Helicopter money, Inflation targets and Quantitative Easing

For economists

                I’m often asked about helicopter money, and occasionally there are calls for this policy to be implemented. (Hereis a recent example.) The way I think about this, at a very basic level, is that it is equivalent to a call for a temporarily higher inflation target.

                Think of an economy with just consumption and a government. Consumers are Ricardian. The government issues money and indexed debt, and it pays the interest on debt using lump sum taxes. There are two periods. The second period has flexible prices, but the first involves sticky prices, a demand deficiency and a ZLB.

                In this set up, a tax cut in the first period financed by issuing debt does nothing, because taxes rise in the second period to pay back the debt. What happens if the tax cut is financed by printing money? Prices must rise in the second period as money is the only nominal quantity, such that real balances in the second period are unchanged. What about the first period? Taxes have fallen, so it is tempting to say that lifetime income must have increased. However that tax cut needs to be kept in the form of cash, and not spent, because prices are going to rise diluting holdings of real money. So people save that tax cut as money. (I guess it’s like the Ricardian case, except it’s the inflation tax that you are saving for.)

                However there is a real effect in the first period, because with nominal rates at the ZLB, higher expected inflation reduces real interest rates, which means it’s sensible to bring forward some consumption into the first period. So helicopter money works through raising expected inflation, and not through any income effect, in this very simple set up. I think this is consistent with some old posts by Tyler Cowen and Brad DeLong. (There is a paper by Buiter (NBER 10163) which talks about this issue, but my pdf reader does not recognise the WPMathA font, so I cannot read the maths. If anyone can help me here I’d be very grateful.)

                In this very simple context, calls for helicopter money are equivalent to calls for a temporary increase in the inflation target. The policy only works because inflation increases. If the government printed money to spend on its own goods and services in the first period, then there would be a direct positive demand effect in addition to the inflation effect, but this direct demand effect could be achieved by a balanced budget fiscal expansion, without the need to print money. 

                If the government cut taxes by printing money, but then reduced the stock of money back again in the second period by raising taxes, then nothing happens in this simple model. The fact that there is more money in the first period does nothing, and consumers are no better off. We do not have any of the imperfections and margins in this simple model that QE is thought to work on in the real world.

QE involves a temporary exchange of bonds for money, if we consolidate the government and central bank. How do we know it’s temporary? First, because central bankers say it is. But, second and more importantly, because central banks appear totally wedded to their inflation targets. Data on inflation expectations suggest this is also what the private sector believes. If QE was not temporary, we would get the equivalent of helicopter money. In the QE case, and unlike helicopter money, the bond stock falls, but we can get back to helicopter money by cutting taxes by issuing bonds, which as the model is Ricardian does nothing.

                So it seems to me that calls for helicopter money are isomorphic to calls for a temporary increase in the inflation target, and none the better or worse for that. But if I’m missing something important here, do let me know.