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. [1]

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.

[1] 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.


61 Responses to “Monetary policy for the 21st century”

  1. […] given that the Federal Reserve is always actively manipulating rates.) Jared Woodard sends me an Interfluidity post suggesting that the most viable way forward for monetary policy after the failure of the Fordist […]

  2. Sam writes:

    I was just reading a bunch of political philosophy articles about basic income grants, so it’s interesting to see someone come at the question from a macroeconomic perspective.

    I have what may be a stupid question, though: would the provision of a basic income grant just cause the prices of lots of goods and services, especially those heavily used by low-income people, to increase accordingly? I’m talking rent, groceries, etc.

  3. chrismealy writes:

    How much money are we talking about? $100/month ain’t Speenhamland.

  4. Bruce Wilder writes:

    The Federal Reserve could take over the electronic payments system — Visa/Mastercard and whatever Verizon/AT&T choose to do to ‘compete’ with Visa/MC. That would give them both a lot of real-time data from which to take accurate feedback, and a conduit to seep money and credit into the economy very broadly.

    The “free lottery ticket” you suggest could just be your participation in the electronics payment system from having a debit card (or futuristic digital equivalent). But, the Fed could also make small variations in the merchant charges, or the time-lapse in crediting and confirming transactions — directly manipulating the “velocity” of money, if that hoary concept can still have meaning.

  5. baduin writes:

    The only stable form of banking would be a version of full reserve banking. The fundamental principle would be that banks are unable to create money. All money creation, no matter whether áwe are speaking about M1, M2 etc, is done by the government. Maturities of assets and obligations must be matched. In other words, a money on a demand account couldn’t be be used to finance a loan. A time deposit would enable the bank to make a loan of no longer duration. Of course, there would be need for adequate capital requirements etc.

    Banking would be divided into at least three separate areas with no overlap, even in ownership, allowed.

    1) “electronic money” which are regulated utilities responsible for “debit cards” – not credit cards. This would be a typical oligopoly with two or three players. Those utilites would do NO investing, lending etc – they would only deal with money transfers, and would live off fees.

    Any credit lines for eg “credit” cards would be provided by absolutely separate companies. On the other hand “electronic money” utilities would handle ALL monetary operations, for private persons and banks.

    It would be impossible to have an account in any other bank. The fundamental principle of the “electronic money” would be the unchanging amount of money in the system. Electronic money utilities could credit an account of someone only by debiting another account. (And, of course, no “electronic money utility” could held their own account.)The only entitity which could create new fiat units would be the government.

    2) Consumer lending – very stringent size limitations, certainly no company would be allowed to have more than 1 % of the market. Mutual lending would be preferred, also Sparkassen etc.

    All monetary operations would be done for them by the electronic money utilities – the same applies for all banks.

    3) Commercial lending and investment. Not as strict size limitations, perhaps one company can have even a few % of the market. There would probably be a need of Glass-Steagal style separation between lending and investment. Of course, there would be very strict capital restrictions – and NO government guarantees. If you want a risk-free investment, lend to the government.

    In this system, all money creation would be done by Central Bank/Government, and the resulting income, as seigniorage, would of course belong to the government. Of course, money would NOT be treated as anyone’s debt – there is no reason for it – but as asset.

  6. Arjun writes:

    A modest proposal. Brilliant.

  7. Jim Bradley writes:

    Hi Steve,

    I really like the idea of cutting out the banking system from continuous subsidy. (In fact, you probably have noted that quite a number of entities / individuals are pure tax consumers, having not paid any tax at all for their existence, since all their funds are gained by non-market illicit means – and that remains true despite what their tax returns say as they simply return a portion of stolen funds). A couple of issues you might have thought about already.

    1 – The psychological effects could be devastating … “Free Money” would lead to tremendous political pressure to continue the printing. I concur that the issue is some people get the free money while the rest of us have to work for it. Gold money seems a lot better from that perspective. I’d like to see free market money … with all the problems that it has … it’s still going to be better than government money run by and for government connected insiders.

