Helicopter Money and the Reflux Problem

Although I try not to seem overly self-confident or self-satisfied, I do give myself a bit of credit for being willing to admit my mistakes, of which I’ve made my share. So I am going to come straight out and admit it up front: I have not been reading Nick Rowe’s blog lately. Realizing my mistake, I recently looked up his posts for the past few months. Reading one of Nick’s posts is always an educational experience, teaching us how to think about an economic problem in the way that a good – I mean a really good — economist ought to think about the problem. I don’t always agree with Nick, but in trying to figure out whether I agree — and if not, why not — I always find that I have gained some fresh understanding of, or a deeper insight into, the problem than I had before. So in this post, I want to discuss a post that Nick wrote for his blog a couple of months ago on “helicopter money” and the law of reflux. Nick and I have argued about the law of reflux several times (see, e.g., here, here and here, and for those who just can’t get enough here is J. P. Koning’s take on Rowe v. Glasner) and I suspect that we still don’t see eye to eye on whether or under what circumstances the law of reflux has any validity. The key point that I have emphasized is that there is a difference in the way that commercial banks create money and the way that a central bank or a monetary authority creates money. In other words, I think that I hold a position somewhere in between Nick’s skepticism about the law of reflux and Mike Sproul’s unqualified affirmation of the law of reflux. So the truth is that I don’t totally disagree with what Nick writes about helicopter money. But I think it will help me and possibly people who read this post if I can explain where and why I take issue with what Nick has to say on the subject of helicopter money.

Nick begins his discussion with an extreme example in which people have a fixed and unchanging demand for money – one always needs to bear in mind that when economists speak about a demand for money they mean a demand to hold money in their wallets or their bank accounts. People will accept money in excess of their demand to hold money, but if the amount of money that they have in their wallets or in their bank accounts is more than desired, they don’t necessarily take immediate steps to get rid of their excess cash, though they will be more tolerant of excess cash in their bank accounts than in their wallets. So if central bank helicopters start bombarding the population with piles of new cash, those targeted will pick up the cash and put the cash in their wallets or deposit it into their bank accounts, but they won’t just keep the new cash in their wallets or their banks accounts permanently, because they will generally have better options for the superfluous cash than just leaving it in their wallets or their bank accounts. But what else can they do with their excess cash?

Well the usual story is that they spend the cash. But what do they spend it on? And the usual answer is that they buy stuff with the excess cash, causing a little consumption boom that either drives up prices of goods and services, or possibly, if wages and prices are “sticky,” causes total output to increase (at least temporarily unless the story starts from an initial condition of unemployed resources). And that’s what Nick seems to be suggesting in this passage.

If the central bank prints more currency, and drops it out of a helicopter, will the people refuse to pick it up, and leave the newly-printed notes lying on the sidewalk?

No. That’s silly. They will pick it up, and spend it. Each individual knows he can get rid of any excess money, even though it is impossible for individuals in the aggregate to get rid of excess money. What is true for each individual is false for the whole. It’s a fallacy of composition to assume otherwise.

But this version of the story is problematic for the same reason that early estimates of the multiplier in Keynesian models were vastly overstated. A one-time helicopter drop of money will be treated by most people as a windfall, not as a permanent increase in their income, so that it will not cause people to increase their spending on stuff except insofar as they expect their permanent income to have increased. So the main response of most people to the helicopter drop will be to make some adjustments in the composition of their balance sheets. People may use the cash to buy other income generating assets (including consumer durables), but they will hardly change their direct expenditures on present consumption.

So what else could people do with excess cash besides buying consumer durables? Well, they could buy real or financial assets (e.g., houses and paintings or bonds) driving up the value of those assets, but it is not clear why the value of those assets, which fundamentally reflect the expected future flows of real services or cash associated with those assets and the rates at which people discount future consumption relative to present consumption, is should be affected by an increase in the amount of cash that people happen to be holding at any particular moment in time. People could also use their cash to pay off debts, but that would just mean that the cash held by debtors would be transferred into the hands of their creditors. So the question what happens to the excess cash, and, if nothing happens to it, how the excess cash comes to be willingly held is not an easy question to answer.

Being the smart economist that he is, Nick understands the problem and he addresses it a few paragraphs below in a broader context in which people can put cash into savings accounts as well as spend it on stuff.

Now let me assume that the central bank also offers savings accounts, as well as issuing currency. Savings accounts may pay interest (at a rate set by the central bank), but cannot be used as a medium of exchange.

Start in equilibrium where the stock of currency is exactly $100 per person. What happens if the central bank prints more currency and drops it out of a helicopter, holding constant the nominal rate of interest it pays on savings accounts?

I know what you are thinking. I know how most economists would be thinking. (At least, I think I do.) “Aha! This time it’s different! Because now people can get rid of the excess currency, by depositing it in their savings accounts at the central bank, so Helicopter Money won’t work.” You are implicitly invoking the Law of Reflux to say that an excess supply of money must return to the bank that issued that money.

And you are thinking wrong. You are making exactly the same fallacy of composition as you would have been making if you said that people would leave the excess currency lying on the sidewalk.People in aggregate can only get rid of the excess currency by depositing it in their savings accounts (or throwing it away) therefore each individual will get rid of his excess currency by depositing it in his savings account (since it’s better than throwing it away).

