Krugman vs. Rowe on helicopter drops

I’m not sure I fully understand the dispute between Paul Krugman and Nick Rowe on helicopter drops and Ricardian equivalence and the Pigou effect, but I’ll take a stab at it.  The bottom line is that I agree with Krugman on this one.  First a very simple example of what I see Krugman as doing here:

The government drops cash out of a helicopter.  But they don’t want there to be any inflation.  So it’s widely understood that the money will be removed from circulation before interest rates rise above zero (after which point the cash would be inflationary.)

How will the cash be removed from circulation?  At gunpoint, by the military.  And what is an X period zero interest rate loan worth during a period where the market interest rate is zero?  Nothing.  The public is not better off.  They fearfully put the cash in a lockbox to await the day when the soldiers show up at the door.  I see the “soldiers with guns” assumption (i.e. taxes) as being the Ricardian part of the exercise.

Now even Paul Krugman would admit that the example is quite far-fetched as stated.  Why would a conservative government with an inflation-phobia be dumping cash out of a helicopter in the first place?

They would not.  But they might well do a combined fiscal/monetary expansion—indeed the Japanese did essentially this in the recent past.  They built bridges to nowhere and paid in cash.  They printed money to pay the pensions of old people.  And then every so often they removed a lot of the cash from circulation (as in 2006) just to show they were serious about not allowing inflation.  I suppose Krugman’s model would predict some expansion from the first order effects of the bridge, but not much.  And none from tax cuts or benefit increases, if you assume extreme Ricardian equivalence.

Nick says that cash is not a liability in any meaningful sense.  I tend to agree, at least in a legal sense.  But the economic effects are similar to a currency that is backed by a commodity, if the central bank has a credible policy of not allowing inflation.  So I don’t see where the fact that cash is not legally a liability comes into play when considering the Pigou effect.  It’s all about what the public expects.  And Krugman believes the Japanese public expects the central bank to act as if the currency is backed by a basket of goods and services comprising the Japanese CPI.  They can only do that by removing the money at gunpoint at the point when interest rates are about to rise.

I see the Japanese situation as a beautiful illustration of Krugman’s claim that the helicopter drop approach doesn’t really solve anything if you already are having trouble inflating because of a “liquidity trap,” and if there is R.E.

So where do I disagree?  My only objection is that I don’t think it would be hard to credibly inflate; there are all sorts of easy techniques that can be used.  I think that central banks that promise to inflate are likely to carry through with that promise, and so I don’t see the liquidity trap as a problem in the first place.  But if it is, then Krugman’s right that a “helicopter drop” doesn’t solve the problem, as the Japanese case shows.  On the other hand I’m sure that even Krugman would agree that an actual helicopter drop (no quotation marks) would work, as it would be an extremely powerful signal that the central bank is determined to inflate.  Indeed the difference between a “helicopter drop” and a helicopter drop is a perfect example of the limitations of abstract macroeconomic models.  It’s also why macroeconomists underestimated the harm done by IOR.

PS.  Here’s another way of stating it.  It looks like the Fed’s problem is that they are having a difficult time creating higher inflation.  But the Fed’s real problem is that Ben Bernanke told Brad DeLong that the Fed was strongly opposed to 3% inflation, and meant it.  And that’s why the Fed will fail to achieve 3% inflation.  (I’d prefer to say succeed in avoiding it, as that’s what they are trying to do.)


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47 Responses to “Krugman vs. Rowe on helicopter drops”

  1. Gravatar of Waffles Waffles
    12. August 2013 at 17:41

    I have a question about NGDP targets, but I don’t really have a place to ask it. How do we know what the appropriate NGDP growth target is? If, say, China and the USA were to both adopt NGDP growth targets, wouldn’t the appropriate target for China be significantly higher than that of the USA? How does an NGDP growth target respond to variations in a country’s overall development trajectory over time? And what happens if you set a growth target that is appropriate at the time, but later becomes inappropriate due to, say, long term structural changes in the economy? Or is that not possible? Japan, for example, is a country that experienced very different levels of real GDP growth over the course of the 20th century reflecting its transition through different stages of development. How would an NGDP targeting regime adapt over time in an environment like that?

  2. Gravatar of Ashok Rao Ashok Rao
    12. August 2013 at 17:51

    “Nick says that cash is not a liability in any meaningful sense. I tend to agree, at least in a legal sense. But the economic effects are similar to a currency that is backed by a commodity, if the central bank has a credible policy of not allowing inflation”

    But isn’t this the important distinction between expectations and Ricardian Equivalence? There is a plausible scenario – where everyone trusts the central bank not to be idiotic – where a premature contraction is not expected. There is no scenario in which – under Ricardian Equivalence – the same can be said of bonds. Right?