    2 – The proposal might create an additional relative pricing problem. As long as the “price level” (unmeasurable, but still a concept worth keeping) remains within a range, relative prices (prices between goods) are more important than the changes in the overall “price level”. The price levels of various non-productive activities would be kept with helicopter-drop money, distorting incentives… Not that the incentives aren’t severely distorted now .. as the bankers apparently get almost all of the money and the rest of us don’t.

    3 – Money tracks the creation of real assets, which cannot occur in a command economy. Now that the productive ability that creates real assets has cratered from decades of accumulated malinvestments, I am not so sure it’s a good idea to try and sustain that mountain of debt by various methods. I confess I don’t have a “least painful” solution to this dilemma (perhaps your proposal is it, but without a correction, it may simply be a similar outcome to what has happened in Japan).

    4 – The powers-that-be are not going to give in to this (effectively eliminating their visible and invisible subsidy) – it would be a revolution and I doubt it would be peaceful. I think the real problem is the transition if it could be done. This objection, to me, is a crucial issue. Outside of the war-making powers of a First-World Nation State, how do you propose that this be implemented over the (violently defended) objection of those that are in power now?

  8. JKH writes:


    Central bank operations are mostly about short term interest rate control. In terms of actual money effects, conventional central bank activity is largely fiscal; e.g. issuing currency on demand as an effective component of deficit financing. The institutional separation of treasury and central bank doesn’t change this.

    Ironically, the only pure central monetary policy (i.e. cleanly separable from fiscal policy) is “credit easing” – swapping risk free assets for risk assets – which in fact is considered “unconventional” monetary policy.

    Helicopter money is definitely fiscal. It’s a negative tax with a particular profile, flat or whatever. You can use the central bank as the institutional conduit, but its deficit spending/financing.

    You’ve been captured a bit by MMT, which prescribes the formal absorption of monetary policy by fiscal policy. Helicopter money is monetary/fiscal easing; taxation is monetary/fiscal tightening.

    Your proposal might work for consumer goods financing and credit card financing, but not for residential real estate financing.

    That’s because real estate requires multi-year capitalization finance that cannot be replaced by pay as you go finance (e.g. helicopter drops). Consumers can save from past income to purchase HD TV’s much easier than they can do for houses.

    Real estate financing and home ownership is the big problem.

    This is symbolized correctly and operationally by the fact that home values are not part of the CPI. That’s because they’re capitalized asset values rather than pay as you go product cost outlays.

    The capacity of governments and their fiat currency central banks to issue reserves, currency, and debt means that their liquidity resources trump any solvency concern. Negative balance sheet equity is the norm. It is not a problem. Deficits and debts don’t get “paid back” in their entirety, or anywhere near their entirety. The big gap on the asset side of the consolidated GCB balance sheet – negative equity – could just as easily be relabelled as the inherent value of state provided liquidity.

  9. winterspeak writes:

    JKH: Agreed. This suggestion is 95% MMT with the clarity of accounting removed.

    SRW: Welcome! (almost)

  10. VJK writes:

    JKH @ 8:

    “In terms of actual money effects, conventional central bank activity is largely fiscal; e.g. issuing currency on demand as an effective component of deficit financing.”

    On the contrary, the conventional Feds activity is monetary. Under the current law, the Treasury account cannot be overdrawn. To cover a possible deficit, the sequence is as follows: 1)issue bonds first; 2)then spend.

    “The institutional separation of treasury and central bank doesn’t change this.”
    In fact, it does unless the existing law is changed and the two entities are merged.

    “The capacity of governments and their fiat currency central banks to issue reserves, currency, and debt means that their liquidity resources trump any solvency concern”
    I am not sure what ‘solvency concerns’ you have in mind and why you bundle HPM and T-bonds/notes together, but the M0 volume fluctuates, trending upward, as a side effect of maintaining the targeted FFR through open market operations. In any case, the ‘high-powered money’ stock of about 1 tril is dwarfed by the debt IOUs of which bank credit money constitute about 20 tril, commercial bonds about 30 tril and the US debt about 50 tril (I may be misremembering the actual numbers but the order of magnitude should be OK).