There are 1,001 different ways an individual can get rid of excess currency, and depositing it in his savings account is only one of those 1,001 ways. Why should an individual care if depositing it in his savings account is the only way that works for the aggregate? (If people always thought like that, littering would never be a problem.) And if individuals do spend any portion of their excess currency, so that NGDP rises, and is expected to keep in rising, then the (assumed fixed) nominal interest rate offered on savings accounts at the central bank will start to look less attractive, and people will actually withdraw money from their savings accounts. Not because they want to hold extra currency, but because they plan to spend it.

There are indeed 1,001 ways that people could dispose of their excess cash balances, but how many of those 1,001 ways would be optimal under the assumptions of Nick’s little thought experiment? Not that many, because optimal spending decisions would be dictated by preferences for consumption over time, and there is no reason to assume that optimal spending plans would be significantly changed by the apparent, and not terribly large, wealth windfall associated with the helicopter drops. There could be some increase in purchases of assets like consumer durables, but one would expect that most of the windfall would be used to retire debt or to acquire interest-earning assets like central-bank deposits or their equivalent.

So, to be clear, I am not saying that Nick has it all wrong; I don’t deny that there could be some increase in expenditures on stuff; all I am saying is that in the standard optimizing models that we use, the implied effect on spending from an increase in cash holding seems to be pretty small.

Nick then goes on to bring commercial banks into his story.

The central bank issues currency, and also offers accounts at which central banks can keep “reserves”. People use both central bank currency and commercial bank chequing accounts as their media of exchange; commercial banks use their reserve accounts at the central bank as the medium of exchange they use for transactions between themselves. And the central bank allows commercial banks to swap currency for reserves in either direction, and reserves pay a nominal rate of interest set by the central bank.

My story now (as best as I can tell) matches the (implicit) model in “Helicopter Money: the Illusion of a Free Lunch” by Claudio Borio, Piti Disyatat, and Anna Zabai. (HT Giles Wilkes.) They argue that Helicopter Money will be unwanted and must Reflux to the central bank to be held as central bank reserves, where those reserves pay interest and so are just like (very short-term) government bonds, or savings accounts at the central bank. Their argument rests on a fallacy of composition. Individuals in aggregate can only get rid of unwanted currency that way, but this does not mean that individuals will choose to get rid of unwanted currency that way.

It seems to me that the effect that Nick is relying on is rather weak. If non-interest-bearing helicopter money can be costlessly converted into interest-bearing reserves at the central bank, then commercial banks will compete with each other to induce people with unwanted helicopter money in their pockets to convert the cash into interest-bearing deposits, so that the banks can pocket the interest on reserves. Competition will force the banks to share their interest income with depositors. Again, there may be some increase in spending on stuff associated with the helicopter drops, but it seems unlikely that it would be very large relative to the size of the drop.

It seems to me that the only way to answer the question how an excess supply of cash following a helicopter drop gets eliminated is to use the idea proposed by Earl Thompson over 40 years ago in his seminal, but unpublished, paper “A Reformulation of Macroeconomic Theory” which I have discussed in five posts (here, here, here, here and here) over the past four years. Even as I write this sentence, I feel a certain thrill of discovery in understanding more clearly than I ever have before the profound significance of Earl’s insight. The idea is simply this: in any intertemporal macroeconomic model, the expected rate of inflation, or the expected future price level, has to function, not as a parameter, but as an equilibrating variable. In any intertemporal macromodel, there will be a unique expected rate of inflation, or expected future price level, that is consistent with equilibrium. If actual expected inflation equals the equilibrium expected rate the economy may achieve its equilibrium, if the actual expected rate does not equal the equilibrium expected rate, the economy cannot reach equilibrium.

So if the monetary authority bombards its population with helicopter money, the economy will not reach equilibrium unless the expected rate of inflation of the public equals the rate of inflation (or the future price level) that is consistent with the amount of helicopter money being dropped by the monetary authority. But the fact that the expected rate of inflation is an equilibrating variable tells us nothing – absolutely nothing – about whether there is any economic mechanism whereby the equilibrium expectation of inflation is actually realized. The reason that the equilibrium value of expected inflation tells us nothing about the mechanism by which the equilibrium expected rate of inflation is achieved is that the mechanism does not exist. If it pleases you to say that rational expectations is such a mechanism, you are free to do so, but it should be obvious that the assertion that rational expectations ensures that the the actual expected rate of inflation is the equilibrium expected rate of inflation is nothing more than an exercise in question begging.

And it seem to me that, in explaining why helicopter drops are not nullified by reflux, Nick is implicitly relying on a change in inflation expectations as a reason why putting money into savings accounts will not eliminate the excess supply of cash. But it also seems to me that Nick is just saying that for equilibrium to be restored after a helicopter drop, inflation expectations have to change. Nothing I have said above should be understood to deny the possibility that inflation expectations could change as a result of a helicopter drop. In fact I think there is a strong likelihood that helicopter drops change inflation expectations. The point I am making is that we should be clear about whether we are making a contingent – potentially false — assertion about a causal relationship or making a logically necessary inference from given premises.

Thus, moving away from strictly logical reasoning, Nick makes an appeal to experience to argue that helicopter drops are effective.

We know, empirically, that helicopter money (in moderation of course) does not lead to bizarre consequences. Helicopter money is perfectly normal; central banks do it (almost) all the time. They print currency, the stock of currency grows over time, and since that currency pays no interest this is a profitable business for central banks and the governments that own them.

Ah yes, in the good old days before central banks started paying interest on reserves. After it became costless to hold money, helicopter drops aren’t what they used to be.

