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The Agenda

NRO’s domestic-policy blog, by Reihan Salam.

A Monetary Policy for the 21st Century



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Mark Blyth, a professor of international political economy at Brown and author of Austerity: The History of a Dangerous Idea, and Eric Lonergan, a hedge fund manager and author of Money, have a provocative article in the new Foreign Affairs that calls for the use of “helicopter drops” as a tool of monetary policy. As a fan of the London-based entrepreneur and writer Ashwin Parameswaran, a longtime proponent of helicopter drops, I was delighted to see the idea given such a prominent place in an influential magazine. What impresses me most about Blyth and Lonergan’s article is that unlike many other critics of austerity, they recognize that austerity isn’t just about spending cuts; it is also about tax increases. And they make a number of arguments that at least have the potential to appeal to right-of-center skeptics of quantitative easing and calls for debt-financed infrastructure investment as a recession-fighting tool.

First, the basic mechanism: 

Rather than trying to spur private-sector spending through asset purchases or interest-rate changes, central banks, such as the Fed, should hand consumers cash directly. In practice, this policy could take the form of giving central banks the ability to hand their countries’ tax-paying households a certain amount of money. The government could distribute cash equally to all households or, even better, aim for the bottom 80 percent of households in terms of income. Targeting those who earn the least would have two primary benefits. For one thing, lower-income households are more prone to consume, so they would provide a greater boost to spending. For another, the policy would offset rising income inequality.

Such an approach would represent the first significant innovation in monetary policy since the inception of central banking, yet it would not be a radical departure from the status quo. Most citizens already trust their central banks to manipulate interest rates. And rate changes are just as redistributive as cash transfers. When interest rates go down, for example, those borrowing at adjustable rates end up benefiting, whereas those who save — and thus depend more on interest income — lose out.

My own view is that given anxieties about the politicization of central banks, which Blyth and Lonergan acknowledge, it would be preferable to distribute cash equally to all households, on the grounds that such an approach is more “neutral,” and that it can safely ignore income fluctuations and disincentives (minor though they might be) at the margin. Those who are drawn to Blyth and Lonergan’s approach on egalitarian grounds might object to such a universal transfer, but they shouldn’t, as it is an alternative to the far more inegalitarian quantitative easing approach, the main effect of which is to prop up asset prices. As Parameswaran has argued, the chief benefit of helicopter drops is that instead of propping up asset prices (and bailing out big banks and business enterprises, a subject to which we will return), they “mitigate the consequences of macroeconomic volatility upon the people.” While quantitative easing and bailouts disproportionately benefit the asset-owning rich, helicopter drops leave the household income distribution untouched, leaving the question of redistribution to lawmakers. All that said, Blyth and Lonergan’s favored approach, in which households in the top fifth are excluded from the transfer, strikes me as preferable to the status quo. 

But wouldn’t helicopter drops create inflationary pressures? Blyth and Lonergan argue that inflation fears are overblown, as helicopter drops would be a flexible tool. Any inflationary pressures they generate could be mitigated by an increase in interest rates. And they make a compelling case that instead of fretting about inflation, there are good structural reasons for central banks to worry about the prospect of deflation:

[I]n recent years, low inflation rates have proved remarkably resilient, even following round after round of quantitative easing. Three trends explain why. First, technological innovation has driven down consumer prices and globalization has kept wages from rising. Second, the recurring financial panics of the past few decades have encouraged many lower-income economies to increase savings — in the form of currency reserves — as a form of insurance. That means they have been spending far less than they could, starving their economies of investments in such areas as infrastructure and defense, which would provide employment and drive up prices. Finally, throughout the developed world, increased life expectancies have led some private citizens to focus on saving for the longer term (think Japan). As a result, middle-aged adults and the elderly have started spending less on goods and services. These structural roots of today’s low inflation will only strengthen in the coming years, as global competition intensifies, fears of financial crises persist, and populations in Europe and the United States continue to age. If anything, policymakers should be more worried about deflation, which is already troubling the eurozone.

And Blyth and Lonergan appeal to legitimate concerns about the scale of asset purchases by noting that the cash transfers they envision would be modest in comparison:

There is no need, then, for central banks to abandon their traditional focus on keeping demand high and inflation on target. Cash transfers stand a better chance of achieving those goals than do interest-rate shifts and quantitative easing, and at a much lower cost. Because they are more efficient, helicopter drops would require the banks to print much less money. By depositing the funds directly into millions of individual accounts — spurring spending immediately — central bankers wouldn’t need to print quantities of money equivalent to 20 percent of GDP.