  11. john c. halasz writes:

    How about an alternative proposal: a progressive consumption tax system. Raise a high VAT, say, 40%, to be counter-balanced by a sharply progressive, mostly negative income tax, say, ranging from 10% to -50%. Add on a land value tax and a Tobin tax to dampen speculative tendencies, and a marginal net worth/wealth tax on the upper crust, say, .5% starting at $1 million and topping out at 3% at $100 million. (And a restoration of the “death tax”, of course). The two basic problems AFAICT that you’re seeking to address are misallocations of capital investment and deficiencies of wage-based aggregate demand, which tend to be recurrent, if not chronic. Direct taxes on both employment and ingoing real capital investment would be eliminated, together with all the complications and manipulations of the tax code that result in wasteful evasion and arbitrage activities, such as PE LBOs, while transaction and administrative costs would be low, (i.e. the tax would be readily collected and redistributed through the same mechanisms by which taxes are currently deducted from wage and transfer payments). Out-flowing profits would be collected through the rise in financial asset prices resulting from dividends and capital gains, and, if the mucky-mucks can’t figure out how to invest their wealth at rates that exceed the marginal tax rate on wealth, then they will either have to spend their wealth, (with trickle down effects amplified by the tax system), or watch their wealth diminish. (I.e. investors will have to earn their keep by seeking out actually productive investment opportunities). And the high VAT should provide some buffer against import/export imbalances.

    I don’t think inflation was ever really the key threat that it was made out ideologically to be, such that monetary policy to maintain “price stability” was the key means to maintain both adequate demand and allocative efficiency in an otherwise entirely self-stabilizing economy. Rather monetary policy primarily works through the credit system and on short-term rates, such that it mainly works on the broader real economy through “interest rate sensitive sectors”, which means mostly housing and construction and consumer durables, without effecting much the calculations involved in long-run real fixed investment, while favoring the accumulation of debt vs. wages and equity and thus the short-termism and financialization of productive activity, thus introducing distortions to economic balances of its own, likely worse than largely exaggerated fears of the self-accelerating and distortionary effects of inflation in the long-run. But, needless to say, the parameters of such a tax system could be adjusted to meet the macro-economic states of business cycles.

  12. JKH writes:


    I’m quite aware of the rather lengthy debate at the Mosler blog on the operational aspects to which you refer.

    The normal central bank balance sheet features government debt as assets for the most part, with reserves and currency constituting most of the liabilities. On consolidation with the government balance sheet, the central bank assets and the corresponding government liabilities cancel out. The net effect is that the central bank balance sheet is used as a conduit for deficit financing, with reserves and currency replacing what would otherwise be government debt. Operationally, this is accomplished by the CB buying government debt to replace the reserves that are extinguished when banks come in for more currency. Reserves are typically minimal and relatively stable in normal economic environments.

    The actual institutional arrangement that you correctly identify relates to the mechanics of the government’s operational interface with the central bank. The issue at the Mosler blog was whether MMT represents that actual relationship consistently within its paradigm for describing monetary operations. That’s quite a separate point. The actual central bank and government operations do lead to the conclusion I’ve noted regarding the natural fiscal policy content of monetary policy.

  13. VJK writes:

    JKH @ :

    “The actual central bank and government operations do lead to the conclusion I’ve noted regarding the natural fiscal policy content of monetary policy.

    I am sure there is a reason why you keep merging CB operations (monetary policy) with government operations (taxation/spending, or fiscal policy). Whatever the reason, under the current law, the Fed is an independent, from other government entities, unit.

  14. JKH writes:


    “I am sure there is a reason why you keep merging CB operations (monetary policy) with government operations (taxation/spending, or fiscal policy). Whatever the reason, under the current law, the Fed is an independent, from other government entities, unit.”

