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.
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’?”
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).