  3. Gravatar of Don Geddis Don Geddis
    12. August 2013 at 18:18

    @Waffles: I know you were asking Sumner, but let me take a shot at the answers. “How do we know what the appropriate NGDP growth target is?” The exact number doesn’t matter much. People generally suggest a number similar to the behavior of the economy during previous good times. In the Great Moderation (~1985-2005), the US annually had roughly 2% inflation, 2% productivity growth, and 1% population growth. So if you target 5% NGDP growth, you wind up with roughly the same kind of macroeconomy. (But one that is not as susceptible to shocks like 2008, as the real US was.)

    wouldn’t the appropriate target for China be significantly higher than that of the USA?” Probably. Because their historical trend is much higher productivity growth.

    How does an NGDP growth target respond to variations” Very easily. Some proportion goes to real growth, and the rest to inflation. You just need a high enough target so that inflation stays positive (without getting too high). Keep in mind that the whole point is not to stabilize inflation; the economic damage is caused by NGDP variability, not by inflation variability.

    what happens if you set a growth target that … later becomes inappropriate?” The exact number isn’t as sensitive to economic conditions as you’re imagining. You can set a 5% NGDP growth target, and be fine with 4% real growth and 1% inflation, and then maybe a few decades later with 1% real growth and 4% inflation. The target doesn’t need changing, even if the economy has (some) massive structural changes.

    How would an NGDP targeting regime adapt” The NGDP target would not change. The structural changes would change the annual mix of inflation and real growth, but the key is that NGDP growth would remain stable and predictable.

  4. Gravatar of Don Geddis Don Geddis
    12. August 2013 at 18:24

    @Waffles: “Japan, for example, is a country that experienced very different levels of real GDP growth over the course of the 20th century

    You’re right that different NGDP growth targets might be appropriate for countries in different stages of development.

    If a central bank kept NGDP growth on a stable annual rate, and did level targeting to make up for errors … I bet Sumner wouldn’t object to reexamining the growth target number once or twice a century.

    But note how different this is from the current US Fed using discretion every couple of months, to decide whether to tighten or loosen monetary policy at that moment.

  5. Gravatar of Full Employment Hawk Full Employment Hawk
    12. August 2013 at 19:28

    “The government drops cash out of a helicopter. But they don’t want there to be any inflation. So it’s widely understood that the money will be removed from circulation before interest rates rise above zero”

    But the helicopter drop is made at a time that income is depressed. Up to a point, the money that is dropped does not have to be removed in order to avoid inflation because as income grows the demand for money increases. As long as it is expected that the income growth will be large enough to absorb the dropped money as an increased demand for money so that the money does not have to be removed, the helicopter money represents an increase in net wealth and will be expansionary even under strict Ricardian equivalence.

  6. Gravatar of Waffles Waffles
    12. August 2013 at 20:19

    I guess the issue I have with that explanation is that if there’s an incentive to “fix” the NGDP growth target, that implies there are costs to having the “wrong” GDP target. Second, the reason for the target in the first place is that there are costs to NGDP growth shifts, hence the reason to want a target in the first place. Therefore, there must be some framework for balancing the tradeoff between these costs, which should inform how often NGDP growth is retargeted. But it seems like this analysis chooses a century interval arbitrarily, based on instinctual conservatism rather than an actual analysis of costs and benefits? And even then, I’m not sure how you pick your new target when you do decide to make a shift. I’m not trying to argue against the idea, I’m just saying I don’t understand how it works well enough to envision how it operates over large periods of time.

  7. Gravatar of Benjamin Cole Benjamin Cole
    12. August 2013 at 20:48

    Krugman has a point, in the “basically rich people sold bonds (to the QE program) and banked the money, and the banks didn’t lend it out” argument.

    Of course, even rich people spend some money, so one could argue we just need more QE.

    David Beckworth has suggested that QE be conducted by sending money into the bank accounts of taxpayers, printed (digitized) by the Fed,but executed by the Treasury.

    I still say there is a better way for a real helicopter drop.

    That is, the states already run lotteries. The mechanism is in place.

    So, the federal government subsidizes the lotteries, so that you have more winners than losers, unde the terms that the the winners are small. You buy three $25 tickets and win $100. The maximum payouts are small, and winners must show Social Security numbers to collect, and can win no more than $15,000 a year (this to prevent bundling).