The demand for central bank currency seems to rise roughly in proportion to NGDP (the US is maybe an exception, since much is held abroad), so countries with rising NGDP are normally doing helicopter money. And doing helicopter money, just once, does not empirically lead to central banks being forced to set nominal interest rates at zero forever. And it would be utterly bizarre if it did; what else are governments supposed to do with the profits central banks earn from printing paper currency?

Why, of course! Give them to the banks by paying interest on reserves. Nick concludes with this thought.

The lesson we learn from all this is that the Law of Reflux will prevent Helicopter Money from working only if the central bank refuses to let NGDP rise at the same time. Which is like saying that pressing down on the gas pedal won’t work if you press the brake pedal down hard enough so the car can’t accelerate.

I would put it slightly differently. If the central bank engages in helicopter drops while simultaneously proclaiming that its inflation target is below the rate of inflation consistent with its helicopter drops, reflux may prevent helicopter drops from having any effect.


21 Responses to “Helicopter Money and the Reflux Problem”

  1. 1 Biagio Bossone August 16, 2016 at 11:07 pm

    Thanks for this interesting post.
    One comment.
    You say:

    “A one-time helicopter drop of money will be treated by most people as a windfall, not as a permanent increase in their income, so that it will not cause people to increase their spending on stuff except insofar as they expect their permanent income to have increased.”

    and also

    “…there is no reason to assume that optimal spending plans would be significantly changed by the apparent, and not terribly large, wealth windfall associated with the helicopter drops.”

    This is correct, but why are you assuming a one-time helicopter drop only? And why should the wealth windfall associated with the helicopter drop be necessarily small?
    In a situation of resource unemployment and lowflation, nothing prevents the central bank from announcing that it will stubbornly keep on doing helicopter drops until full employment is restored or until NGDP (meaning real output and prices) reaches a target level.
    Helicopter drops would then not be just a one-off event, but would part of a (monetary-fiscal) policy strategy precisely designed to: 1) affect people’s permanent incomes and expectations, and 2) remain in place until people’s permanent incomes and expectations do in fact change.
    Sooner of later people would start spending the excess cash, and as output and prices grow the aggregate excess supply of cash would be eventually absorbed.
    (Future seigniorage would take care of eventual central bank capital issues.)
    I don’t think this would be inconsistent with your conclusion and that of Nick Rowe. Actually, I believe this is the only sensible way HM policy should be designed in order to avoid the risk of ineffectiveness both you and Nick Rowe point to.


  2. 2 JKH August 16, 2016 at 11:58 pm

    Several points circling around what I think is the main theme of your post:

    First, NR’s starting experiment of imagining a helicopter drop of currency is not directly relevant to the HM discussion currently taking place in most cases. Most discussants are talking about some form of electronic transfer from the central bank to private sector participants (at least ultimately). The drop takes the ultimate form of balances in commercial bank accounts (perhaps first credited to the Treasury account at the central bank for subsequent distribution, or created by issuance of cheques or electronic transfer somehow directly from the central bank to private accounts at the commercial banks). So there is no drop of currency, and the reflux question in that context becomes moot.

    That said, this is somewhat equivalent to a starting position of 100 per cent assumed currency reflux – as a preamble to spending and/or asset allocation decisions based on new money in commercial bank accounts – perhaps including non-interest bearing accounts. For example, the paper by Claudio Borio et al to which Nick refers doesn’t relate directly to currency drops and reflux. It implicitly assumes that the entire drop ends up in bank accounts of some type and corresponding bank reserves. And the point of the paper is that there will be no significant fiscal saving (i.e. “free lunch”), given that super-excess reserves must be compensated somewhere around the level of the target policy interest rate – whether zero or positive. Yet much of the helicopter literature seems to assume such a fiscal saving.

    All that said, I’m not sure that the point of your post really depends a whole lot on the initial form of the helicopter distribution – given that any form will ultimately be redistributed across some mix of assets and spending, whether initially in currency form or in bank deposit form.

    Second, NR’s assertion that helicopter drops are “normal” in the sense of central bank balance sheet evolution is simply wrong in the context of what distinguishes helicopter money. Helicopter money is the active monetary financing of an active fiscal expenditure or transfer action. That’s not what happens in normal central bank balance sheet evolution. Central banks respond to currency demand that arises ultimately from the customers of commercial banks. The banks in responding buy the currency from the central bank by paying with their own reserve settlement balances. The typical pre-crisis follow up mechanism to this is that the central bank uses open market operations to buy bonds from the public – in order to restore system reserve balances to the banks. So the central bank in such cases is providing (consolidated) monetary financing in respect of fiscal decisions that have already been made – back when the purchased bonds were issued.

    If anything, the more correct analogy in terms of “normality” is that the central bank is building its balance sheet over time through “mini-QE” episodes in the form of OMO. Those are not “mini-HM” episodes, in the same sense that we know that the usual HM idea is distinct from QE at the margin of conception.

    (This process just described gets modified post-crisis, since the banks have been provided with super-excess reserve balances they can use to pay for currency demand over time. The actual QE process has already pre-supplied the reserves that would normally be needed to fund central bank balance sheet expansion over time. So there is no expansion due to currency growth so long as those super-excess reserves are available. Ironically as a manner of speaking, actual QE has pre-empted the need for the “mini-QE” episodes that take place in normal pre-crisis conditions.)

