Is it permanent? A reply to Nick Rowe

Nick Rowe has written a typically-lucid note which makes clear why it might make a difference to consumer behaviour if a tax cut is permanent, or temporary. To this extent, we are in full agreement: giving someone $100 is different to giving them $100 and taking it back in a year’s time.

Where I may disagree with Nick is that I see no need to introduce the term ‘permanent’ to discussions of helicopter drops – in fact I think it is a major hindrance. I’m happy with Nick’s definition of a helicopter drop as the central bank transferring cash directly to the private sector. Period. But in this context, ‘permanence’ seems a meaningless descriptor.[1]

When I think it through, the modelled world of two-period, forward-looking consumers reacting to tax cuts does not map intelligently onto the real world policy example of a cash transfer from central banks to households. No one is suggesting that the central bank is going to make a cash transfer and a week later levy a lump sum tax. In stark contrast, the central bank governor is going to say something like this:

“We are going to transfer $250 every three months to all adult citizens for the foreseeable future until certain macroeconomic conditions are met. We expect this to last for 12-18 months.”

All the empirical evidence that we have on how individuals respond to transfers analogous to this suggests that demand will rise. Individual household circumstances matter – low income, credit-constrained families are likely to spend more, some families will save it, some will repay debt, etc. But the net effect is an increase in demand, and the other effects – higher savings, debt repayment, are all helpful.

These effects are known without any reference to ‘permanence’. I am not even sure that it is meaningful to ask “is it permanent?” You get $250 every three months. Period.

To make it clear why ‘permanence’ confuses, I’ll revisit the fictional dicussion in a previous post between a journalist, in this case a former student of Nick’s, who asks the central bank governor: “Is this policy permanent?”

“What do you mean? Is what permanent?”

The journalist hesitates, desperately trying to recall which aspect of the policy needs to be permanent for his macro-model to produce an increase in output and fall in unemployment, and eventually tries this: “Is the increase in the monetary base permanent?”

“Hmm. Out of curiosity, do you have a strong belief about the future path of the monetary base, prior to me announcing this policy? Actually, you know what, don’t answer that. I’m not sure ‘permanent’ means much in this context, but here are some thoughts on the future path of the monetary base. It depends on lots of factors – the demand for base money, asset growth in the banking sector, which in turn is influenced by the demand for credit, the regulatory framework etc. Furthermore, we really don’t know how large the output gap is, nor how responsive the supply-side will be in response to an increase in demand. I would not be surprised to see a strong recovery in investment spending and corporates exploiting many new technologies – all of which will raise productivity. We expect inflation to stay low, but if the output gap is larger than we estimate, inflation may even fall and we can keep doing lots of helicopter drops until a relatively high sustained rate of growth and incomes is occurring. Which, by the way, means that fiscal positions are likely to improve dramatically. For exactly these reasons, households really shouldn’t devote any resources of time and effort into understanding what the monetary base is and what causes changes in demand for base money – most economists have a weak grasp. But rest assured, there’s lots of ways we can alter the quantity or the demand for the monetary base without impacting households – so it’s really a separate question. From a household’s perspective, all that has changed is that their financial position and economic prospects have improved.”

Now, in contrast to Nick Rowe, our central banker is a lousy pedagogue. He doesn’t have a neat, simple or clear model. His staff will provide formal models to support everything (anything?) he says, if required – models where households and firms are credit constrained, others where agents have correlated beliefs and make errors of extrapolation and have more debt than they want, models with multiple-equilibria, some of which occur with high unemployment, models where risk premia on many assets are pro-cyclical and supply is endogenous, even models with flexible prices and a large output gap, where behavioural mood-swings create recessions.

But on this occasion, the central bank governor makes his own rare foray into almost theoretical discourse:

“Having said all of that, and seeing as you are an economist, let me address the issue of ‘permanence’ slightly more abstractly. Let’s forget about changes in the monetary base. I like to think the shocks in a random walk are permanent. That does not mean it is impossible for a positive shock to be followed by a negative shock. It does mean it is equally likely that a positive shock will be followed by a positive shock as by a negative shock. In this instance, I would say that our policy is not accurately described in this way. Positive and negative shocks are not equally probable. The processes I am concerned with determine incomes, employment, output and productivity. Now that I have announced this policy, households and firms should expect further positive shocks, as I have described: higher productivity, better employment prospects, higher wages, improving fiscal positions – because that is what happens in a strong and sustained cyclical recovery. So expect positive, correlated shocks – is that ‘permanent’?”

[1]Not least because the definition he introduces in the opening paragraph – which is superb – does not require any assumptions about the future path of inflation, which is typically assumed (including, I think, by Nick in his final paragraph).