    So, we can have real helicopter drops—and it may even be politically feasible. The winners have risked capital.

    In Beckworth’s plan, I worry the largest taxpayers will say they deserve the largest payouts, and that mean less stimulus as they will bank the money. There will be cries of “giveaway.”

    But in a lottery, no one is chosen. It is random, and you must risk capital to win. Anyone can enter.

    Really, the federally subsidized lottery is the best helicopter drop.

  8. Gravatar of Negation of Ideology Negation of Ideology
    12. August 2013 at 21:19

    Ben –

    If we want to do a helicopter drop, wouldn’t an equal citizen’s dividend be fairer? A lottery sounds pretty arbitrary to me.

    Waffles –

    “Second, the reason for the target in the first place is that there are costs to NGDP growth shifts, hence the reason to want a target in the first place”

    Yes, it’s the dramatic shifts we need to avoid. Going from 5% NGDP growth to -4.0% suddendly like 2008-2009 needs to be avoided. If we felt that 5.0% wasn’t optimal, we could change it, but we probably would want to change it too quickly. I don’t think the exact target is as important as the stabilty.

  9. Gravatar of Benjamin Cole Benjamin Cole
    12. August 2013 at 23:50

    Negation:

    Well, interesting. Every citizen, or taxpayer gets the same $2000 in cash say? But how to deliver the goods? Beckworth suggest bank accounts of taxpayers. But not everyone has a bank account. And the number involved–we are talking about hundreds of millions of accounts.

    Also, I think the public would view this as “free money=free lunch=bad morals.”

    The beauty of my lottery system is that the mechanism is already in place. If you win $100 in a state lottery, the store (7-11, often) will hand over your money.

    The Fed later directly compensates stores selling winners. Much smaller number of accounts, much more verifiable, and already in place.

    Basically, the state lotteries keep operating as before, but with rules that create monetary expansion, rather than contraction (the current set-up, btw).

    I think (oddly enough) the public is more accepting of someone risking capital getting a winning, rather than the Fed just gives someone $2000.

    No one is being “given” anything. They are playing the lottery just like they always have. It is just that they win a lot more than before.

    And the kind of person who plays the lottery for small stakes probably spends the money.

    Really, I think I have a great plan here…..

  10. Gravatar of J.V. Dubois J.V. Dubois
    13. August 2013 at 00:14

    Scott: I think you misunderstood the gist of Nick’s argument, which is quite weird because you esentially say the same many times – interest rates are bad indicator of monetary policy. This is the key part of Nick’s post:

    “In Paul’s model, since production can rise in the current period, but not in any future period (when it’s back at full-employment), what happens when there is an increase in net wealth is that the curent price level stays the same and production increases, the future price level rises for all future periods, which means the current real interest rate falls (nominal interest rate stays constant because it’s at the ZLB), and all future real interest rates stay the same.”

    So the nominal interest rate stays at zero in current period (because of ZLB), real interst rate falls which is the good thing because it brings economy back to full employment.

    S what about expected increase in price level of future periods? I am quite perplexed that you introduced condition that CB targets inflation as if it was part of Krugman’s assumptions. Because it clearly was not. Ricardian equivalence does not require CB to target inflation. Money injection does not have to be offset by money sterilization at all. It is by itself a tax by supposedly reducing real purchasing power of public. There are two possible explanations how this works:

    1) Even under Ricardian equivalence no member of public can be prepared for unexpected monetary injection in any form – like for instance lump sum transfer from people who were not under helicopter in the right time to those that were. There will never be anybody knocking on your door demanding money that you picked up, so there is no reason for anybody to lock that money in a box.

    2) Even if monetary injection is expected and everybody knows who will get it there is no need to lock money in the box. This will not help you avoid seinorage, you may do that only by buying some assets.

  11. Gravatar of ssumner ssumner
    13. August 2013 at 04:35

    Waffles, Since inflation doesn’t matter, there is no obvious reason why NGDP targets should adjust for changes in productivity growth. However we might want to adjust them for changes in population growth. Target NGDP/pop.
    In extreme cases like China it’s more complicated, and you need to think about what’s going on in the labor market.

    In other posts I’ve discussed the costs and benefits of higher or lower NGDP target paths. Short answer, high NGDP growth increases distortionary taxes on capital, low NGDP growth makes the labor market less efficient (money Illusion)

    Ashok, You are missing the combined fiscal monetary aspect of his thought experiment. Krugman starts by assuming the monetary injection is temporary. You are right that that is not required. Then the money can be removed with debt or taxes, and RE says they are the same. That’s where RE comes in. You might as well assume the cash is removed via taxes, as OMOs have the same effect.