    Finally, there is another argument being made by some in the blogosphere that is complementary to the one just described – but equally false in its own way. That is, that central bank profits constitute “mini-HM” in the sense that these profits are credited to the Treasury account and used in real time for spending and transfer purposes according to fiscal decisions (already made) but currently being executed. However, I would say this is a false argument. Central banks contribute in an ongoing way to the government fiscal position as a result of their normal financial intermediation / net interest margin activity – they record profits that are subsequently credited to Treasury. But such financial intermediation activity obviously is not in the same category as directing fiscal expenditures or transfers to households or businesses, and financing that with money creation. The fact that the central bank makes a marginal fiscal finance contribution through its normal activities and consequent profit does not mean it is engaged in helicopter drops as “normal” business. But a number of bloggers are attempting to make this case in support of the CB helicopter agenda. It is a false inference and a false case.


  3. 3 Mike Sproul August 17, 2016 at 8:15 am

    Great post David!
    Two opposing views of money are at the heart of the matter:
    1) The backing theory, which says that the value of money is set by the assets and liabilities of the money issuer, and money supply/money demand have nothing to do with it. Everyone agrees that this is true of stocks, bonds, and financial securities in general, so there’s no need for a ‘special’ theory of money.
    2) The quantity theory, which says that the value of money is set by money supply and money demand, and the assets and liabilities of the issuer have nothing to do with it. Money is different from other securities, and so requires a ‘special’ theory of its own.

    Since the backing view says that money’s value is determined by the issuer’s assets and liabilities, it follows that it is NOT determined by the law of reflux. For example, if dollars are pegged to silver at $1=1 oz., and if the issuer of dollars has 1 oz worth of assets for every dollar issued, then $1=1 oz. regardless of whether dollars are flowing out of or into the central bank.

    I always find it helpful to compare money to stocks and bonds. If GM did a helicopter drop of GM shares, increasing the quantity of shares by 10%, would that cause inflation? Yes, of course. GM shares would fall by about 10%. What if GM helicoptered GM bonds? Well, since bonds are senior to stocks, the bonds would probably not drop, but shares of stock would drop.

    So what if the Fed helicopters 10% more money? Well, money is more like bonds than like stocks, in the sense of being a fixed, senior claim to the government’s (not just the Fed’s) assets. So if it’s the Fed doing the drop, then probably no inflation. If it’s the central bank of Zimbabwe, then probably inflation.


  4. 4 Britonomist August 17, 2016 at 10:46 am

    I actually share a bit of skepticism (probably not as much as you though) that the stimulus from a simple direct helicopter transfer would be that powerful, especially in situations where people are heavily leveraged – in which case a lot of this will just go to debt servicing rather than consumption (although cost-less deleveraging is very usefl!!). The solution is obviously fiscal expenditure financed by a helicopter drop – nobody can make a convincing argument that this would not be stimulative.


  5. 5 Nick Rowe August 17, 2016 at 11:17 am

    Thanks David!

    Lovely post. I’ve spent the last couple of hours mulling it over.

    I get your point about equilibrating mechanisms. Funny thing is, when I wrote the post, I made the (deliberately extreme and silly) assumption that the demand for money is exactly $100 per person, regardless of anything. Which gives us the equilibrium condition:

    Ms = $100 x population.

    And a rabid equilibrium theorist would deduce from this that Helicopter money *must* cause a baby boom! (A Neo-Malthusian model, in the same sense as Neo-Fisherian models).

    This is one bit I’m going to zero in on:

    “So the main response of most people to the helicopter drop will be to make some adjustments in the composition of their balance sheets. People may use the cash to buy other income generating assets (including consumer durables), but they will hardly change their direct expenditures on present consumption.”

    Let’s assume, for the sake of argument, the permanent income hypothesis is 100% true (though empirically it seems to be about half true). Each individual plans to spend his windfall 100% on income generating assets (and to spend only the income from those assets on consumption). But even though each individual can get rid of the helicopter money by buying stocks, or bonds, or houses, they can’t in aggregate get rid of their money that way. It just hot potatoes back into their pockets. They can’t in aggregate, change the composition of their balance sheets that way; only the prices of those assets. But their attempts to get rid of their money will cause those asset prices to rise. And that rise in prices will induce people to spend more on consumer goods, and firms to create more of those assets to finance investment spending.


  6. 6 Rob Rawlings August 17, 2016 at 12:02 pm

    Very interesting post.

    In the absence of central bank intervention won’t (other things equal) an increase in money via a one-off helicopter drop lead to an across-the board percentage increase in the price level equivalent to the percentage increase in the money supply even if people do practice consumption smoothing ? If people initially want to (directly or indirectly) buy capital goods with the money to push additional consumption into the future then this will initially push up capital good prices and lower their rate of return, which will cause the price of consumer goods to seem relatively under priced, and so-on until the new higher price equilibrium is arrived at.

    If there is a central bank and it chooses to prevent the price increase after the Helicopter Drop by offering higher rates of interest on money then it will initially succeed in doing so. But as it starts paying out interest payments on its “borrowing” will it not have to keep increasing the rate of interest it pays as time passes to prevent the ever increasing money supply (initial drop plus rounds of interest payments) from causing price rises ? Ultimately it will have to tax the money back if it wants to remove the inflationary pressure.

    Finally, when you say “So if the monetary authority bombards its population with helicopter money, the economy will not reach equilibrium unless the expected rate of inflation of the public equals the rate of inflation” it sounds like you are referring to a steady flow of helicopter money that will (potentially) drive a steady rate of inflation, is that correct ? I agree that expected and actual inflation would need to match to get equilibrium in this case. But it seems intuitive that there would be a mechanism beyond “rational expectations'” to describe how that equilibrium comes about – but that will need some more thought on my part!