    I haven’t merged operations. Under current institutional arrangements, the independent central bank buys back government debt when it issues currency. The net result is that prior deficits are offset with currency instead of debt. That’s a fiscal financing arrangement.

    The consolidated balance sheet effect is the result of separate institutional operations as per current law.

  15. Sergei writes:

    VJK: “the Fed is an independent”

    Independent from what?

    Currency (Federal reserve notes) is required to be fully backed by collateral which is required to be Treasuries. Currency is issued to banks on their request and not FED will

    OMO (open market operations) are a response of FED to interest rate changes in the interbank bank. Not doing this means violation of interest rate policy and so FED has to intervene. Primary tool of OMO is purchase and sale of treasuries.

    So what is really FED independent from? It does what private sector forces it to do. It thinks it can set interest rates independently but does it really really matter for the economy? There was a booming economy from rates were going up and now there is no economy when rates are at zero.

  16. JeffreyY writes:

    I’ll try to get a handle on the likely sizes of payments:

    Assume 2% inflation implies 2% annual money supply growth, in the long run. Before the recent crisis (Jan 2008), M1 was 1.38T ( I’ll assume that the crisis represents only a temporary increase in demand for money. So a 2% increase/year gives 27.6B/year. Divided among the U.S.’s 307M people, that’s $90/person/year. If you want a 4% inflation rate instead, it’d be $180/year. If you think the recent increase in money demand is permanent and also want 4% inflation, it’d be about $230/year.

    Even at $230/year, the risk that people would start “living off the dole” seems small. Coming to rely on the payments would be more of a risk, but recall that the payments would only decrease when the economy was booming anyway, so it shouldn’t cause much hardship.

  17. […] interfluidity » Monetary policy for the 21st century […]

  18. BSG writes:

    Steve – it seems that the problem your proposal is intended to solve is the one created by a debt driven economic system in which ever escalating levels of debt inevitably and invariably lead to destructive and disruptive inflation-deflation (boom-bust) cycles.

    Maybe it would be better to eliminate the root problem to begin with rather than taking the doomed ptolemaic approach of ever more intricate tweaking to solve a problem that is preventable to begin with.

    It does appear that currency dispersal will likely be part of a one time solution to extract ourselves from the current morass (along with a special – read equitable – resolution/bankruptcy regime.) Longstanding experience with large scale money creation casts doubt on its sustainability as an on-going mechanism for wealth creation and distribution. You say you don’t know what makes fiat currency valuable, but I’m sure you know that regardless of what it is, it can lose its value quite quickly, causing a lot of havoc.

    Also, perhaps it’s just your rhetorical approach, but it seems that once again you’re giving TPTB way too much credit by reversing reason and rationalization. I submit that the evidence suggest that the reasons for current and longstanding policy is that it favors highly influential banksters and other financiers who use mostly other people’s money to buy their influence influence and use it to transfer wealth upward to themselves. I don’t detect any concern on policy makers’ part for the general welfare, quite the contrary. The rationalization is certainly external and most likely internal as well – mental gymnastics is arguably the most popular participative sport.

    Having said all that – kudos once again for an excellent presentation of the issues.

  19. JKH writes:

    “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.”

    Of course, that’s true at the micro level but not at the macro. The marginal CPI unit purchased with asset related wealth and consumer credit generates equal and offsetting micro saving at book value. One person’s consumption expenditure from wealth is another’s saving from income. It’s a distribution game at the macro level. We don’t hear much about the micro savers that are required in this macro equation, unless they’re in China. But some of them are in the US as well. The wealth and credit fuelled CPI purchase just puts those taking advantage of it at the front of the aggregate demand queue, looking to satisfy demand from a finite supply source, and increasing the totality of aggregate demand in doing so.

  20. JKH writes:

    “The purpose of a central bank’s balance sheet is to present a snapshot of its cumulative interventions, not to measure solvency.”

    Right on!

  21. JKH writes:

    “There is also a kind of macro-level justice in combating depressions with flat transfers of cash.”