    Full, But Krugman assumes it isn’t expected to create growth because it isn’t expected to create inflation.

    Ben, One reason I oppose gimmicky policies is that it creates the false impression that it is hard to create inflation. It isn’t.

    JV, No, I didn’t miss that at all. But Nick seems to have missed Krugman’s assumption that the central bank would not allow the future price level to rise.

    I agree that RE does not require inflation targeting, I never assumed otherwise. read my responses above.

  12. Gravatar of TravisV TravisV
    13. August 2013 at 05:38

    Prof. Sumner,

    You gotta see this. AWESOME post by Yglesias!

    “What the U.S. Virgin Islands teach us about real & nominal economic shocks (Hint: Everything)

    http://www.slate.com/blogs/moneybox/2013/08/13/virgin_islands_recession.html

  13. Gravatar of TravisV TravisV
    13. August 2013 at 06:08

    Fascinating old Friedman interview that I hadn’t read before:

    http://www.hoover.org/publications/hoover-digest/article/6459


    FRIEDMAN No, I think circumstances do make a difference. I think there is no doubt that, from 1992 to 1995, around there, there was a very sharp uptick in the velocity of M2 and that targeting money supply at that time in a rigid fashion would not have been a good thing to do.

    EPSTEIN You are saying, in effect, that the relationship between the money supply and nominal gross domestic product broke down. The old rules no longer held.
    FRIEDMAN It has always been a very loose relationship.

    EPSTEIN But it became much looser.
    FRIEDMAN Right.

    EPSTEIN To the point that you would have abandoned””
    FRIEDMAN I don’t know what I would have done. I am not going to speculate on that. I only say in retrospect that Greenspan did the right thing in abandoning primary reliance on M2 during that period. Whether I would have had the sense to do that or not, I don’t know.

    EPSTEIN Then he did the right thing at the time. But how about now?
    FRIEDMAN Now he is worrying about the problem. As you know from his various testimony, he has said that he is concerned about monetary growth and the relationship between money and income.

    ……….

    FRIEDMAN That is a very general statement that has very little content. I think the Austrian business-cycle theory has done the world a great deal of harm. If you go back to the 1930s, which is a key point, here you had the Austrians sitting in London, Hayek and Lionel Robbins, and saying you just have to let the bottom drop out of the world. You’ve just got to let it cure itself. You can’t do anything about it. You will only make it worse. You have Rothbard saying it was a great mistake not to let the whole banking system collapse. I think by encouraging that kind of do-nothing policy both in Britain and in the United States, they did harm.”

  14. Gravatar of Morgan Warstler Morgan Warstler
    13. August 2013 at 06:18

    Roger Farmer is very interesting. That is all.

  15. Gravatar of Milton Freeman Milton Freeman
    13. August 2013 at 07:37

    Scott,

    In light of Waffles question what do you think the most effective method to be when setting a NGDP target? Your recent paper touched on using decision markets (conditional based prediction markets) to help guide in setting the target. With political feasibility aside, would you prefer using Hanson styled prediction markets over Fed discretion when setting growth targets?

  16. Gravatar of Nick Rowe Nick Rowe
    13. August 2013 at 07:50

    Scott:

    Nope. PK made two mistakes on theory:

    1. He thinks that the truth of the consumption-Euler equation means the falsity of the money-wealth effect. This is wrong. It is a false dichotomy. The money-wealth effect tells you that consumption will increase. The consumption-Euler equation tells you *the timing* of that increase in consumption.

    2. He thinks that the truth of Ricardian Equivalence for bonds means the falsity of the money-wealth effect. This is wrong. Both depend on whether the nominal interest rate on an asset i is greater or less than the NGDP growth rate n. In his model, i > n for bonds, but i < n for money. So in his model, bonds are not net wealth but money is net wealth. And so helicopter bonds means an increase in future taxes must happen but helicopter money does not mean an increase in future taxes must happen. That is why he thinks any helicopter money will have to be taxed back sometime.

    Basically, PK said that he's got a theoretical model and us MM's don't, so he understands it better than us. And I said that I understand his theoretical model better than he does, on this point anyway.

  17. Gravatar of flow5 flow5
    13. August 2013 at 07:51

    QE induces dis-intermediation (where the NBs shrink in size but the size of the CB system remains unaffected).

    But the countercyclical initiative to increase bank capital destroys our “means-of-payment” money stock & further bloats excess reserves. It is another contractual money policy running counter to QE (like the FDIC’s unlimited deposit insurance program that ended in 2012).

