The Money Multiplier Lives: Thoughts on the INET Debate about Helicopter Money between Richard Koo and Adair Turner at the Piecing Together a Paradigm-conference in Budapest (Oct 19-22 2016), arranged by Institute for New Economic Thinking in Budapest.
The introductory event of the INET Young Scholars’ Initiative conference was a debate between Richard Koo and Adair Turner about helicopter money, although I am not sure that “debate” is the right word: as Turner put it, he agrees with “99 percent” of his opponent’s view. Both believe that the advanced world is suffering from a lack of aggregate demand, which should be corrected through expansive fiscal policy (although Koo favors public spending over tax cuts while Turner seems agnostic on the issue). Their disagreement concerns whether fiscal expansion should be financed by selling bonds or printing “helicopter money.” Turner favors helicopter money because he believes that a growing public debt could induce Ricardian equivalence, i.e. the belief among economic actors that the government debt would at some point in the future have to be repaid with higher taxes, prompting people to set aside money for that purpose instead of spending it. Koo favors bond-financed fiscal policy because he believes that helicopter money could eventually cause runaway inflation. Helicopter drops, he believes, would remain as “excessive reserves” on banks’ balance sheets, which at a later date could be multiplied and lent out to borrowers in excessive amounts. Somewhat surprisingly, his opponent agrees with this view, but argues that the risks could be contained. With the right tools, governments would be able to “mop up” excessive reserves once the money helicopters have returned to their platforms.
In other words, Koo and Turner adhere to the fractional reserve view of banking, the idea that banks lend by multiplying reserves created by the central bank. In his IMF paper on helicopter money, Turner writes:
If [banks] are subject to reserve requirements which limit their deposits (or other categories of liability) as a multiple of reserves held at the central bank, then their capacity to do so in aggregate is constrained by the quantity of reserves (monetary base) which the central bank chooses to create.
Critics would argue that banks are not constrained in this way. In practice, central banks cannot refuse to supply banks with reserves, since they correspond to loans that have already been made. As Alan Holmes, former vice president of the Federal Reserve Bank of New York, wrote in 1969 “in the real world, banks extend credit, creating deposits in the process, and look for the reserves later.” Refusing to supply reserves would merely raise their price, ratcheting up interest rates until the central bank would have to choose between sticking with its policy and watch the credit system collapse, or give in and supply the needed reserves. That is what happened, I believe, when Paul Volcker tried to restrict reserves during the monetarist experiment 1979 – 1982.
I must say that I was a little surprised to learn that Koo and Turner adhere to the fractional reserve view of banking, since I thought that it had gone out of fashion. In 2014, the Bank of England issued a document stating that:
“…the relationship between reserves and loans typically operates in the reverse way to that described in some economics textbooks. Banks first decide how much to lend depending on the profitable lending opportunities available to them…It is these lending decisions that determine how many bank deposits are created by the banking system. The amount of bank deposits in turn influences how much central bank money banks want to hold in reserve (to meet withdrawals by the public, make payments to other banks, or meet regulatory liquidity requirements), which is then, in normal times, supplied on demand by the Bank of England.”
If banks wanted to cause hyperinflation, they could do so without “excess reserves.” Moreover, as Paul Sheard, chief economist at Standard & Poor’s, argues, reserves cannot cause inflation because they do not leave the banking system. In a 2013 paper titled Repeat After Me: Banks Cannot And Do Not ”Lend Out” Reserves, he states that “the reserves that leave one bank’s balance sheet just pop up on another, remaining on the central bank’s balance sheet all the while.” If his view is correct, Koo’s (and Turner’s) fears of helicopter money would be unfounded.
Koo began the debate by stating that we are currently “not living in a textbook world.” But he seems to believe that we did live in that world once, and that we will do so again. This view, while possibly having short term tactical advantages, seems to undermine the argument for the fiscally expansive policies that both speakers favor. It amounts to the “make me chaste but not yet”-argument that I believe is quite confusing to the public.
Ultimately, the issue of helicopter money versus debt finance is probably a moot point. Paul Krugman and others (e.g. Kelton, Kocherlakota) have argued that they are essentially the same thing as long as the central bank engages in quantitative easing (purchasing financial assets from the private sector). The only difference is that in one case no bonds are issued while in the other “banks briefly hold some government bonds, before selling them back to the government via the central bank. Why should this matter for, well, anything?” The real issue, which both Koo and Turner have raised repeatedly, is political and ideological opposition. As Turner acknowledged with, apt wording, in another session, expansive fiscal policy in the advanced world is still verboten.
When it comes to ecological sustainability, resistance to public spending makes the prospects for meeting the Paris Agreement through increased public investment in low carbon industry and infrastructure look bleak. Things may change after the next crisis, but if central banks continue to be the only game in town, policies to meet the Paris Agreement might need to be pursued through their asset purchasing programs. This is an issue worth considering and exploring in a different post.
Written by: Max Jerneck, researcher at Misum