TGA balance, which does have an effect on the size of total bank reserve balances (though this has no effect on the Fed Funds rate largely due to IOR – interest paid on reserves):

    “The structure of interest rates after December 2008 prompted the Treasury to make a second change in its cash management practices since it now had an economic incentive to keep its cash balances in the Treasury General Account rather than in Treasury Tax and Loan Note accounts… The volatile swings in TGA balances associated with the decision to keep essentially all of the Treasury’s operating cash balances in the TGA did not cause a problem for the Fed because the swings did not result in any comparable volatility in the federal funds rate. In particular, expanding TGA balances did not reduce the quantity of reserves available to the banking system to a level at all close to what banks wanted or were required to hold and thus did not put upward pressure on the funds rate.”

    http://www.newyorkfed.org/research/current_issues/ci18-3.pdf

    Also, during the crisis but prior to IOR the Treasury collaborated with the Fed to manage the total quantity of excess bank reserves:

    “The first Treasury cash management change following the onset of the crisis involved the sale of Treasury bills by the U.S. Treasury and the deposit of the proceeds with the Federal Reserve””actions that drained reserves from the banking system and reduced the volume of excess reserves. On Wednesday, September 17, the Treasury announced the initiation of “a temporary Supplementary Financing Program [SFP] at the request of the Federal Reserve.” The announcement stated that the program would “consist of a series of Treasury bills, apart from Treasury’s current borrowing program, which will provide cash for use in the Federal Reserve [lending and liquidity] initiatives.” The Treasury announced three SFP sales that day for a total of $100 billion. The proceeds from the sales were deposited in a newly created SFP account at the Fed, thereby draining approximately $100 billion of reserves from the banking system. By Friday, October 3, two weeks and two days after the start of the Supplementary Financing Program, the Treasury had issued eleven SFP bills (one of which was to refi nance a maturing SFP bill) and the program had drained about $355 billion of reserve balances. SFP bills peaked at $560 billion between October 2 and November 12.”

    http://www.newyorkfed.org/research/current_issues/ci18-3.pdf

  19. Gravatar of Ralph Musgrave Ralph Musgrave
    21. November 2013 at 07:55

    Scott,

    I don’t agree that helicopter drops have not had a big effect because “the injections are not expected to be permanent.” Reason is that at least 95% of households and firms have no idea what “injections” are, and have no idea what increases in the monetary base have occurred as a result of helicopter drops.

    All they see, I suggest, is increased orders coming from government (to the extent that that’s how the extra money is fed into the economy) and extra household income (to the extent that the extra money comes in the form of tax cuts or benefit increases). And in normal times, that would have an effect.

    I suggest the reason helicopter drops have had less effect than when helicoptering started is the same as the reason that ultra low interest rates have had less effect than expected: an aversion to risk as a result of the large numbers of people who got their fingers burned during the crunch. I.e. the private sector is just sitting on its helicopter money.

    As to Japan, there is the very high propensity of Japanese households to save.

  20. Gravatar of ssumner ssumner
    21. November 2013 at 08:21

    Philippe, I stand corrected. But isn’t it still true that these changes are not important, as the Fed will simply counter any moves in the base that it doesn’t wish to occur?

    Ralph, If IOR was abolished and the Fed announced the increases in the base were permanent, you’d see a huge effect. I would personally borrow every dollar I could and speculate in hard assets (something I’d never otherwise do. Lots of other people would do the same after the financial press explained to them that hyperinflation was coming.

  21. Gravatar of Mark A. Sadowski Mark A. Sadowski
    21. November 2013 at 09:53

    Florian,
    “As an example for Europe, as of September 2013 there were roughly €900 Billion in currency in circulation, with €4.5 trillion of overnight deposits at the ECB.”

    Huh?!?

    Yes, there is nearly €4.5 trillion in bank deposits in the Euro Area. But there is only €52 billion at the ECB’s Deposit Facility:

    http://sdw.ecb.europa.eu/quickview.do?node=2018802&SERIES_KEY=123.ILM.M.U2.C.L022.U2.EUR

    Scott is talking about reserve balances, not bank deposits.

  22. Gravatar of Mark A. Sadowski Mark A. Sadowski
    21. November 2013 at 09:58

    http://www.ft.com/intl/cms/s/0/aaa492ca-520d-11e3-adfa-00144feabdc0.html#axzz2lHudMhgk

    November 20, 2013

    Fed eyes options to offset end of QE3
    By Robin Harding

    “The US Federal Reserve is considering cutting the interest it pays to banks on their reserves in a dramatic move to offset an eventual slowing of its $85bn-a-month asset purchases.

    The central bank offered no new hints on when it could “taper”, reiterating that it was still expecting such a move “in coming months”, but the discussion of alternatives at the rate-setting Federal Open Market Committee suggests it is keen to slow its buying.

    Cutting the extra interest on reserves banks hold with the Fed would drive down already low overnight interest rates even further, probably to just a few basis points, hurting bank profits but adding extra stimulus to the economy.

    According to the minutes of its October meeting, most officials on the FOMC thought such a move “could be worth considering at some stage” as a way to signal continued easy monetary policy after they start to slow asset purchases from $85bn a month…”

  23. Gravatar of jknarr jknarr
    21. November 2013 at 10:16

    Ralph, demand deposits are not bank reserves. Not even close.

