Saturday 13 February 2016

Negative Interest Rates vs Helicopter Money

Negative interest rates are the new QE in terms of central bank crazes and this is something that upsets me a lot. This is not because I care about savers losing their money. Unfortunately this is something that has to happen if the economy is to grow again.

It is partly because the policy makers don't realise that they have been stimulating the economy using private sector debt for years. Their rational agent models say that lower interest rates encourage people to spend more rather than save. They can quantify the difference with the Taylor rule. It all makes sense. But in reality, the way that lower interest rates increase growth is by increasing private sector debt.

The more debt, the lower the interest rate must be as there is only a certain amount of economic activity that can be diverted to bond holders and bankers. So eventually the interest rate goes down to zero. Instead of pausing here, and thinking maybe we need to change the model, they have come to the conclusion that what they need is to do more of the same.

They don't realise that their actions will create more private debt and mean that interest rates will need to be moved ever lower to stimulate the economy next time. The lowering the interest rate cycle is never ending. The imbalances of the economy (stagnant wages, high house prices etc) all get worse.

My distress is partly because it is an ideological decision. Given the choice of negative rates or helicopter money, from the point of view of the saver the effect is the same. One takes money directly, the other by inflation. Both encourage spending equally. So if the impact really is from rational savers bringing forward consumption, the two are equivalent.

But people often do not think about the fact that every central bank decision has distributional consequences. It takes money from some and gives to others. No decision is neutral.

If you look at the distributional impacts they are completely different from each other. Negative interest rates reduce the discount rate on asset prices and lead to their prices rising. The beneficiaries of negative interest rates are those with assets as the value of their holdings will go up. The bigger beneficiaries are thus the rich.

With helicopter money, given directly to people or spent by the government on investment or consumption, then the money goes to people who benefit from it more; the country as a whole. It is fair and it is targeted. With QE and lower interest rates it is unfair and scattergun.

And my distress is partly about the economic impact. Helicopter money directly boosts demand in a quantifiable and controllable way. It means that inflation targets can be hit. It means that investment gets made to increase future capacity.

QE and negative rates only boost demand very little through the wealth effect and by encouraging further private sector debt. They do nothing for future investment.

Both morally and economically helicopter money is the better option. Unfortunately the rich always win in these debates.


  1. Thank you for writing this. "Right on!..."

  2. I support helicopter money not only because I feel it is the best tool that CBs have with the current political barriers to higher deficits but because it resembles a basic income, which MAY be the long-term solution to growing automation and falling demand.

    However, assuming governments were willing to run larger deficits, would you prefer that to helicopter money? And why (not)?

    1. I am inclined to agree. I used to think that the stigma attached to government debt was too high to allow the kind of deficits required to get the economy working well. So I would call for helicopter money. All it takes to mess up a deficit policy is a new political party to come into power and decide that austerity is needed.

      The idea that debt is bad is very common and difficult to dispel.

      Like you, I like the idea of a basic income and think that this would be an excellent use of helicopter money - and almost non-political.

      But if government debt could be used the same way, then that would be equally good. I suppose the main thing is to make people realise that the government makes the money and that its job is to use this power optimally for the people. And debt in your own currency is not a big deal - having a competitive, well regulated and well run economy is the main thing. Then if you ensure that the money system works as well there should be nothing to fear.

      The longer the stagnation goes on for, the more people are starting to realise the problems with the current system, so maybe one day this will be possible.

  3. Hello,

    I had a question, how would this affect interest rates in the long run ?

    I mean were are increasing money supply, so interest rates should remain close to 0, if we are the lower bound. I don't quite see how it would help alleviate the liquidity trap.

  4. I think the problem is thinking of money supply as a number that goes up and down with money issued by the government.

    Money supply goes up every time debt is created too. So any worries about this are similar to worries that banks are issuing too many mortgages. They all put extra money into the system.

    This just does it in a way that gets more effect on the real economy.

    The important thing is how much money is spent, not how much is produced. If the government stimulates with helicopter money it will increase demand, increasing both economic growth and inflation, and make interest rates rise in the short to medium term.

    Long term that extra money will end up in people's bank accounts as savings and won't affect anything.

    I know this goes against velocity of money stuff etc which assumes that money flows through the economy at a certain rate. But it doesn't. At some point people hoard it and you have to either take it back from them in taxation, or produce more.

  5. The above was by me btw. I was just signed in with different email.


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