    A sort of negative convexity for the wealthy as things implode?

    That’s rubbing it in. Hear them scream.



  22. […] policy is like a character on Jersey Shore. You never quite know what it’s going to do. We’ve got inflation v. recession. Then there was the whole […]

  23. JKH writes:

    “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.

    Very interesting again, SRW. While I dislike dwelling on MMT at this stage, it does seem to be useful at times. The MMT absorption of monetary policy by fiscal policy extends the idea of OMO (open market operations) from conventional asset-liability monetary operations to expenditure/tax fiscal operations. Taxation is viewed as a direct drain on aggregate demand, somewhat analogous to the conventional view of CB bond sales as a drain on system liquidity. The desired MMT fusion of monetary and fiscal policy could be implemented operationally with the actual fusion of government and CB balance sheets and operations, as is the case in the “no bonds” option. What is not said is that this endows the resulting entity of government with a fundamentally bank like characteristic. It is a mismatched bank, with negative equity, but it is a bank that both spends and lends money into existence, and drains it when desired with a variety of policy “tightening” options, including taxes. The MMT “job guarantee” further extends the OMO mechanism into the employment realm, with JG employees being injected into the private sector during booms and withdrawn during busts. Along these lines, your flat transfer mechanism seems like still another type of OMO for income distribution purposes, calibrating relative incomes on a countercyclical basis, I think. It’s all looking like a continuum to me now.

  24. David Pearson writes:

    Strikes me that Brazil had an effective transfers mechanism in the form of public sector salaries. Public sector raises there came very close to the Central Bank depositing more money in millions of individual accounts.

    The problem in Brazil, of course, is that people chose to store their wealth in either goods or stronger currencies.

    Any proposed solution to de-levering raises two questions. The obvious one is, “what are the chances of success?” The one that doesn’t seem to get asked is, “what are the consequences of failure?” The problem with central-bank financed tranfers is that, ultimately, a loss of faith in the currency would necessitate a worse austerity than the one you are trying to avoid now. At least that has been the experience of countries that turned to dollarization to escape hyperinflation.

    Don’t tell me that central bank transfer payments are beneficial; instead tell me a story about why Americans will retain faith in the currency. Story #1 seems to be, “just look at Japan”. That is a good headline, but it raises many more questions than it answers.

  25. Indy writes:

    Or you could do it in two steps. The Central Bank could announce a permanent increase in the monetary base and buy government bonds with a commitment to eternally reinvent (“Monetize The Debt” in the parlance of some). The government then uses the money to buy goods and services and make transfers according to the whole democratic legitimacy, consent-of-the-governed paradigm.

    It can do so in as economically efficient a manner as possible (according to the current best-guess of the ever-changing behavior patterns of the citizenry), but such efforts will most likely have to be compromised with a bit of efficient political economy.

    But take another step down the game-theoretic rabbit hole (towards a kind of Nash equilibrium but always keeping in the mind the the Central Bank has the privilege of being a true last actor) and the Central Bank can respond to the government’s politicized distribution scheme by decided when to monetize and by how much to achieve the desired effect through this political transmission channel (as they sought to do over the past three decades with the credit channel.

    But is a Central Bank that acts in this (arguably equivalent) manner with its hands always on the knobs of monetization … really altogether different from the current regime?

  26. VJK writes:

    JKH @ 14:

    “Under current institutional arrangements, the independent central bank buys back government debt when it issues currency.”


    “The net result is that prior deficits are offset with currency instead of debt. ”
    No. The net result is increase in superfluous bank reserves. The treasury account is not affected so no offset can possibly take place. Thus, at the FFR at almost zero — the knob does not move any more counterclockwise, the Feds’ “writing check on itself” has no effect on credit money demand and cannot be considered fiscal spending either –no money is getting into the private sector’s pockets — unless having bloated reserves and subsidizing banks by paying interest on the reserves can count as such.

  27. VJK writes:

    Sergei @ 15:

    “Currency is issued to banks on their request and not FED will”
    Banks *buy* cash from the Fed by having their reserve accounts debited — there is no money creation here.