  7. 7 JKH August 17, 2016 at 12:46 pm

    Nick Rowe:

    “and to spend only the income from those assets on consumption … only the prices of those assets. But their attempts to get rid of their money will cause those asset prices to rise. And that rise in prices will induce people to spend more on consumer goods, and firms to create more of those assets to finance investment spending.”

    The price rises but the income presumably doesn’t change – so the yield declines.

    Just wondering – why should the price effect on the marginal propensity to consume dominate the yield effect ?


  8. 8 David Glasner August 17, 2016 at 7:13 pm

    Biaggio, You are right to ask about a continuing flow of helicopter money or a huge one-time bombardment of helicopter money. But my point was not to argue that helicopter money is a useless and inherently ineffective tool of monetary policy; it was to call into question the underlying analysis offered by Nick Rowe by which its effectiveness is established in theory. My other point is that what would really make helicopter drops successful is to cause the public to raise their expectations of the future price level. Without such a change in expectations, the policy is unlikely to succeed.

    JKH, If I understand you, and I am not at all sure that I do, your point is that the seemingly helicopter dop actions that central banks now undertake have an entirely different function in modern monetary systems from the objectives that current advocates of helicopter drops are now seeking to accomplish. But I don’t think that your point actually refutes the helicopter drop position. The techniques for expanding the monetary base are what they are, and even if motivation for open-market operations is not to provide banks with sufficient reserves to keep the payment system functioning smoothly, creating sufficient excess reserves for the banking system may nevertheless create a disequilibrium in the banking system that will spill over into the rest of the economy.

    Mike, Thanks. The difference between stocks and bonds and money is that stocks and bonds generate no services other than the pecuniary yields that they generate over time while money generates actual monetary services which are, at least in part, independent of the expected future pecuniary yields associated with money. The money demand reflects the value of the monetary/ liquidity services provided by money which are consumed independently of the potential value of the assets backing money. That’s where I think your analogy breaks down.

    Britonomist, The argument for helicopter drops plus government expenditures as a stimulus measure is worth taking seriously. To translate it into my framework, it could be viewed as a method for moving price level expectations in the direction required for a new equilibrium to be established.

    Nick, You’re very welcome. Your point that in attempting to acquire income earning assets with their excess cash balances, people will bid up the value of those assets which will induce people to spend more on consumer goods and firms to create more of those assets is potentially a path whereby a new equilibrium could be achieved. However, if expectations don’t adjust in the “right” way, the desire to buy new assets will not bid up the price of those assets because those assets will be able to rise in value only if the expected flows of services and cash derived from those assets rise. The fact that people are looking for assets to exchange their excess cash balances for doesn’t mean that those assets will rise in value by more than epsilon unless expectations adjust to justify paying an increased price for the assets. That’s why I say that price level expectations are an equilibrating variable, unless expectations change in a way that supports the increased asset values, the adjustment process gets stuck or goes haywire.

    Rob, You are repeating the conventional story, but I am saying that the conventional story doesn’t work unless expectations change in a way that supports the change in asset values. And you can’t just assume that increasing the quantity of money just reduces the rate of interest. How are the underlying rates of time preference and the productivity of capital suddenly altered by an increase in the quantity of money? I actually did present my argument in terms of either a continuous rate of inflation or a period by period increase in the price level. I don’t think anything fundamental depends on which way the story is told.


  9. 9 JF August 18, 2016 at 6:26 am

    Helicoptering would only be done via govt Spending. The accountants key stroke new magnitudes into selected govt accounts to which claims for payment are directed. The point is to increase Spending under the selected programs. Govt would be very unlikely to pick only the programs that flow to people wealthy enough to see new money as just one increment of financing to buy their next financial asset. Govt should use the key stroking in thise programs intended to increase basic spending, as I call it, the new money would be used by recipients for increases in basic expenditures, the normal kind of goods and services that 90 percent of us do.

    So key stroking avoids taxes. It avoids borrowing too. These are politically chosen stances, though we could do them too, and key stroke – but with the purpose of stimulating basic demand.


  10. 10 bluenosersouth August 18, 2016 at 7:00 am

    Your concluding paragraph seems particularly strong. It reminds me of a point Mike Woodford made while discussing this issue with Adair Turner over at VoxEu. In a perfect-foresight, full-credibility world, committing to h money and raising the inflation target are equivalent.


    The perfect foresight world is a useful fiction because it highlights just how much inflation is associated (as a first approximation) with an h drop pursued to its logical conclusion. More than you would think, for any given h money program, given how small the equilibrium demand for currency is relative to nominal GDP.

    This raises the question of calibration, for which there seem to be two solutions on offer. The first assumes that a very small h money program would succeed in knocking the economy out of liquidity trap. For example, see Gali 2014, who works with a program of just 0.5% of annual GDP. Gali is fun because he is both an advocate of h money and clear that the small money stock is an issue. (See pages 7 and 8.)

    Per Gali, if h money works in such small doses — and if we could imagine the Fed changing its policy regime to commit to monetizing just $100 billion of debt –then the calibration issue would dissolve. The Fed and Treasury would just do several small programs over time until they got what they wanted. I see other commenters here making roughly this same point.