    I.e., “an expansion of commercial bank capital accounts tends to cause an equal reduction in the banks’ deposit liabilities…releasing excess reserves” See: The American Economic Review June 1953 “A Note on the Relationships of Bank Capital to the Lending Ability of the Commercial Banks”.

  18. Gravatar of Suvy Suvy
    13. August 2013 at 08:28

    Prof. Sumner,

    I have a question for you. When you take rates down to zero, the federal government can borrow cheaper, right? So it basically allows the guys in Congress to be dumber since they can borrow more(ex. Congress right now). Suppose that Congress continues to be stupid and then it becomes time for the Fed to tighten. Do you think the Fed will tighten enough to fight an inflation if it means forcing Congress to restructure? I know it’s a far off scenario right now, but I want to get your opinion. Do you think the Fed would do the right thing in that scenario? Or do you think the Fed would cave in to the demands of an irresponsible Congress/President?

  19. Gravatar of ssumner ssumner
    13. August 2013 at 08:34

    Thanks Travis.

    Morgan, I wasn’t too impressed with that letter.

    Milton, I’m not really sure how we should decide. Perhaps a poll of leading economists. I suppose one could use futures markets, but it would be difficult.

    Nick, You may understand his theoretical model better than either of us. But here’s what I don’t get:

    1. Krugman seems to be saying money is normally net wealth, but not when interest rates are zero and the money injected is perceived to be temporary. That seems right to me. If the government gives me money, and tells me I must return it in a few years, and if I can earn zero interest on that money in the interim, then how does that money make me better off?

    2. I still say a helicopter drop solves nothing. Oh it would probably work, but for exactly the same reason an ordinary OMP works, the base increases. All the helicopter does is add fiscal stimulus to monetary, and RE tells us fiscal stimulus is useless. (and least tax/benefit stimulus, which is what a helicopter drop literally is.)

  20. Gravatar of ssumner ssumner
    13. August 2013 at 08:42

    Suvy, The whole premise of your question is wrong. A zero rate policy is a tight money policy. The question you should ask is what happens when the Fed loosens and rates rise.

    In case you didn’t notice the “dumb” people in Congress are rapidly reducing the deficit.

  21. Gravatar of TravisV TravisV
    13. August 2013 at 08:59

    Hooray Lockhart!

    *LOCKHART EXPECTS U.S. ECONOMY TO PICK UP IN 2013 SECOND HALF
    *LOCKHART SAYS ANY QE CHANGE SHOULD BE ‘CAUTIOUS FIRST STEP’
    *LOCKHART SAYS QE TAPER POSSIBLE AT ANY OF NEXT THREE MEETINGS

    http://www.zerohedge.com/news/2013-08-13/market-soars-anticipation-lockharts-sept-taper-chatter

  22. Gravatar of Nick Rowe Nick Rowe
    13. August 2013 at 09:56

    Scott @8.34:

    1. That seems right to me too. But I think PK is saying more than that.

    2. Under Ricardian Equivalence, a helicopter drop of bonds (or a vacuum cleaner reduction in bonds) does nothing. (And Ricardian Equivalence is true in PK’s model). Therefore, an OMO is equivalent to a helicopter drop of money (because helicopter money + vacuum cleaner bonds = OMO increase in M).

  23. Gravatar of Don Geddis Don Geddis
    13. August 2013 at 11:33

    @Milton Freeman: It seems to me that you’re confusing the setting of a goal, with using tools to achieve that goal.

    Decision markets, Fed discretion, etc., are about manipulating the near-term tools (OMOs, setting the Fed funds rate, deciding to loosen or tighten at this point). But those aren’t the mechanisms that you use to set the overall target (e.g. 5% NGDP growth, or the current <2% inflation target).

    Prediction markets help you take actions to achieve the goal. But they don't set the goal.

  24. Gravatar of ssumner ssumner
    13. August 2013 at 12:21

    Thanks Travis.

    Nick, So are you claiming that Krugman believes that helicopter drops have zero impact under a wider range of assumptions than the narrow conditions I outlined? Does he think it applies to permanent increases in the base?

  25. Gravatar of Morgan Warstler Morgan Warstler
    13. August 2013 at 12:29

    Have you read any of his stuff, I listened to lecture this morning. It is very tricky.

    He’s total 100% Keynesian and says the lever is Animal Spirits.

    Says High Unemployment is one possible equilibrium.

    Confidence in market tells us what equilibrium we are in.

    From there it is into the rabbit hole.