About The Author

Eric Lonergan is a macro hedge fund manager, economist, and writer. His most recent book is Supercharge Me, co-authored with Corinne Sawers. He is also author of the international bestseller, Angrynomics, co-written with Mark Blyth, and published by Agenda. It was listed on the Financial Times must reads for Summer 2020. Prior to Angrynomics, he has written Money (2nd ed) published by Routledge. He has written for Foreign AffairsThe Financial Times, and The Economist. He also advises governments and policymakers. He first advocated expanding the tools of central banks to including cash transfers to households in the Financial Times in 2002. In December 2008, he advocated the policy as the most efficient way out of recession post-financial crisis, contributing to a growing debate over the need for ‘helicopter money’.

7 Responses

  1. David Harold Chester

    The introduction of a citizen’s dividend (as some people call the “helicopter drop”), will inflate the currency and make lenders loose less spending power on the return of their debts, whilst causing savers to loose the same quantity.

  2. David Harold Chester

    I would like to see the new models and their greater use in economics, including banking. However, there is a danger that incomplete models will distort the situation being depicted. In fact only a complete model is satisfactory and consequently I would advise the model builders to follow the methodology and model type that I have used in my new book (“Consequential Macroeconomics”), which also may be seen on Wikimedia, commons, macroeconomics as: DiagFuncMacroSyst.pdf . The book may be freely obtained by writing to me for a e-copy,

  3. Nick Rowe

    Eric: thanks for the response.

    Let me put it this way: suppose you convinced me that central banks will be unable in practice to convince people that the new money is permanent. I will say “OK, then central banks cannot in practice do helicopter money”.

    • Eric Lonergan

      I think I have been expressing my point poorly. I define a helicopter drop as a base money-financed transfer to the private sector from the central bank. That to me is a policy innovation (we can debate whether or not paying an IOR on required reserves qualifies – I think it does, but usually it’s trivial). Now, I think helicopter drops as I have described them – and without any further changes to standard policy frameworks – would work as a policy tool for closing the output gap.

      Consider the Eurozone, which is the main candidate currently. If the ECB announces that it will transfer €250 every month to very adult citizen until the output gap closes, do you think it would raise demand? I think it has a very high probability, close to certainty, of doing so.

      My problem is that I don’t see the relevance of ‘permanence’ to this proposal, because the means by which demand rises is clear, although the effects on other target variables, notably inflation are uncertain – perhaps symmetrically so. Inflation might fall. And base money might shrink, if for reasons of financial stability the ECB reverses QE and raises interest rates to 2% – realising that cash transfers are a far more effective way of targeting demand. (It is also by no means clear that raising interest rates in these circumstances would not provide a ‘doughnut effect‘ stimulus.)

      This policy is different to a tax cut. Usually, when we think of a tax cut being reversed it is analogous to your plan B – I give $100 and then take it back. But there is no analogue to this in the helicopter policy I describe. Let’s say some people expect the central bank in the future to remove the additional reserves created by the transfer – even with these beliefs there is no reason to expect the effect on a household to be symmetric. Raising reserve requirements, selling bonds through OMOs, raising IOR – none of these policies amount to a symmetric ‘reversal’ in their effects on household balance sheets and incomes.

      But most importantly, even if you assume that the central bank, contingent on the output gap closing, is going to fully reverse the financial benefit (which might imply a greater future reduction in base money, btw) – you are still better off for the helicopter drop. Why? Because you are only going to be ‘taxed’ at full employment, and conditional on full employment persisting even after you are taxed.

      A final way to think about this may be to relate it to the two scenarios you presented. We have two policies: Policy A, I print $100 and give you $100. Period. We then have a new Policy B. You are now unemployed and you get given $100, but in contrast to Scenario A, it gets taken off you if you get a job. Oh, and if you get your job you’ll barely remember the $100 … nor care too much about losing it.

      I’m not convinced the economics of policies A & B are that different.

  4. Antti Jokinen

    Thanks for the post, Eric!

    I think you make relevant points about the problem with “permanence”. I’ve found the “permanent increase in monetary base” a problematic concept in Adair Turner’s writings on Over Monetary Finance.

    Being an accountant, I’m interested in hearing what it means to you, accounting-wise, for a CB to “transfer” euros or dollars to citizens (i.e. crediting citizens’ accounts)? Which account will get debited at the CB, and whose liability does that account represent? I don’t want to get too technical — I just want to understand the logic. A parallel from a commercial bank: The bank can credit one person’s account with $100, but it needs to simultaneously debit another account. And this other account must be connected to a party other than the bank itself. (This is the logic behind banking, and I’d like to understand how that logic works in your “helicopter drops”.)

    Have I missed some steps here?

    • Eric Lonergan

      Thanks Antti. Good question, which highlights the difference between CB & commercial bank. When a CB buys a bond under QE – it creates a new deposit in the system. Money has not been transferred from one bank account to another. Same with a transfer to a household. There is no ‘debit’.


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