    The second solution to calibration involves tweaking the relationship between “base money” and what h money advocates somewhat misleadingly call “seniorage” by tweaking reserve requirements (Turner) or extracting a tribute from the banking system in the form of a lump sum tax (Bernanke). These solutions are tax hikes posing as “money” finance and serve mostly to highlight that some advocates of h money fear the calibration issue and don’t really have a serious solution.

    Practically speaking, it would probably be wise for the Fed for now to just sit there, do nothing, and hope inflation drifts up a bit on the back of whatever impetus this business cycle has if left unmolested. That would not be a cure all, obviously, but it seems to be the low hanging fruit.

    I have a question regarding the reflux problem. I am skeptical of h money, but it does not seem that reflux is necessarily all that damning. If the Fed sees itself through on the inflationary (or nominal demand) consequences of an h money program, then doesn’t the higher nominal demand eventually create the demand for currency held outside banks?

    I don’t think advocates of h money would deny that reflux happens or accept that it is terminal to their argument for the program. In the h money story, it is the higher nominal demand (via inflation) that EVENTUALLY creates the demand for currency, with the timing determined by how quickly the economy responds.

    But I may be missing something. My question is sincere, not rhetorical.


  11. 11 bluenosersouth August 18, 2016 at 7:03 am

    Sorry for the silly anonymity, which was unintended. My actual name is Gerard MacDonell. I blame a combination of WordPress and my being a bit clueless.


  12. 12 George Selgin August 19, 2016 at 9:43 am

    I think it would help the discussion, David, if you and Nick would consider recognizing more explicitly the difference between the “law of reflux” as it is understood by banking-school theorists, including Fullerton and, more recently, Mike Sproul, and what Larry White and I have called the law of adverse clearings, with which the Fullartonian reflux is often confused. The latter assumes that credit creation by commercial banks is constrained by the tendency of excess money holdings to be re-absorbed by banks _by means of loan repayments_. It’s a fundamentally unsound view, for the obviously reason that a bank, in having its loans repaid, is “constrained” only in the sense that it must take steps to replenish its loan book. It is not constrained in the sense of lacking liquidity with which to engage in further credit extensions.

    Adverse clearings simply refer to the reserve losses banks encounter when, other things equal, more of their IOUs fall into the hands of rival banks than they themselves gather from those rivals. They certainly can, and do, constrain lending by individual banks.


  13. 13 Mike Sproul August 19, 2016 at 11:10 am

    A bank that has had its loans repaid is constrained by the demand for loans. Nineteenth century note-issuing banks made it clear that their issue of notes was governed by demand for notes. A banker that issued new notes in slow economic times would have those notes returned to him the next day, while a banker that issued notes during busy times would not see his notes again for months.

    Just as unwanted coins would be melted and thereby reflux to bullion, unwanted notes would return to the issuing bank in exchange for the assets that had been deposited.


  14. 14 George Selgin August 19, 2016 at 1:05 pm

    “A bank that has had its loans repaid Is constrained by the demand for loans.” No sir. “demand for loans” is a _schedule_; the constrain must, to be meaningful, be a constraint of quantity demanded. But the bank, finding itself with extra means on hand, but “constrained” by the “demand for loans” at prevailing interest rate x, can always resort to charging some interest rate y<x that is sufficiently low to attract the desired borrowings.


  15. 15 Mike Sproul August 19, 2016 at 2:28 pm

    That’s like saying that an apple farmer isn’t constrained by the demand for apples, because the demand for apples is a schedule. If the apple farmer is small, then he can’t cut price without going broke. If the apple farmer is big, then his price cuts stop where MC=MR. Likewise for banks. A small bank can’t cut the interest rate, and a big bank won’t.

    Or forget about loans and think of bonds instead. A bank that issues 100 paper dollars in exchange for a bond worth $100 is not going to start accepting bonds worth only $99. As long as the bank follows the rule of only issuing 100 paper dollars to people who bring in bonds worth $100 or more, its note issue will rise and fall with the demand for notes.


  16. 16 David Glasner August 19, 2016 at 3:39 pm

    JF, How the cash is actually delivered is not my concern; the question I am interested in is how people respond to extra cash in the hands. But I don’t deny that government spending financed by money creation may raise total income.

    Gerard, Thanks for your interesting comment. It seems to me that the perfect foresight assumption is way too easy. It guarantees that you get to a new equilibrium by printing money. Fine, but I don’t think that’s an interesting result. The point is that something has to be done to make expectations change, helicopter drops don’t change expectations automatically.

    George and Mike, I think of adverse clearings as one element of reflux. The other element of reflux is how what banks perceive as their profit-maximizing response. Adverse clearings must be interpreted by the bank experiencing the adverse clearings, and it will respond to adverse clearings based on what it perceives to be its profit maximizing strategy. How much revenue does a bank expect to earn from the deposit created by making a loan versus the cost of servicing the loan. The bank chooses a strategy based on its expectations about how many deposits its customers will hold. Adverse clearings will cause the bank to change its strategy only if the adverse clearings indicate that its expectations about outstanding deposits are not being met. If not, the bank may reduce lending or it may take steps to make deposit holding more attractive to customers, e.g, by raising the interest rates it pay to depositors. So the demand for loans and the demand for deposits both play a role in how much money a bank creates, but that decision is based on a comparison of the cost of and revenue from creating deposits (making loans) at the margin.


  17. 17 Benjamin Cole August 19, 2016 at 8:08 pm

    I am a fan of helicopter drops, that is money-financed fiscal programs. See Korekiyo Takahashi, Japan 1932 to 1936. It is a sign of how orthodox and dogmatic Western macroeconomics has become that the Japan chapter in the Great Depression is resolutely ignored.