    At the end he’s clearly saying something like NGDPLT is worthwhile because it creates confidence in private sector and that’s WHY unemployment falls.

    http://www.youtube.com/watch?v=MbDWYsQHScM

  26. Gravatar of Milton Freeman Milton Freeman
    13. August 2013 at 12:34

    Don Geddis,

    Sorry if I was being unclear. I was asking Scott what he deemed the most beneficial way of setting a policy goal (NGDP target); whether that be a level or percent growth target.

    I was curious as he’s written about market based decisions in the context of monetary-policy instrument setting. Just wondering what his thoughts on market derived policy-goal (setting of the NGDP target) are.

  27. Gravatar of Morgan Warstler Morgan Warstler
    13. August 2013 at 12:35

    Watch hime debate Schiff:

    http://www.youtube.com/watch?v=gc4ggBpm9w0

    I’m telling ya you two ought to march on Krugman.

  28. Gravatar of Nick Rowe Nick Rowe
    13. August 2013 at 14:05

    Scott: “Nick, So are you claiming that Krugman believes that helicopter drops have zero impact under a wider range of assumptions than the narrow conditions I outlined? Does he think it applies to permanent increases in the base?”

    I don’t know. I don’t think his beliefs are internally consistent, so you can’t say, which is what happens when you get theory wrong.

    But re-read this bit by PK (emphasis added):

    “One way to say this “” which Waldmann sort of says “” is that even a helicopter drop of money has no effect in a world of Ricardian equivalence, since you know that the government will eventually ***have to*** tax the windfall away.”

    He doesn’t just say he is assuming the government *will in fact* tax the windfall away. He is saying the government *will have to* tax the windfall away. That would be true for a helicopter drop of bonds, under Ricardian Equivalence, but it isn’t true for a helicopter drop of money.

    Plus, he does *not* say that those eventual taxes will take the form of reducing the supply of *money*. They could take the form of vacuuming up bonds, not money.

    He’s just wrong on theory. No big deal, in the great scheme of things. Nobody is infallible.

  29. Gravatar of Nick Rowe Nick Rowe
    13. August 2013 at 14:09

    Milton: Scott advocates a level-path target for NGDP, not a growth rate target for NGDP.

  30. Gravatar of Full Employment Hawk Full Employment Hawk
    13. August 2013 at 14:10

    “LOCKHART EXPECTS U.S. ECONOMY TO PICK UP IN 2013 SECOND HALF

    *LOCKHART SAYS QE TAPER POSSIBLE AT ANY OF NEXT THREE MEETINGS”

    If the decision makers in the economy believe the last statement, it will falsify the expectations in the first statement.

  31. Gravatar of ssumner ssumner
    13. August 2013 at 14:23

    Nick, I’m inclined to think it was just sloppy wording on Krugman’s part. His entire post is focused exclusively on the zero bound situation. He doesn’t say zero bound in the sentence you quote, but it’s implied. Krugman knows very well that a monetary injection expected to last after we exit the zero bound is inflationary.

    But what I think a lot of monetarists have missed is that there is nothing special about a helicopter drop. I think QE at the zero bound is effective for all the reasons that other monetarists think it is efective, but adding fiscal stimulus (helicopter drop) doesn’t really make it more effective. That’s all I was really trying to defend. And that argument, BTW, that adding fiscal policy doesn’t make it more effective, relies on Ricardian Equivalence. So I’m inclined to think Krugman’s basically right on this issue. You also may be 100% right, as you had thought he was going a bit further than I thought.

  32. Gravatar of ssumner ssumner
    13. August 2013 at 14:27

    Morgan, You just wasted 4 minutes of my time, there is no mention of NGDPLT.

  33. Gravatar of Full Employment Hawk Full Employment Hawk
    13. August 2013 at 14:29

    “If the government gives me money, and tells me I must return it in a few years, and if I can earn zero interest on that money in the interim, then how does that money make me better off?”

    1. You can use the money to buy equities and earn a return on them. Similarly, if you are a business owner and the expected recall of the money is a significant time away, you can use it to buy some capital and earn a return on it. But models used to analyze the Pigou effect rarely include such options.

    2. If you have positive time preference and therefore get greater utility from consumption today than from consumption in the future, using the money to consume more now and consuming less in the future, when the government takes the money away, increases your utility.

  34. Gravatar of Full Employment Hawk Full Employment Hawk
    13. August 2013 at 14:50

    “Full, But Krugman assumes it isn’t expected to create growth because it isn’t expected to create inflation.”

