Monetary policy for the 21st century
Twentieth Century monetary policy can be understood very simply.
One can imagine that, prior to the 1980s, the marginal unit of CPI was purchased from wages. That made managing inflation difficult. In order to suppress the price level, central bankers had to reduce the supply of wages. But reductions in aggregate wages don’t translate to smooth, universal wage cuts. For institutional reasons, attempts to restrain aggregate wages generate unemployment. Prior to the 1980s, central bankers routinely had to choose between inflation or recession.
Then came the “Great Moderation”. The signal fact of the Great Moderation was that the marginal unit of CPI was purchased from asset-related wealth and consumer credit rather than from wages. Under this circumstance, central bankers could fine-tune the economy without disruptive business cycles. When resources, especially humans, were under-employed, expansionary monetary policy could be used to inflate asset prices and credit availability, until increased expenditures on consumption goods took up the economy’s slack. When inflation threatened, contractionary monetary policy restrained asset price growth and credit access, reducing the propensity of the marginal consumer to spend. (“Asset-related wealth” includes speculative gains, the capacity to borrow against appreciated collateral, and the increased willingness of consumers to part with wages and savings due to a “wealth effect”.)
Regular readers know that I am not a fan of the Great Moderation. Central bankers and economists found it pleasant at the time, but sustaining that comfort required that cash wage growth be suppressed, that credit be expanded regardless of overall loan quality, that asset prices be frequently manipulated, as means to a macroeconomic end. In exchange for price stability and moderate business cycles, we mangled the price signals that ought to have disciplined capital allocation, we levered and impoverished American households, we transformed our financial system into a fragile and corrupt cesspool of self-congratulatory rent-seekers. I call that a very poor bargain. (I want to emphasize, because it always comes up, that it was not central bankers primarily that suppressed wages during the period. Globalization and declining union power did most of that work. But central bankers understood very well the importance of wage suppression, and emphasized their willingness, their “credibility”, to push back hard against any increase in the share of income accruing to labor.)
Still, if Great Moderation monetary policy sucked, pre-Moderation business cycles sucked as well. Is there a better way?
It’s no good when the marginal unit of CPI is purchased from wages. That’s the bad old days. It’s no good when the marginal unit of CPI is purchased from asset wealth or consumer credit. That’s the Ponzi scheme that got us into our current troubles. So what kind of dollar should buy the marginal unit of CPI? Ideally, it should be something central banks can “fine tune” without provoking recessions or bubbles, and something that doesn’t involve a macroeconomic imperative to expanded indebtedness.
Here’s my proposal. We should try to arrange things so that the marginal unit of CPI is purchased with “helicopter drop” money. That is, rather than trying to fine-tune wages, asset prices, or credit, central banks should be in the business of fine tuning a rate of transfers from the bank to the public. During depressions and disinflations, the Fed should be depositing funds directly in bank accounts at a fast clip. During booms, the rate of transfers should slow to a trickle. We could reach the “zero bound”, but a different zero bound than today’s zero interest rate bugaboo. At the point at which the Fed is making no transfers yet inflation still threatens, the central bank would have to coordinate with Congress to do “fiscal policy” in the form of negative transfers, a.k.a. taxes. However, this zero bound would be reached quite rarely if we allow transfers to displace credit expansion as the driver of money growth in the economy. In other words, at the same time as we expand the use of “helicopter money” in monetary policy, we should regulate and simplify banks, impose steep capital requirements, and relish complaints that this will “reduce credit availability”. The idea is to replace the macroeconomic role of bank credit with freshly issued cash.
Of course we will still need investors. But all that transfered money will become somebody’s savings, and having reduced the profitability of leveraged financial intermediaries, much of that will find its way to some form of equity investing.
There are details to consider. Won’t this proposal render central banks almost immediately insolvent? After all, conventionally, currency is a liability of a central bank that must be offset by some asset, or the balance sheet will show a gigantic hole where the bank’s equity ought to be. But that’s easy to remedy. Central banks can just adopt an old accounting fudge and claim that policy-motivated transfers purchase an intangible asset called “goodwill”. But, you may object, fudging the accounts doesn’t alter economic realities. Quite so! But what are the economic realities here? Balance sheet insolvency is nothing more or less than a predictor of illiquidity. No firm goes out of business because it’s shareholder equity goes negative. Firms die when they are presented with a bill that they cannot cover. But a central bank with liabilities in its own notes can never be illiquid, since it can produce cash at will to satisfy any obligation. It is book insolvency, not intangible goodwill, that would misrepresent the economic condition of the bank. If the central bank does not pay interest on reserves (which it should not), currency’s status as a “liability” is entirely formal. Central bank accounts should be defined by economic substance, not by blind analogy to the accounts of other firms. The purpose of a central bank’s balance sheet is to present a snapshot of its cumulative interventions, not to measure solvency. Consistent with that objective, a placeholder asset that offsets the formal liability incurred from past transfers would render transparent the cumulative stock and net flow of policy-motivated transfers. 