    Money-financed fiscal programs already worked, in real history. The argument is settled.

    That said, I quibble with this:

    “though they will be more tolerant of excess cash in their bank accounts than in their wallets.”

    Maybe, but not in times of deflation. Already, in the US there is $4,500 in cash in circulation per resident, or $1.46 trillion. Japan is much higher, about $7,000 yen equivalent.

    Now, the response of orthodox economists has been to say the US cash is offshore, or in briefcases doing drug deals. Half to it. Why half I don’t know, One serious study suggest possibly one-third is offshore. No one knows.

    Even if true that half is offshore, cash in circulation has been ballooning for years, more than doubling in the last 10 years and that would mean $2,250 in circulation per resident, and growing rapidly.


    The family of four has $9k in cash in the house? (Even assuming only $700 billion or so onshore in circulating cash).

    Obviously, something is going on. There must a larger underground or cash economy evolving than recognized. As people save in the form of cash, it becomes natural to ditch taxes and conduct cash transactions.

    As long as cash is legal, then a low inflation, or deflationary economy will generate a larger and larger off-the-books economy. Think Third-World nations.

    If indeed much of the cash is offshore, that suggest tax avoidance on a huge scale, since the drug business cannot be growing that quickly.

    Who knows, maybe offshore safety deposit boxes in Panama are stuffed full of US cash.

    Anyway, cash in circulation remains a most fascinating topic.

    And sned in the Hueys, the Sikorkskys and the Chinooks! When we are wiping our rear apertures with Benjamin Franklins, then call off the drops.


  18. 18 joel bernard August 20, 2016 at 7:26 am

    @David Glasner

    I think that your response to JF begs the question.

    The *essential* consideration is how monetary finance (aka helicopter money) is delivered: whether to representative consumers (as you imagine) or dispersed through government fiscal stimulus. As JF says, fiscally stimulating public works employment is directed toward consumers who are unemployed and who have no problem spending “excess” cash. And toward public investment in infrastructure that is not financed by consumer choice. The largest brake on the multiplier effects of fiscal stimulus is the debt repayment of the highly indebted poor, which is forced savings. The monetary finance/fiscal stimulus would have to be of long duration.

    A theoretical debate over the consumption preferences of typical economic actors–excess cash, equilibrium expected rate of inflation, etc.–seems to me to unnecessarily complicate the practical point of designing effective policies.


  19. 19 Rob Rawlings August 21, 2016 at 7:23 am


    In your reply to Nick you say “The fact that people are looking for assets to exchange their excess cash balances for doesn’t mean that those assets will rise in value by more than epsilon unless expectations adjust to justify paying an increased price for the assets.”

    I am not fully getting this. If I find a large sum of money lying in the road that I want to use to increase my consumption in the current and all future periods, I’m going to want to buy some rent-earning assets (or lend the money at interest) to increase my future income. I’m going to do that no matter what the rate of return on those assets is as long as its above zero (with a bit of variation due to my liquidity preference). My entry into the asset market will increase asset prices and reduce their return a bit if I am the only recipient of the money. If everyone has had the same good fortune then won’t we (irrespective of our expectations) all collectively start bidding up the price of assets until they reach the price where we decide we would rather spend some of our wealth on consumer goods, and keep large cash balances? And eventually we will all be happy to hold the increased money supply at a new and higher price level. I don’t get where expectations come in here – I think the new equilibrium could be reached even if everyone worried about their own plans and adjusted them in the light of new price information.

    I suppose its true that if as a result of the money drop, or due to other things that happen at the time, people’s expectations about the new price level may cause it have different relative prices to the initial state. I can also see that if everyone’s expectations about the new price level are at odds with each other (they interpret the information that prices are providing them in inconsistent ways?) then the new equilibrium may never be reached and the economy would remain out of equilibrium , or in a non-optimal equilibrium.
    But this seems to be bolting expectations onto an economic process that does not need them to work – which makes me think I am missing something.


  20. 20 David Glasner August 21, 2016 at 1:57 pm

    Benjamin, By “cash,” I assume that you mean currency. A lot of the currency is held overseas and a lot is held for use in the various strata of the underground economy. The motives for holding currency are very different for some people than for others, so my comment was made as a general statement, but it really applies only to a certain class of people with bank accounts and credit cards who don’t routinely make large transactions using cash.

    Joel, That analysis is different from the one I went through. I am not making any specific assertions or drawing conclusions about what the implications of financing public works by money creation would be.

    Rob, The standard analysis of the helicopter drop says that it doesn’t affect any real variable, it just causes the price level to rise. In real terms, consumption, and the rate of interest are unchanged. I’m saying you can’t get to that conclusion without having the expected price level change. If you work through the analysis without a change in the expected price level you don’t get to the equilibrium of unchanged real variables and a price level that rises by the same proportion as the increase in the money stock.


  21. 21 Egmont Kakarot-Handtke September 13, 2016 at 6:17 am

    Clueless about money an profit
    Comment on David Glasner on ‘Helicopter Money and the Reflux Problem’

    Not only humans but animals, too, know how to use levers of all forms and sizes since time immemorial. And it is certainly possible to write a history of the use of levers from the Stone Age to the Egyptians and beyond. However, this history of the practical use of levers will NEVER arrive a the Law of the Lever as put down by Archimedes.