    “OMO (open market operations) are a response of FED to interest rate changes in the interbank bank. ”
    You have the causality reversed here.

  28. scrilla_gorilla writes:

    I am not sure what I think of your idea in practice. But I will say that you a truly original, deep thinker. Too bad that isn’t the norm.

  29. Lord writes:

    The amounts would be too small to have much deterrent effect on work. There might be a clamor for larger and more regular payments especially for the needy, but by limiting bonuses to recession and near aftermath and keeping it at the Fed and stressing job, welfare, and tax policy to be from Congress, it could work. Then in the current downturn, 6% of $50k per household or about $3k for a few years would help remedy recessions. Most would be less.

  30. Steve,

    Thoughtful post as always. You should have a look at this piece by Professor Scott Fullwiler,

    which deals with the “fiscal aspects” of helicopter drops. Barring this “fiscal role” monetary policy in its classic incarnation has limited scope to deal with a major spending collapse which then evolves into an entrenched period of deflation. The notion that fiscal policy should be passive and monetary policy should be the primary counter-stabilisation tool is still anathema to most policy makers.

  31. […] Monetary policy for the 21st century Steve Waldman. Today’s must read. […]

  32. Alex F. writes:

    Great blog and a great post.

    I made a similar proposal at Scott Sumner’s “Money illusion” blog some weeks ago, combining helicopter drops with Sumner’s ngdp targeting. (Please, excuse my bad English.) :

    “…why can’t we have monetary policy without debt?…Let say the president addresses the public: “Dear Americans, you underpriced yourself causing deflation, depression, unemployment… Ngdp growth under 5% is un-American. We have do believe in ourselves. I believe in you, the Fed believes in you. To fight another depression, the Fed will therefore stimulate the economy (not by buying any debt or forcing people to go into debt) but by buying the “goodwill” of each and every American. Everybody gets for his “goodwill” each month a check from the Fed until we have 5% ngdp growth expectations.”

    The Fed just writes down on its balance sheet: bought “goodwill” of 300 million Americans.

    If we get too much ngdp growth the Fed devalues the “goodwill” by tightening the money supply. If ngdp falls again, the Fed raises the value of “goodwill”, sending checks to each American. No debt involved.

    Sure, “goodwill” works just like a helicopter drop financed through selling government bonds but it looks and feels different since no debt is involved. It’s like a gigantic debt-equity-swap. It’s a way to monetize expectations. Treating expectations as an asset. Paying people to be optimistic when ngdp is down, letting them pay when they are over-optimistic and ngdp is too high. A bit like treatment of bipolar disorder:-)

    Could this work?”

    Sumner responded that it could work, but he didn’t like it. He is not a fan of fiscal policy.

    I got the idea by reading about Abba Lerner’s “functional finance” proposal. Great economist! Even Milton Friedman was once a Lerner fan. See his “A Monetary and Fiscal Framework for Economic Stability”

    By the way, I think Friedmans “negative income tax” goes back to Abba Lerner. If you use taxes as a means for monetary policy, negative taxes become helicopter drops, positive taxes are helicopter pick ups. The overall idea was to have a progressive income tax preventing inflation by putting workers in good times in higher income brackets (an automatic stabilizer). In bad times people are in lower income brackets = taxes get reduced. Since the lowest income brackets pay no taxes, reducing can only be done by a negative tax. So a negative income tax becomes a natural part of functional finance framework.
    I like this way of introducing a negative income tax, because there is no redistribution implied. It’s just monetary policy.

  33. RueTheDay writes:

    Steve – An interesting idea, though I doubt there would be much political will to reduce the transfers when the time came, so it would likely become a very asymmetrical policy over time.

    At the end of the day, what needs to happen is the banking system needs to become more utility-like, and once that happens, then a cleaner sort of counter-cyclical credit control can be implemented.

