You can't have your helicopter money cake and eat high interest rates, Adair

Prompted by Adair Turner in an exchange on Twitter, I read this paper of his delivered to the IMF.  The paper is one to set current and former central bank pulses racing.

It's a measure of how far the crisis has led some to think the previously unthinkable that a name mentioned as a candidate for the Governorship of the Bank of England is now writing forcefully about the advantages of helicopter money.  Even pushing it as an option to be preferred over debt financed fiscal policy and forward guidance.

The exchange with Adair was prompted by him pointing out that helicopter money was a less dangerous option for the economy than negative interest rates.  To my mind, this does not make sense.

Helicopter money leads to an increase in the supply of money and liquidity, and this will depress the price of money/liquidity, lowering the interest rate, in other words.  Put differently, the discount at which securities trade below face value will include compensation for the absence of liquidity, or moneyness.  But as money and liquidity become more abundant, money-like assets command less of a premium, and the compensation for its absence falls, raising the price towards the face value of the security, or, equivalently, lowering the interest rate.

Before the crisis, I would have doubted that rates would be pushed negative, even by large-scale helicopter drops.  But with Denmark, Sweden, Switzerland, the ECB and now Japan setting negative rates without dire consequences, I would not bet against it.  That detail aside, the main point is that you can't control both the quantity and price of money at the same time, which is what Adair claims.

Actually, as put, what I have qwritten above is not quite right.  And in his paper, Adair notes that the central bank can require banks to hold reserves, and charge whatever negative rates it liked on those reserves.   However, this is just a tax, one that takes banks off their central bank reserve demand curve.  And one that won't inhibit the injection of money through the helicopter drop from affecting the interest rates on all other assets, along the spectrum of liquidity from very close substitutes to central bank money, to more distant ones.

It will be those interest rates which will, subsequently, most meaningfully express monetary policy, and, since those are not monopoly-supplied by the central bank, the authorities have to live with agents being ON their demand curves for those assets, and, having affected the relative quantities through the helicopter drop, will have to live with the interest rates that emerge afterwards.

In that sense, central banks can't control the supply and price of money/liquidity at the same time.  And this is the only sense that is of material consequence, particularly for the question that worries Adair, namely, the effect of low rates of borrowing on spending, borrowing and leverage.

The tax isn't irrelevant, but it is best understood as part of fiscal policy.  It's no more an indicator of monetary policy than if we were to hear that the central bank required bank CEOs to deliver trays of cupcakes to Mark Carney every morning.

To carry out this thought experiment, I have - without mentioning it explicitly above - had to imagine that the BoE stops paying interest on reserves.  Without reverting to the old monetary policy implementation framework, helicopter money will simply increase the quantity of reserves out there - either directly, or indirectly - on which the central bank has to pay interest, in the form of more interest bearing reserves, leading to an explosion in liquidity.  Adair explains this himself in his paper, and MPC members Carney and Vlieghe have both talked about these consequences too, the former at Treasury Committee, and the latter during a Q and A after his first public speech as MPC member.

Abandoning interest rates on reserves is not a material reason to refuse to contemplate helicopter money, in my view.  But that is probably worth a post on its own, so I will not go into it further here.