    Obviously, there are different views of the lever: the practical, the historico-genetic, and the scientific. The fact of the matter is that roughly 99 percent of people use the lever without any understanding of the essence/principle/nature of the lever which is ABSTRACT and INDEPENDENT of concrete historical time/space. Only the 1 percent of scientists really understands the lever.

    The same holds for economic phenomena like money or debt. We have the commonsensical history of money and the theory of money. Actually, we do NOT have a valid theory of money. What we have is Walrasianism, Keynesianism, Marxianism, and Austrianism and all four approaches are provable false, that is, materially and formally inconsistent. Put in methodological terms, the axiomatic foundations of the four approaches are false and this means that the whole analytical superstructure is false, even if each intermediate logical step is correct. In short, economics is a failed science and this includes, of course, the theory of money.

    From this follows: “For it can fairly be insisted that no advance in the elegance and comprehensiveness of the theoretical superstructure can make up for the vague and uncritical formulation of the basic concepts and postulates, and sooner or later … attention will have to return to the foundations.” (Hutchison, 1960, p. 5). What is needed is a paradigm shift or as Joan Robinson put it: “Scrap the lot and start again.”

    It is pretty obvious that the discussion about helicopter money suffers from the fact that each participant has a different model of the economy at the back of his mind. Lacking a common workhorse model the natural result is ongoing confused blather that forever remains inconclusive. Make no mistake, though, inconclusive confusion is were the representative economist is most at home: “I find I’m learning so much from the back and forth on this issue (both from Nick and David plus related posts like this one) ― I hope they never resolve it!”*

    This is the very difference between economist and scientist: the economist is happy with never ending inconclusive wish-wash, the scientist is happy with a provable true/false conclusion.

    So, let us first of all define common ground. The most elementary configuration of the economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm and is given by these three objective structural axioms: A1. Yw=WL wage income Yw is equal to wage rate W times working hours L, A2. O=RL output O is equal to productivity R times working hours L, A3. C=PX consumption expenditure C is equal to price P times quantity bought/sold X (for details see 2015; 2014; 2011).

    The first mistake is to think of money as a given stock. That is historically true but analytically false. The very characteristic of transaction money is that it is permanently created and destroyed.

    In order to reduce the monetary phenomena to the essentials it is supposed that all money transactions are carried out by the central bank. The household and business sector’s respective stock of money then takes the form of current deposits or current overdrafts.

    By sequencing the initially given period length of one year into sub-periods one gets a simple pattern of wage payments and consumption expenditures.** It is assumed here that the monthly income Yw/12 is paid out at mid-month. In the first half of the month the daily spending of Yw/360 increases the current overdrafts of the households. At mid-month the households change to the positive side and have current deposits of Yw/24 at their disposal. This amount reduces continuously towards the end of the month. This pattern is exactly repeated over the rest of the year. At the end of each sub-period, and therefore also at the end of the year, the household sector’s stock of money is ZERO. Money is present and absent depending on the time frame of observation. The reflux is perfect due to the fact that C=Yw for the given period.

    Seen from the central bank the income-expenditure pattern gives rise to an AVERAGE stock of transaction money which is here proportional to the period income Yw.***

    In period 2 the wage rate and the price is doubled. Since no cash balances are carried forward from one period to the next, there results no real balance effect provided the doubling takes place exactly at the beginning of period 2. If employment L is doubled income Yw and output O doubles and under the condition of C=Yw and R=const. the market clearing price P remains constant. In the first case there is a correlation between price and average stock of money in the second case not. The quantity of money is NOT causal for the market clearing price as the commonplace quantity theory claims. Under the condition that the central bank is passive, i.e. that it accommodates the autonomous transactions between household and business sector there is a perfect reflux. The stock of money is zero at the beginning and the end of each period.

    Things change when the household sector saves or dissaves, i.e. when C is no longer equal to Yw. In this case, there is no perfect reflux and money morphs from a pure transaction medium into a store of value. This uno actu creates a new economic phenomenon, viz. profit/loss for the economy as a whole. The details are an issue for another occasion.

    The point that is ENTIRELY OVERLOOKED in the usual treatment of saving/dissaving/money/credit/reflux is the effect on overall profit. Put bluntly: helicopter money is the best profit machine ever invented. So nobody should be surprised about massive distributional distortions as collateral damage.****

    Conclusion: The representative economist is a person who filibusters about the monetary economy without any idea about the two most important phenomena of his subject matter, viz. money and profit.

    Egmont Kakarot-Handtke

    Hutchison, T.W. (1960). The Significance and Basic Postulates of Economic Theory. New York, NY: Kelley.
    Kakarot-Handtke, E. (2011). Reconstructing the Quantity Theory (I). SSRN Working Paper Series, 1895268: 1–28. URL http://ssrn.com/abstract=1895268.
    Kakarot-Handtke, E. (2014). Economics for Economists. SSRN Working Paper Series, 2517242: 1–29. URL http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2517242.
    Kakarot-Handtke, E. (2015). Essentials of Constructive Heterodoxy: Money, Credit, Interest. SSRN Working Paper Series, 2569663: 1–19. URL http://papers.ssrn.

    * Source: Koning blog http://jpkoning.blogspot.de/2014/04/rowe-v-glasner-round-33.html
    ** Wikimedia https://commons.wikimedia.org/wiki/File:AXEC86.png
    *** Wikimedia https://commons.wikimedia.org/wiki/File:AXEC87.png
    **** See post ‘Keynesianism as ultimate profit machine’ http://axecorg.blogspot.de/2015/07/keynesianism-as-ultimate-profit-machine.html


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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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