  24. Gravatar of Ralph Musgrave Ralph Musgrave
    21. November 2013 at 11:27

    Scott,

    It just isn’t logical for the Fed to announce that “the increases in the base is permanent” to quote you. A more rational policy is for the Fed to leave the expanded base in place as long as it’s needed. That could be for another two months or twenty years.

    Nor does it make sense for the private sector to expect that “the injections are not . . . permanent”, to quote your post. Again, the rational policy is for the Fed to leave the injections in place as long as they’re needed. Even expand them, if that’s needed.

    And that all means that the base will only be reduced when the private sector goes into irrational exuberance mode, i.e. when demand and inflation become excessive. But in that circumstance, the base reduction (i.e. tax increases) do not reduce GDP: they simply control inflation.

    It therefor does not make sense for private sector entities to try to cling to their newly acquired stock of base (not that they actually CAN DISPOSE OF IT in the aggregate till the Fed / government decides with withdraw base from the private sector).

    Assuming my above points are correct, they assume a level of understanding of economics by private sector entities which is TOTALLY UNREALISTIC, of course. I.e. it would be far more realistic to base discussions here on EMPIRICAL EVIDENCE as to how households and firms ACTUALLY REACT to budget deficits, base increases, etc.

  25. Gravatar of Ralph Musgrave Ralph Musgrave
    21. November 2013 at 11:46

    jknarr,

    You have totally and completely failed to deal with the points I made.

  26. Gravatar of Philippe Philippe
    21. November 2013 at 12:30

    Ralph,

    I think what he means is if you have a bank deposit, you don’t own bank reserves, you own a bank liability.

  27. Gravatar of Philippe Philippe
    21. November 2013 at 12:34

    you could withdraw your deposit as cash, thereby removing some reserves from your bank, but the deposit itself is not the same thing as bank reserves. It’s a liability of the bank.

  28. Gravatar of lxdr1f7 lxdr1f7
    21. November 2013 at 17:44

    ssumner

    ” We’ve done that (as has Japan), and although it “worked” in the very limited sense of slightly boosting NGDP, it did not “work” in the sense of sharply boosting inflation, as the naive quantity theory would predict. The reason is obvious; the injections are not expected to be permanent.”

    Heli drops or similar policies can be permanent and adjusted in terms of frequency and size of operations in order to affect inflation and ngdp like any monetary policy. The CB could be modified so that it doesnt need to cooperate with the government to conduct heli drops. Heli drops would bypass stagnant credit markets and increase money to agents with higher MPC and lower liquidity preference than existing CB counterparties or asset holders. Therefore the effect on ngdp from MP through ‘”heli drops” would be greater than the current MP approaches.

  29. Gravatar of Ralph Musgrave Ralph Musgrave
    22. November 2013 at 00:30

    Philippe,

    I realise that a deposit at a commercial bank is not exactly the same thing as a commercial bank’s reserves. But my point (to repeat) is that if I get a check from the Fed as a result of selling the Fed some Treasuries, I can shift that money to anyone I want. That money is therefor (contrary to JKnarr’s suggestions) being “traded in the real economy”.

    In fact UK citizens can have even more direct access to central bank money and trade it via a government run savings bank called National Savings and Investments (and about 20 million people do). NS&I invests only in government debt. It doesn’t issue check books or plastic cards, nor does it make loans, but a depositor with a credit balance can make a payment to anyone in about 24 hours over the phone. And that’s near enough the same as individual citizens having an account at the central bank.

  30. Gravatar of Philippe Philippe
    22. November 2013 at 02:56

    ok, but when you deposit cash or a government cheque in a bank, the cash or base money no longer belongs to you. You have lent your base money to the bank, and now own a bank liability instead.

  31. Gravatar of ssumner ssumner
    22. November 2013 at 06:09

    Mark, Interesting.

    Ralph, You said;

    “It just isn’t logical for the Fed to announce that “the increases in the base is permanent” to quote you. A more rational policy is for the Fed to leave the expanded base in place as long as it’s needed.”

    I agree. But some of the increase needs to be expected to be permanent if the policy is going to be credible.

    You said;

    “EMPIRICAL EVIDENCE as to how households and firms ACTUALLY REACT to budget deficits, base increases,”

    The empirical evidence suggests that how the public reacts depends on whether they expected the base increase to be permanent.

    lxdr, A better approach would be to do permanent non-helicopter drops of new base money. Helicopter drops are very costly, and not needed at all.

    We all agree current policy is bad, the question is which alternative is better.

  32. Gravatar of Michael Michael
    22. November 2013 at 07:08

    Scott – you said:

    “But some of the increase needs to be expected to be permanent if the policy is going to be credible.”

    This is perhaps what Glasner was getting at in the post I linked to the other day (though he talked about inflation expectations).

    We haven’t had a “regime shift” yet and it seems unlikely that we will get one from the Yellen Fed. So is it fair to say that much of the base increase since 2009 is expected to be *temporary*? Or, if permanent, that it will be “sterilized” somehow (e.g. by increases in IOR)?

    Would you argue that we could have had a faster recovery with less QE, if the QE that was done was seen as permanent?

  33. Gravatar of lxdr1f7 lxdr1f7
    22. November 2013 at 07:17

    “lxdr, A better approach would be to do permanent non-helicopter drops of new base money. Helicopter drops are very costly, and not needed at all.”

    Why are heli drops costly?

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