Abstract
Abstract The paper offers a rigorous analysis of Milton Friedman’s parable of the ‘helicopter’ drop of money – a temporary fiscal stimulus funded through an increase in the stock of fiat base money that is never completely reversed in present discounted value (PDV) terms. A monetized fiscal stimulus is more expansionary than a debt-financed one because a monetized expansion of the Central Bank balance sheet is profitable: it relaxes the intertemporal budget constraint of the State – it creates fiscal space. It is up to the fiscal authority to make appropriate use of this fiscal space. Four conditions must be satisfied for a helicopter money drop to boost aggregate demand. First, it must not be reversed fully in PDV terms. Second, there must be benefits from holding fiat base money other than its pecuniary rate of return: that is, the interest rate on any additional base money issued is below the rate of return on the Central Bank’s assets. Third, fiat base money is irredeemable – an asset to the holder but not a liability to the issuer. Fourth, the price of money is positive. Given these conditions, there always exists – even in a permanent liquidity trap – a combination of monetary and fiscal policy actions that boosts private and/or public demand demand) – in principle without limit. Deflation, ‘lowflation’ and secular stagnation are therefore policy choices. Other conclusions are: (1) the increase in the monetary base need not be permanent for helicopter money to be effective; (2) Treasury debt cancellation by the Central Bank or the purchase by the Central Bank of perpetuities (with zero, negative or positive coupons) rather than finite maturity debt are fundamentally irrelevant policy actions. At most they have signaling value; (3) dropping perishable helicopter money will make it more effective if households are liquidity-constrained.
Highlights
This paper aims to provide a rigorous analysis of Milton Friedman’s famous parable of the ‘helicopter’ drop of money (Friedman 1948, 1969)
An example would be a temporary fiscal stimulus, funded permanently through an increase in the stock of base money. It could be a permanent increase in the stock of base money through an irreversible open market purchase by the Central Bank of non-monetary sovereign debt held by the public – that is, QE
The household consumption function for this case is given by c (s,t=) (θ + λ ) j (s,t). This is the same as the consumption function derived in (9) from a CobbDouglas utility function with α = 0. That this is where the analogy with the Cobb-Douglas function case ends: when α = 0 in the Cobb-Douglas model, the demand for real balances is, from equation (12)zero – we are in a cashless economy in which money will not be held if the nominal interest rate is positive, because money is rate-of-return dominated as a store of value and does not yield any non-pecuniary benefits
Summary
“Let us suppose that one day a helicopter flies over this community and drops an additional $1000 in bills from the sky,. The paper shows that, because of its irredeemability, state-issued fiat money is net wealth to the private sector, in a very precise way: the initial stock of base money plus the present discounted value of all future net base money issuance is net wealth, an ‘outside’ asset to the private sector, even after the intertemporal budget constraint of the State (which includes the Central Bank) has been consolidated with that of the household sector This irredeemability of base money and the resulting asymmetric treatment of base money in the solvency constraints of households and of the state accounts for our base money expansion/QE effectiveness at the zero lower bound (ZLB), when Eggertsson and Woodford (2003) ( EW) established the existence of a self-fulfilling deflationary trap at the ZLB and ineffective base money issuance or QE. If Woodford’s money were irredeemable (his specification of the solvency constraint of the State suggests it is not) there could be effectiveness of helicopter money drops if the economy were at the ZLB forever
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