So far the Fed has resisted the temptation to turn to helicopter money. But in entering its fourth round of quantitative easing (QE4), the Fed will buy $85 billion worth of mortgage backed securities and longer-term Treasuries per month until expected inflation reaches 2.5 percent, or unemployment falls to 6.5 percent. The Fed’s macroeconomic models predict those thresholds won’t be reached until mid-2015.
With the end of Operation Twist, the Fed has largely depleted its stock of short-term Treasuries. Under that program, the Fed bought $40 billion worth of longer-term Treasuries per month but sterilized those purchases by selling an equal amount of short-term bills. QE4 will add more than $1 trillion to base money in 2013 because none of the outright purchases of MBS ($40 billion per month) and Treasury securities ($45 billion per month) will be sterilized. Consequently, the Fed’s balance sheet will expand to more than $4 trillion by 2014 from less than $1 trillion prior to the 2008-09 financial crisis.
The explosion in base money has mostly ended up being held as excess reserves at the Fed and hasn’t had much impact on the monetary aggregates. Weak credit demand (even at ultra-low interest rates) due to the efforts of private borrowers to rebuild their balance sheets, along with uncertainty due to regulatory fog and the “fiscal cliff,” and the payment of interest on excess reserves, have helped prevent the fourfold increase in the Fed’s balance sheet from spilling over into rapid money growth and inflation—as least for the time being.
The danger is to think that rapid increases in the monetary base will keep nominal interest rates permanently lower and that the excess reserves will not eventually be lent out in search of higher returns. The Fed’s short-term vision and its acceptance of the idea that monetary policy can effectively generate maximum sustainable employment ignore a basic truth—printing money cannot substitute for the real determinants of prosperity. Increasing the range of options open to individuals depends on greater economic freedom, not on destroying the value of money by creating an excess supply.
The problems of high unemployment and slow growth are not due to a failure of aggregate demand; they are due to a failure to safeguard the institutions necessary for economic harmony. Those institutions include sound money, private property rights protected by the rule of law and limited government, interest rates and other relative prices that are free to move in line with market forces, and taxes and regulations that do not destroy incentives to work, save, and invest.
There is no evidence that easy money reduces unemployment or promotes long-run growth; but there is abundant evidence that excess money growth creates inflation and increases unemployment. With QE4, the Fed is tilting its dual mandate toward reducing unemployment while allowing its price stability target to drift upward.
That policy drift is dangerous. There are limits to monetary policy: the Fed does not have the knowledge to bring about full employment, which requires flexible relative prices for all factors of production. The inflation-unemployment tradeoff is an illusion. By trying to use easy money to lower unemployment, the Fed risks further eroding the purchasing power of the dollar. We should also not overlook the threat to economic freedom posed by even mild inflation, as the U.S. experiment with wage-price controls illustrated in the early 1970s.
A market-based monetary regime, like the gold standard, would not fix interest rates or have a central authority determine the optimal quantity of money. The money supply would adjust to the demand for money—and the long-run value of money would remain relatively stable. The central bank would not be able to monetize the debt or bail out banks that are too big to fail. Fiscal policy would have to stand on its own.
The Federal Reserve Act, as amended, makes the Fed responsible for “maximum employment, stable prices, and moderate long-term interest rates.” Only the second goal is attainable via monetary policy, provided the quantity of money grows in line with real output over the long run. However, that objective (price stability) is more credibly attainable under a convertible currency than a pure fiat money. Congress, by overextending the Fed’s policy objectives, has set the Fed up for failure and the politicization of monetary policy.
Instead of being a source of stability, the Fed has too often been “a major source of instability,” as Milton Friedman noted in 1972. Without a credible monetary rule, there is no firm anchor for the dollar. Moreover, the Fed has used its discretion to allocate credit and engage in fiscal policy. By suppressing nominal interest rates and pushing real rates into negative territory, the Fed has engaged in financial repression. There is a strong case that QE is boosting the growth of government spending while hampering real economic growth.
Fed Chairman Ben Bernanke has recognized the limits of monetary policy, but he believes those limits have not been reached. Yet, in the view of one prominent policymaker, Charles I. Plosser, president of the Federal Reserve Bank of Philadelphia, “The potential costs outweigh what appear to be meager potential benefits of further asset purchases and extended forward guidance.”
Trying to stimulate the housing market by purchasing additional MBS only postpones the adjustment in housing prices that still needs to occur to bring about a balancing of demand and supply. Supporting the government debt market, and creating a bubble in that market, only prolongs the incentive of politicians to turn to debt financing and continue the spending spree. And keeping interest rates at near zero levels continues to penalize millions of individuals who have saved for their retirement and now have to take on greater risks to try to maintain their living standards. Those and other costs of Bernanke’s “grand experiment” need to be recognized.
Bernanke has argued that he is not putting “monetary policy on auto-pilot” with QE4. He is merely using economic targets for unemployment and inflation as guides to monetary policy—that is, as indicators about when to begin increasing the Fed funds rate. As such, there is still no binding monetary rule, so uncertainty about future policy persists.
The Fed is evading commonsense and sound economics by relying on fancy stochastic dynamic general equilibrium models, in which erratic money plays no role, and ignoring the fact that the real source of consumption is production, not money. But for supply to create its own demand, markets must be free to determine relative prices, including interest rates. Free private markets also require sound money—that is, money of stable value. Inflation, even mild inflation, destroys confidence in the future value of money under a discretionary government fiat money regime.
The Fed will find it increasingly difficult to reverse course—and raise rates—as core inflation reaches the 2.5 percent threshold. It will be more politically tenable to inflate the debt away than to increase interest rates and taxes. That is why one should not rule out the temptation for the Fed to resort to helicopter money. Indeed, there is a growing chorus now calling for considering the “helicopter drop.”
The Financial Times, in an editorial entitled “Helicopter Money: Extreme Money-Printing Should Be Openly Discussed” (October 13–14, 2012), stated: “Printing money—not just temporarily for trading securities in the market, but permanently handing it over to be spent by someone—is the central banker’s ultimate heresy. Yet it would be irresponsible to rule the option out.”
Sir Samuel Brittan, a columnist for the FT, has suggested that in a situation with “deficient demand,” a helicopter drop of newly printed money would “boost output and employment.” He even offers an “ingenious” twist in which “helicopter money could be stamped so that it lost its value if it were not spent by a certain date” (Financial Times, August 31, 2012).
That experiment was tried in Zimbabwe and failed miserably. Gideon Gono, head of the central bank, created massive amounts of Zimbabwean dollars and placed expiration dates on the notes. The result was a large increase in the velocity of money and hyperinflation. The government then imposed price controls and blamed “capitalists” for the disorder. The loss of economic and personal freedom that resulted should be a warning to any central bank considering the helicopter drop.
If there were “deficient demand,” there would be deflation, not inflation. The high rate of unemployment in the United States is due primarily to structural problems, high marginal tax rates, minimum wage laws, the extension of unemployment benefits, the high cost of employer-provided health benefits, and uncertainty regarding future fiscal rules and regulations. Fear of going off a “monetary cliff” unless the Fed increases aggregate demand is misplaced. The real issue is the rise of the welfare state and a monetary system aimed at supporting big government—rather than limiting its power by denationalizing money.
Rather than considering helicopter money, it would be wise to convene a National Monetary Commission and have a serious debate about rules versus discretion and about alternatives to government fiat money. Limiting the Fed to a single target—zero inflation—would be a step in the right direction. Making the dollar convertible into gold or silver or a basket of commodities and abolishing the central bank would be even more consistent with a free society. As Alan Greenspan wrote in 1966, “Gold and economic freedom are inseparable.”