Then there are more interesting problems, like how routinizing transfers from the central bank to citizens might reshape society. “Free money” would certainly carry consequences, both good and bad, foreseeable and unforeseeable. My suggestion would be that the central banks should make equal transfers to all adult citizens irrespective of income, job, or tax status. That would be simple to understand and administer, and it is “fair” on face. It has other good points. To the degree that transfers are motivated by wasteful idleness of real resources (e.g. unemployment), flat transfers are guaranteed to put money in the hands of cash-constrained people who will spend it. Flat transfers are much more effective stimulus than income tax cuts (much of which are saved), and more effective even than payroll tax cuts (because people with jobs are more likely to save an extra dollar than people without). Further, because such transfers would be broadly distributed, the information contained in the spending patterns provoked by such transfers is more likely to be representative of sustainable demand than other means of stimulus. Status quo monetary policy, in obvious and direct ways, distorts economic activity towards the financial assets and debt-financed durable goods. I hope it’s obvious by now why that’s bad. Transfers to the already wealthy (e.g. income tax cuts) amplify the influence of a relatively small group of people whose desires are already overrepresented in shaping patterns of demand.
There is also a kind of macro-level justice in combating depressions with flat transfers of cash. During booms, income inequality typically grows as workers and investors in “hot” sectors do very well. In theory, there’s a positive sum social bargain that encourages us to tolerate that inequality. If people are growing rich by performing activities that are genuinely of great value, even very unequal distribution of the new wealth may leave everybody better off, and the fact that people at the center of that production get rich provides a useful incentive for people to do great things. However, when booms are followed by great busts, it suggests that some of the apparent wealth created during the boom was in fact illusory. Ideally, we’d have a system where the producers of illusions lose their wealth when it is revealed that they had in fact produced nothing of value. But in a world where everything is liquid, where risks are easily transfered and apparent gains can be converted to cash on a moment’s notice, the relationship between quality of production and wealth-you-get-to-keep becomes murky. Episodes of illusory production end up causing aggregate pain, even while the illusionists keep their gains. Using flat transfers to combat the aggregate pain compresses the distribution of relative income, taking back some of the advantage that, in retrospect, was not well earned during the boom.
The most obvious hazards of monetary policy transfers have to do with dependency and incentives to work. If people grow accustomed to getting sizable checks from the central bank, that would change behavior. But not all changes are bad. For example, it may be true that many workers would be pickier about what jobs to take if government transfers generated incomes they could get by on without employment. Employers would undoubtedly have to pay people who work unpleasant jobs more than they currently do. But that’s just another way of saying that workers would have greater bargaining power in negotiating employment, as their next best alternative would not be destitution. That we’ve spent 40 years increasing the bargaining power of capital over labor doesn’t make it “fair”, or good economics. Supplementary incomes are a cleaner way of increasing labor bargaining power than unionization. Unionization forces collective bargaining, which leads to one-size-fits-all work rules and inflexible hiring, firing, and promotion policies, in addition to higher wages. If workers have supplementary incomes, employment arrangements can be negotiated on terms specific to individuals and business circumstances, but outcomes will be more favorable to workers than they would have been absent an income to fall back upon.
Still, it is possible that too many people would choose to “live off the dole”, or that people would come to depend upon income from the central bank, limiting the bank’s flexibility to reduce transfers when economic conditions called for that. So here’s a variation. Rather than distributing cash directly, the central bank could make transfers by giving out free lottery tickets. The winnings from these lottery tickets would constitute transfers from the central bank to the public. But the odds that any individual would win in a given month could be made small, in order to prevent people from growing dependent on a regular paycheck from government. Plus, it would be easier for the central bank to reduce the “jackpot” offered in its free lottery than to scale back payments that people have come to expect. If you buy the thesis that poor people experience increasing marginal utility to wealth, paying out large sums occasionally rather than modest sums frequently might be ideal.
I know this all sounds a bit crazy, a new normal under which central banks would print money to fund lottery payouts and then fake an asset on their balance sheets to offset the spending. But these are perfectly serious proposals. Futurama, baby.
 There is a theory that the value of a currency is somehow related to the strength of the issuing central bank’s balance sheet, so a currency issued against fictional “goodwill” would quickly become worthless. Suffice it to say that, with respect to non-redeemable fiat currencies, there is absolutely no evidence for this theory. There is no evidence, for example, that the purchasing power of the US dollar has any relationship whatsoever to the Fed’s holdings of gold or foreign exchange reserves. The assets of existing central banks are mostly loans denominated in the currency the bank itself can produce at will. You may argue that those assets are nevertheless “real”, because repayments to the central bank will be with money earned from real activity. But that assumes what we are trying to explain, that people are willing surrender real goods and services in exchange for the bank’s scrip. Perhaps fiat currency derives its value from coercive taxation by government, as the MMT-ers maintain. Perhaps the imprimatur of the state serves as an arbitrary focal point for the coordination equilibrium required for a common medium of exchange. I don’t know what makes fiat currency valuable, but I do know that the real asset portfolio of the issuing central bank has very little to do with it.