    Since the Pigou effect does not work through the interest rate mechanism, but, rather, through the direct effect of increased wealth on increasing expenditures, it does not have to be expected to create inflation in order to reduce the expected real interest rate.

  35. Gravatar of Milton Freeman Milton Freeman
    13. August 2013 at 15:12

    Nick,

    I know

  36. Gravatar of Morgan Warstler Morgan Warstler
    13. August 2013 at 16:38

    Arghhh! watch from here:

    http://www.youtube.com/watch?v=gc4ggBpm9w0#t=12m45s

    Good lord, its an interesting argument. One that my gut say bears fruit.

    I always say economists MUST have a ying and yang, and their proponents always focuses on the ying.

    Well this guy is saying the Yang is what matters about Keynes.

  37. Gravatar of Suvy Suvy
    13. August 2013 at 17:06

    Prof. Sumner,

    Isn’t the “easiness” or “tightness” of the monetary policy dependent not so much on what interest rates are, but on the shape of the yield curve itself. If you have an inverted yield curve, monetary policy is extremely tight, right? At the ZLB, this yield curve would look flat since there’s no such thing as a inverted yield curve if short end rates are at zero, right? Now, if the yield curve started to steepen very quickly on the long end, this would mean the monetary policy would be easy, right? The way Volcker killed inflation was that he took short term rates so high that it inverted the yield curve, which required him to contract the money supply sharply.

    If, in some distant future, the yield curve begins to steepen sharply in a highly inflationary environment. Do you think the Fed would do what Volcker did in the early 80s to choke off the inflation? Do you think the Fed would do it if it meant to force a restructure on the US government? Basically, do you think the Fed would continue to monetize deficits if push came to shove?

  38. Gravatar of Morgan Warstler Morgan Warstler
    14. August 2013 at 04:50

    Why exactly target income and not wealth

    http://online.wsj.com/article/SB10001424127887324769704579010440749700038.html

  39. Gravatar of ssumner ssumner
    14. August 2013 at 05:47

    Full, But even without a monetary injection you can borrow money at zero rates to buy equities (in Krugman’s model.) You need to think in terms of models, not reality. Everyone with an ounce of sense knows that helicopter drops work in the real world, the question is whether they work in theory.

    I don’t follow your second point, nominal rates are at zero.

    Morgan, He wants a floor on the stock market?

    Suvy, You said;

    “Isn’t the “easiness” or “tightness” of the monetary policy dependent not so much on what interest rates are, but on the shape of the yield curve itself.”

    No.

    I think the Fed would target inflation over monetizing debts, if given the choice.

    Morgan, You are trying to stabilize the labor market, that’s why you choose income over wealth.

  40. Gravatar of Morgan Warstler Morgan Warstler
    14. August 2013 at 11:29

    Stabilizing the labor market is the job of Labor Policy GI CYB.

    You’ve said before also that if we are targeting NGDPLT 4.5% and we still have unemployment, then we have PROOF that’s the govt. policy fault.

    No he doesn’t want a floor on the stock market. But he does advocate the fed buy stocks, all kind shit to make sure that we have steady growth.

    He’s adamant that Keynes is mostly being misread / misrepresented – not taken en toto – which you also agree with.

    Again, I really think you might find this interesting:

    http://economistsview.typepad.com/economistsview/2011/08/animal-spirits-rational-bubbles-and-unemployment-in-an-old-keynesian-model.html

  41. Gravatar of Morgan Warstler Morgan Warstler
    14. August 2013 at 11:40

    I think this stuff would give PK fits:

    In the winter of 2009, as the world economy spirals into a deep recession, Keynesian economics has once more become fashionable. Some, but not all of this resurgence in Keynesian ideas is positive. The positive part of the Keynesian revival is the recognition that sometimes markets fail and that, when this occurs, there is a potential for government policy to improve human welfare. The negative part of the revival is the rush for policy economists throughout the world to dust off their copy of Samuelson’s introductory textbook1 and blindly apply fiscal policies that do not have a distinguished history of success. As economists, we need to get the economics right before we rush in as saviors.

    The General Theory had two important messages for economists. First, the labor market is different from most other markets and, as a consequence, there may be may different labor market equilibria and many different equilibrium unemployment rates. Second, the unemployment rate we end up with is selected by the confidence of market participants. Keynes did not try to reconcile these ideas with Walrasian economics and the attempt to do so by post-war economists was, in my view, a failure. It led to the bastard Keynesianism of the neoclassical synthesis which castrated the main message of the General Theory: Persistent high unemployment is an equilibrium phenomenon. This paper makes this idea precise, in a way that the General Theory did not, by explaining the market failure that leads to multiple steady state equilibria.

    http://www.clevelandfed.org/research/conferences/2009/10_15-16-2009/farmer_confidence_paper.pdf

  42. Gravatar of ssumner ssumner
    14. August 2013 at 16:52

    Morgan, Why have the Fed buy stocks?

