The monetary & fiscal distinction revisited
Monetary policy involves changes in the supply of base money and is carried out by central banks. Fiscal policy involves taxation, spending and transfers carried out by national treasuries.
There are important and subtle distinctions which apply to these terms. Importantly, terms such as ‘tax’ and ‘transfer’ are not just purely economic concepts – they have legal and institutional characteristics too. For example, not paying an IOR on required reserves is often described by economists as a ‘tax’ on banks. In a purely economic sense this may be true. But legally it is not considered a tax.
Economists are rarely acutely focused on these distinctions. They are increasingly relevant – and we may be found wanting. Such distinctions are central to the next frontier of macroeconomic policy – the policies which will prevail when QE and lower policy rates become exhausted. We may already be there.
If you’re bored of the helicopter money debate, I apologise. It may help to think of it like this: how should we organise monetary and fiscal policy when further reductions in official interest rates, asset purchases and forward guidance have reached sensible limits? Colourful metaphors aside, that is the heart of the matter. If ‘helicopters’ upset you – think of it as post-interest rate monetary policy.
The somewhat illusive Mr JKH, who writes this blog, recently suggested that I am being dogmatic in insisting that helicopter money is ‘monetary policy’. As dogmatic, in fact, as those who say it is ‘fiscal’.
My position is that there does not need to be a fiscal component of helicopter money, but if there is one, it depends on the jurisdiction, and on the specific institutional arrangements used to implement it. In considering helicopter money, there are many important institutional choices to make.
Helicopter money can be purely monetary policy (and I suspect that this is institutionally optimal), but it could also be a combined action between the treasury and central bank. For example, under the definition of helicopter money as base money-financed transfers to the private sector which are not aimed at altering market interest rates, any central bank which pays different interest rates on different categories of reserves can engage in a helicopter drop. Consider a central bank which pays a higher interest rate on required reserves than on excess reserves, which affect market interest rates. The central bank can raise the interest rate on required reserves to whatever level it chooses and make a transfer to the banking sector. This is a purely monetary helicopter drop – a base-money financed transfer to the private sector using the legal and institutional tools of the central bank, something the Bank of Japan is already doing. (To argue that this has ‘fiscal effects’ in an abstract theoretical sense is not relevant – all monetary policy changes have fiscal effects, this does not make them fiscal policy – this is the ‘Bundesbank fallacy’).
Alternately, if a central bank agrees to coordinate with the fiscal authorities and says it will initiate a QE programme to purchase all of the bonds involved in a new fiscal stimulus, or will directly finance the new fiscal stimulus, this is clearly a combined monetary and fiscal operation (some economists will argue that a commitment about the future by the central bank is required to make this a ‘helicopter drop’, but that is a separate point).
Similarly, if by Act of Parliament, the UK government gives the Bank of England a new power to credit households with money financed by reserve creation in order to meet its inflation target, this would be deemed monetary policy in future. Is this delegating a combined fiscal-monetary operation to the central bank? I’m not sure, but at a certain point the operational distinction cedes to one of convention.
It seems clear then that helicopter money is always monetary policy – to the extent that it involves base money and, at a minimum, the cooperation of the central bank. Sometimes it is coordinated monetary and fiscal policy. This, in fact, is implicit in Milton Friedman’s 1968 AER address, where he points out that monetary policy is never redundant.
So we end up observing that the precise legal and institutions arrangements of future monetary policy will vary by jurisdiction; and within current constraints, different approaches are likely.
I suspect Bernanke’s institutional arrangement for the US, may be the only way the Fed can do helicopter drops – to households, at least. Here is what he suggests:
“So, how could the legislature and the central bank play their appropriate roles in managing a joint monetary-fiscal operation, without endangering central bank independence or falling down a slippery slope of unconstrained monetary finance of fiscal spending or tax cuts? A possible arrangement, set up in advance, might work as follows: Ask Congress to create, by statute, a special Treasury account at the Fed, and to give the Fed (specifically, the Federal Open Market Committee) the sole authority to “fill” the account, perhaps up to some prespecified limit. At almost all times, the account would be empty; the Fed would use its authority to add funds to the account only when the FOMC assessed that an MFFP [money-financed fiscal policy] of specified size was needed to achieve the Fed’s employment and inflation goals.”
I’m not convinced that this is an optimal arrangement for the Fed, because monetary policy’s effectiveness becomes contingent on the partisan and ideological make up of Congress. But it’s a reasonable suggestion and certainly better than nothing.
The institutional framework Bernanke proposes, is explicitly illegal in Europe. In the Eurozone, as I have argued elsewhere, helicopter drops can and must be purely monetary policy. The ECB will have to use its direct lending powers and operate without any involvement of national Treasuries. The UK, has yet to decide which way it will go – and the Bank of England should contribute more to this debate. It has the tools and institutional structure to take either, or both, approaches.
In conclusion, the distinction between monetary and fiscal policy can be carefully made. The next phase of macroeconomic policy will depend more heavily on legal, political and institutional arrangements. Its likely implementation will vary by jurisdiction, and dogmatic categorisation is both unhelpful and, in the main, false.