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freddiemac
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Helicopter money - Borios argument against

May 25th, 2016, 11:36 am

I always thought helicopter money was a fool-proof way of increasing nominal purchasing power and reviving inflation. But Claudio Borio (chief economist at BIS) made a case against it. I have tried to summarise my understanding of his argument. I would very much appreciate if people have any reactions to Borio's reasoning.. Short descriptionThe key argument for helicopter money is that because the central bank can print money at (essentially) zero cost it is always possible to boost nominal purchasing power by simply printing money. But for a given level of demand for physical cash, helicopter money can only increase the amount of bank reserves. And bank reserves cannot be created at zero cost for society unless interest rates are zero forever. This is because they are a liability for the public sector funding helicopter money deficit and they are at the same time an asset for the banking system funded by eg deposits. If interest rates were to rise the banking system would incur a loss on its reserve holdings, provided that the public sector do not choose to pay interest on reserves. But if they did that then the public sector would instead incur the same loss. So there is a cost either way. And this cost prevents the increase in nominal purchasing power to materialise unless rates stay at zero forever. Longer oneHelicopter money is the central bank shovelling out money from a helicopter. But in practice it would it would probably not be conducted that way... Rather the idea is along these lines: The government issues a perpetual non-interest bearing bond that the central bank buys and pays for with newly printed money. Now the government has money to spend. And this money is free because the government doesn't pay any interest on the bond. So the government don't have to raise taxes in the future and therefore society as a whole has increased its nominal purchasing power. The central bank finances the purchase of the government bond by creating new money (bank reserves). Hence, the central bank and the consolidated balance sheet of the public sector incur a loss if the yield on the perpetual government bond (zero) is lower than the cost of the corresponding liability (bank reserves).For the banking system the reserves are an asset. The asset is funded at the overnight rate (or higher). The banking system makes a loss on the reserves if interest rate at which it funds the reserves is higher than the rate paid on reserves. Banks have some demand for reserves mainly because there are requirements to hold reserves in many (but not all) systems. An increase in the supply of reserves would result in excess reserves - reserves that banks don't want because they are in excess of the requirement. Depending on the particular set-up in a specific monetary system, excess reserves can be remunerated either below the policy rate (scheme 1) or at the policy rate (scheme 2). If they are remunerated below the policy rate (scheme 1) then excess reserves would drive the effective overnight rate to the rate at the central bank deposit facility as banks would seek to get rid of the excess by lending it out to other banks at a rate closer and closer to the rate at the deposit facility. If excess reserves are remunerated at the policy rate (scheme 2) then banks would not care so much if they sit on the excess reserves or not. Under scheme 1 helicopter money would drive the overnight rate to the rate of the deposit facility as the introduction of excess reserves is permanent. The rate of the deposit facility is now the de facto policy rate as it is the one that sets the overnight rate. But if the policy rate is not set to zero then there is no debt financing cost savings for the consolidated balance sheet of the public sector. The same goes for scheme 2. This is because the central bank must now pay interest on the excess reserves while the corresponding asset, the perpetual bond issued by the government, yields zero. The central bank can avoid this cost by creating demand for reserves by introducing a reserve requirement equal to the amount of excess reserves in the system. And then it pays zero per cent interest on those reserves. Now the public sector's cost for the increase in supply of money is zero. But if the policy rate is not meant to stay at zero forever banks will have to bear the cost instead as they would have to hold excess reserves yielding zero but finance those at the positive overnight policy rate. This is the mirror image of the central bank's balance sheet above. The cost has to fall somewhere - either at the public sector or at the private sector. And because this cost only can be avoided by setting rates to zero forever there is no free increase in the money supply and therefore the intended increase in the nominal purchasing power will not materialise, unless we do just that - set rates to zero forever. It wouldn't matter if the central bank literally shovelled the money out from a helicopter instead or more soberly provided cash grants to households. True, the amount of cash would increase mechanically and momentarily. But if the public's demand for cash didn't increase substantially the cash would be deposited at banks and the banks would have to place that money at the central bank as excess reserves. And then we are back at the same situation. Link to Borios VoxEU articleGreatful for any comments on this reasoning!
Last edited by freddiemac on May 24th, 2016, 10:00 pm, edited 1 time in total.
 
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DavidJN
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Helicopter money - Borios argument against

May 26th, 2016, 1:41 pm

How much would you be inclined to pay for a non-interest bearing perpetual bond?
 
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freddiemac
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Helicopter money - Borios argument against

May 27th, 2016, 10:43 am

Fair point. I guess par if rates stay at zero forever. Otherwise less than par... But the bond is irrelevant because the whole point is for the central bank to print money for the government in return for nothing. The bond just serves the purpose of not making the central bank bankrupt. Without it the central bank's liability side would increase as it prints money but nothing would happen to the asset side making the central bank insolvent. But to your point, if the central bank overpays for the bond it is the same issue. And that will result in future taxes at some point as the consolidated balance sheet of the public sector has taken a loss.
Last edited by freddiemac on May 26th, 2016, 10:00 pm, edited 1 time in total.
 
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Orbit
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Helicopter money - Borios argument against

June 1st, 2016, 2:38 pm

QuoteOriginally posted by: DavidJNHow much would you be inclined to pay for a non-interest bearing perpetual bond?In what currency? Confederate dollars? Zim? USD? Just kidding, they're all the same.Zero. With extreme prejudice.
 
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freddiemac
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Helicopter money - Borios argument against

June 2nd, 2016, 10:15 am

QuoteOriginally posted by: OrbitQuoteOriginally posted by: DavidJNHow much would you be inclined to pay for a non-interest bearing perpetual bond?In what currency? Confederate dollars? Zim? USD? Just kidding, they're all the same.Zero. With extreme prejudice.The value should be par if rates stay at zero forever as there is no discounting when rates are zero. If rates go negative then it could be worth more than par as it would be a way of protecting your money if you are facing restrictions to hold cash. But this is beside the point here - the point is that it is only possible to create costless new nominal purchasing power if rates are to stay at zero forever. And I guess you could express it through the value of the bond, ie if the central bank overpays for the bond (which it by definition does if it believes in the scheme in the first place) then you create a loss for the consolidated balance sheet of the public sector. And this loss needs to be restored by future taxes. So there is no permanent increase in nominal purchasing power, which was the very purpose of the scheme.
 
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Traden4Alpha
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Helicopter money - Borios argument against

June 2nd, 2016, 12:24 pm

QuoteOriginally posted by: DavidJNHow much would you be inclined to pay for a non-interest bearing perpetual bond?Good question...Like this one?