Later in their article, Blyth and Lonergan offer an intriguing scheme for debt-financed sovereign wealth funds (SWFs) as an alternative to the global wealth taxation envisioned by Thomas Piketty. Here is where Blyth and Lonergan repeatedly play against type by, for example, warning that “taxes on capital would discourage private investment and innovation” — a banal sentiment, you’d think, yet one that is far from universal among anti-austerians. They reference France’s recent budget problems to suggest that burdening upper-middle class households in the highest income tax brackets “would yield little financial benefit,” another provocative claim in some circles. And they explicitly contrast their call for new SWFs with talismanic, and often intellectually sloppy, calls for increased government-financed infrastructure spending. After noting that “infrastructure spending takes too long to revive an ailing economy,” they insist that infrastructure investments “shouldn’t be rushed” before noting the wastefulness of some infrastructure projects, an aside that came as music to at least my ears. The particulars of these debt-financed SWFs will give some critics pause, and I’d be eager to read a critical take:

[I]nstead of trying to drag down the top, governments could boost the bottom. Central banks could issue debt and use the proceeds to invest in a global equity index, a bundle of diverse investments with a value that rises and falls with the market, which they could hold in sovereign wealth funds. The Bank of England, the European Central Bank, and the Federal Reserve already own assets in excess of 20 percent of their countries’ GDPs, so there is no reason why they could not invest those assets in global equities on behalf of their citizens. After around 15 years, the funds could distribute their equity holdings to the lowest-earning 80 percent of taxpayers. The payments could be made to tax-exempt individual savings accounts, and governments could place simple constraints on how the capital could be used.

For example, beneficiaries could be required to retain the funds as savings or to use them to finance their education, pay off debts, start a business, or invest in a home. Such restrictions would encourage the recipients to think of the transfers as investments in the future rather than as lottery winnings. The goal, moreover, would be to increase wealth at the bottom end of the income distribution over the long run, which would do much to lower inequality.

Here Blyth and Lonergan anticipate the objection that public sector purchases of financial assets risks deepening state control over private firm, an objection that was often raised when politicians contemplated invested Social Security funds in equities, by noting that central banks already have enormous asset portfolios. But then I worry that they might be too sanguine about the long-term consequences:

Best of all, the system would be self-financing. Most governments can now issue debt at a real interest rate of close to zero. If they raised capital that way or liquidated the assets they currently possess, they could enjoy a five percent real rate of return — a conservative estimate, given historical returns and current valuations. Thanks to the effect of compound interest, the profits from these funds could amount to around a 100 percent capital gain after just 15 years. Say a government issued debt equivalent to 20 percent of GDP at a real interest rate of zero and then invested the capital in an index of global equities. After 15 years, it could repay the debt generated and also transfer the excess capital to households. This is not alchemy. It’s a policy that would make the so-called equity risk premium — the excess return that investors receive in exchange for putting their capital at risk — work for everyone.

As we contemplate the aging of developed world populations, technological advances that will continue to put pressure on market wages, and the growing temptation of elected officials to embrace rigid regulations as policy “solutions,” the effort to preserve free and open economies will require new strategies

My main criticism of Blyth and Lonergan is that they ought to have emphasized the role of helicopter drops as an alternative to bank bailouts, a point that Parameswaran emphasized in “A Simple Policy Program for Macroeconomic Resilience” (in which he also usefully differentiates between helicopter drops as tools for macroeconomic stabilization and basic income guarantees, which are conceptually distinct):

In order to promote system resilience and minimise moral hazard, any system of direct transfers must be directed only at individuals and it must be a discretionary policy tool utilised only to mitigate against the risk of systemic crises. The discretionary element is crucial as tail risk protection directed at individuals has minimal moral hazard implications if it is uncertain even to the slightest degree. Transfers must not be directed to corporate entities – even uncertain tail-risk protection provided to corporates will eventually be gamed. The critical difference between individuals and corporates in this regard is the ability of stockholders and creditors to spread their bets across corporate entities and ensure that failure of any one bet has only a limited impact on the individual investors’ finances. In an individual’s case, the risk of failure is by definition concentrated and the uncertain nature of the transfer will ensure that moral hazard implications are minimal. This conception of transfers as a macro-intervention tool is very different from ideas that assume constant, regular transfers or a steady safety net such as an income guarantee, job guarantee or a social credit.

The argument for bank bailouts is that they are necessary to prevent a catastrophic deflationary collapse. Yet direct transfers to individuals can do that just as well, if not better. And so banks can be allowed to fail, clearing the ground for new banks to emerge in their place.  If Blyth and Lonergan are seeking to build a broad coalition for their proposals, and I think they are, pressing the case against bank bailouts would be a good place to start. 



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