  43. Gravatar of Geoff Geoff
    14. August 2013 at 20:44

    The Fed is a helicopter that drops on special interest groups.

    If was really only about aggregate demand, they would have sent everyone in the country a check for free money, and raise NGDP that way. But of course that would have generated a different Cantillon Effect, one that does not benefit the elite, which is exactly why it isn’t done.

  44. Gravatar of Bill Woolsey Bill Woolsey
    15. August 2013 at 04:46

    Scott:

    The Pigou Effect is about how a lower price level (and nominal wage level too) will increase real balances, real wealth, and real consumption.

    Krugman argues that this doesn’t work with Ricardian Equivalence. The idea is that the increase in real balances is an increase in real tax liabilities.

    This is not true if the monetary regime is one where the quantity of base money is fixed, or its growth path is fixed. Thre is never any tax liability associated with it. This is Nick’s framing, but he knows that with inflation targeting that isn’t quite true. He just assumes that the demand for base money always grows. And then gets into intermediate cases where there is always at least some demand for base money.

    Rowe also points out an error by Krugman where he assumes that current real consumption solely depends on the real interest rate. If that is true, then the Pigou effect cannot exist. But it is false.

    Now, none of this is supposed to prove that a temporary increase in the quantity of money will have much effect on aggregate demand.

    It is rather that a lower price level (and nominal wage level) will expand real expenditure (back to potential,) if the nominal quantity of money is fixed or on a constant growth path.

    This is about a permanent decease in the price and wage level.

    A temporary decrease in the price level will expand real aggregate demand, even with pure inside money, because the prices are temporarily lower. They are expected to rise again.

    In my view, Ricardian Equivalence combined with inflation targeting and a fiat currency does take away the Pigou Effect. With inflation targeting, the decrease in the price level is permanent. And the real tax burden of eventually removing the base money from circulation is greater. So the added real wealth those holding base money (or indirect claims to it) due to the decrease in the price level is exactly offset by the decrease in real wealth due to the expected higher tax burdens. (I don’t think Ricardian Equivalence is realistic. But because I am interested in pure inside money regimes, this issue is interesting. It is a weakness of growth rate targeting.)

    Of course, Pigou was writing in a time with a gold standard. A permanent increase in the demand for gold will result in a lower price (and wage) level. This increases the real wealth of those holding the gold. And there is no liability associated with that. And so, the Pigou Effect does apply to gold base money. (And, for that matter, to all of the gold jewelry.)

    It is very regime specific.

    By the way, I don’t think temporary increases in the nominal quantity of money, given an inflation target, has much effect.

    But I don’t think it has much to do with Ricardian Equivalence. It has to do with the primacy of the target.

  45. Gravatar of Morgan Warstler Morgan Warstler
    15. August 2013 at 06:01

    You’re a the MM economist, he runs UCLA Economics.

    Is this guy a friend of yours and you are toying with me?

    You yourself have argued the Fed could / should buy whatever the hell it needed to if push comes to shove.

    I suspect that IF your prediction market could actually be the transmission mechanism itself – and IT CAN (see my approach which favors SMB owners), Farmer would be ok with it too.

    Look, let’s get down to brass tacks:

    He says Keynes described unemployment as an equilibrium. This is given equilibrium is based on animal spirits of private sector.

    Is this correct? The man seems to know the GT.

    Just read this thing and tell me what you agree / disagree with:

    http://www.voxeu.org/article/does-fiscal-policy-matter-there-better-way-reduce-unemployment

  46. Gravatar of ssumner ssumner
    15. August 2013 at 10:54

    Bill, I think you are misreading Krugman, he is not saying that an expansion of the monetary base is ineffective at the zero bound. He is saying that a temporary expansion of the base is ineffective. It’s partly Krugman’s fault, as he didn’t express himself well.

    Morgan, Yes, I agree that Keynes assumed an unemployment equilibrium.

  47. Gravatar of So What Exactly Did Krugman Steal From Roger Farmer? | Last Men and OverMen So What Exactly Did Krugman Steal From Roger Farmer? | Last Men and OverMen
    18. March 2017 at 05:36

    […]     https://www.themoneyillusion.com/?p=22990     Sumner answers evasively:     “Morgan, Yes, I agree that Keynes […]

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