Japan: The Way Out
"Helicopter money" started out as, and long remained, nothing more than a heuristic device — and a brazenly counterfactual one at that — employed by monetary economists as a means for gaining a better theoretical understanding of the consequences of changes in the stock of money. "Suppose," the analysis went, that instead of increasing the monetary base by buying bonds in the open market, central banks dropped new supplies of currency from helicopters, thereby instantly increasing everyone's money balances. What would that do to spending and, eventually, to prices?
Lately, however, helicopter money has made its way from the inner recesses of economics textbooks to the financial pages of major newspapers and magazines, where a debate has been joined concerning its merits, not as an abstract analytical tool, but as an actual policy tool for relieving Japan, and perhaps some other economies, of their deflationary woes. Look, for some examples, here, here, and here. And see as well this recent blog post by our dear friend Jerry Jordan, written for the Atlas Foundation's Sound Money Project.
Yet for all the controversy surrounding the suggestion that Japan should actually try dropping money from helicopters (or something close to that), my own response to it consisted, not of either surprise or dismay, but of a strong sense of déja vu. For I myself wrote an op-ed proposing helicopter money for Japan in the spring of 1997, that is, almost exactly 19 years ago. I never tried to publish it, in part because I myself couldn't quite decide just how firmly my tongue was poking my cheek as I wrote it, and because I had then as I do still an abiding dislike of "clevernomics," which is the sort of stuff economists write to show just how clever they they can be, rather than because they are seriously trying to help the world along. Worried that I was myself lapsing into that sort of thing, I stuffed the essay into a file cabinet, where it has been buried ever since.
All the recent writing on the subject has, however, emboldened me to resurrect my dusty old essay and to publish it hereunder its original title. I don't pretend that it adds anything to what recent commentators have had to say on the topic. Consider it a bagatelle, if you like: you'll get no argument from me.
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They said it was like "pushing on a string." It was the middle of the 1930s, and the U.S. and much of the rest of the world were in the midst of an unparalleled deflationary crisis. Normally the way out of such a crisis would have been for central banks, including the Federal Reserve, to inject more reserves into their banking systems by buying securities in the open market and paying for them with central bank credits. That policy would do provided banks put the new reserves to work by lending them out, thereby stimulating an increase in demand for investment or consumer goods. But in the U.S. interest rates on loans and securities had fallen so low, the Fed claimed, that adding to bank reserves no longer helped: the new reserves “pushed” into commercial banks would simply pile-up there, instead of causing the banks to extend more private credit. Hence, “pushing on a string.” Economists, following John Maynard Keynes, referred to the conundrum in question as a "liquidity trap."
Whether the U.S. economy was really stuck in a liquidity trap during the Great Depression remains controversial. For several decades afterwards, however, the issue was moot, as inflation replaced deflation throughout the world's economies. Only recently it has again taken on practical significance, with economists and Japanese monetary authorities pointing to Japan today as another instance of an economy faced with an insatiable demand for liquidity. Japanese consumer and producer spending has been shrinking for months, causing wholesale prices to decline and inventories to accumulate. The overnight call loan rate has hit zero, and short-term lending rates are at historically low levels. Although the Bank of Japan has been pumping reserves into the banking system, bank lending remains sluggish. The banks have more reserves than ever, but seem to lack any incentive for putting them to use.
Japan's dilemma has at least one Federal Reserve official worried that the same thing might happen again (or, as some would have it, for the first time) in the United States. Marvin Goodfriend, a Vice-President of the Richmond Fed, proposes in a recent paper that, in the event that we should fall into a liquidity trap, Congress should grant the Fed authority to tax bank reserves, causing them, in effect, to earn a negative return. Since even a zero interest rate on loans beats a negative return on reserves, the banks would have reason to lend even at zero rates. For good measure, Goodfriend recommends that public currency holdings be taxed as well, so as to discourage hoarding by the public.
Goodfriend's proposed taxes are meant to be emergency measures only, which would be removed in good times. Still, one shudders to think what might happen should the government decide to take advantage of the new measures' capacity for enhancing its share of the profits from the Fed's money monopoly.
Fortunately, central banks don't need new taxing powers to free their economies from liquidity traps. All they need to do is to supply new money directly to the public, instead of trying to get it to them indirectly by first adding it to bank reserves. Individual citizens, unlike commercial banks and other financial firms, do not have to decide either to hoard money or to lend it at some trivial rate of interest. They have a third, more tempting, option, namely, that of spending unwanted money balances directly on goods and services. Central banks, on the other hand, don't have to issue new money in exchange for securities or collateral owned by private financial firms: they can simply give it away to citizens, avoiding the middlemen.
In Japan today, the strategy could work as follows: the Bank of Japan could announce its intention of giving away, say Y5000 (roughly $50 U.S.) to every Japanese citizen each month until private spending picks up, bringing Japan's deflationary crisis to an end. The giveaway could be engineered in a manner similar to that employed during the 1990 German monetary unification, when the Bundesbank supplied East German citizens with limited quantities of Deutsche marks in exchange for Ostmarks. The policy would assure Japan's citizen's that, one way or another, their money earnings were about to permanently increase, giving them ample reason to consume more. Given Japan's population, the promised rate of new money creation would increase Japan's monetary base by around ten percent after a year — a substantial rate, but not large compared to recent annual figures. Moreover, the mere announcement of the policy might suffice to revive spending quickly, allowing the policy to expire in relatively short order.
Critics of the monetary giveaway proposed here might fear that it would ultimately trigger inflation. The same sort of thinking led the Federal Reserve, in the mid 1930s, to actually raise bank reserve requirements out of fear that banks might change their minds any minute and begin lending their hoards of cash. The Fed's fears turned out to be exaggerated, to put it charitably: its decision actually helped to keep the U.S. depression going for several more years. Of course, if spending had actually revived on its own, surpassing the level necessary to revive the economy, the Fed could have dealt with the "problem" easily enough, by reabsorbing excess money by means of bond sales.
Keynes had a good quip about Fed officials who worried, in 1936, about inflation: they “professed to fear that for which they dared not hope.” Let's hope that the Bank of Japan won't harbor such misplaced fears, and that it doesn't otherwise allow the liquidity-trap bogey to keep it from doing all it can to revive Japan's economy.
[Cross-posted from Alt-M.org]