  34. Neill writes:

    I appreciate your article. Almost any proposal is better than the chaos that is about to ensue if the downward spiral of unemployment and depressed demand isn’t contained. It’s a shame the powerful and the elite have acted so recklessly in the pursuit of gain, that the average person may potentially be left with nothing. It isn’t too far removed from feudalism, and the peasantry may well rise against the elite if things get bad enough. The history of civilization is one of conquest and man’s rising against oppression.

    You stated that “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.” The three inputs of production are capital, labor, and material, with capital purchasing the other two. Assuming $1 of input from all three, we can dismiss the cost of material as a form of rent. The laborer is paid their $1 of wages and told, thank you very much, but the capitalist assumes more than $1 in return. This is in effect the flaw in capitalism that can be easily corrected by profit sharing.

    I was an undergraduate in Economics in the mid 80’s, the fall of the Soviet Union and the stock market crash of 1987 were the prominent events of the decade. Businesses had suffered during the 1970’s with peak oil and tight credit. The crash of 1987 was merely a hiccup during the highest period of prosperity of the 20th century. Stocks gained ten-fold in value, not accounting for inflation. The tech bubble of 2000 came near the end of the period, and when stocks weren’t making two digit returns, the baby boomers saw real estate as a natural avenue for their accumulated wealth, and we saw the gentrification of urban areas and vacation retreats. It was around this time that Congress, for whatever misguided reason, felt it their duty to increase housing ownership for those unable to afford it. Mortgage lenders saw an opportunity to generate commissions, passing the obligation on the Fanny Mae, and investment firms made commissions selling packaged mortgages to the clients. When it became apparent the investments were sour, the problem became compounded by the derivatives market, which became unduly highly leveraged by the manipulation of a few firms and the lack of regulation and oversight by the institutions in place to prevent such practices.

    If the US economy recovers within the next ten years, it will be due to the resiliency and to the credit of the man and woman on the street, the average citizen. New York has long been the financial capital of the world, but it has not been without the protection afforded by the borders of the nation, and indeed the league of nations, which aren’t ruled by the few, but by the many who have put their faith in a system of government with checks and balances. The enemy is the same enemy of old, rule by the few. Wall Street and the central bankers must be stood up to and forced to capitulate by any means necessary. Please read my article at Politics and Economics for a discussion of the spiritual nature of the conflict in which we are engaged.

  35. But What do I Know? writes:

    This makes a lot of sense–we could accomplish something similar by eliminating or reducing the payroll tax (and have the Fed buy the “necessary” Treasuries). The main flaw I see in the scheme is that those who are not getting (or have no chance of getting) free dollars are likely to begin to refuse to accept them at face value–that is, foreigners. I suppose that isn’t a problem if the Chinese central bank is continuously willing to exchange yuan for dollars at a fixed rate, but could lead to a nasty inflation brought on at a foreign central bank’s convenience.

    But the lottery idea is good too–let’s call it the Shirley Jackson plan :>)

  36. […] Wednesday, August 18, 2010 — Adam Kotsko I asked Philip Goodchild what he thought of the article on “helicopter drop” monetary policy I linked earlier this week, and he has given me permission to post his response […]

  37. Muwabi writes:

    I just can’t understand why people are so brainwashed by these “quick fix, everyone wins” solutions. Like one of the earlier comments said…Why don’t we fix the underlying problem instead of attempting one half brained solution after another. Let’s start with why we’re in this mess in the first place. Sure, you can recite all the normal causes of poor lending, interdependent banks, etc but these were mere symptoms of a much larger, more serious problem. The main issue in our economy is this inflation targeting nonsense that slowly destroys the most productive sector of our economy: the middle class and savers. This ridiculous idea that moderate inflation through fractional reserve lending and expansion of the money supply is the very reason for this perpetual imbalance. Inflation and monetary expansion creates incentive for risky investment (with no tangible capital to back it up), loose lending standards, jobs moving overseas, and asset appreciation which benefits those with first access to money (the most wealthy). This was the problem to begin with… as time goes on, the money supply increases at an exponential rate allowing the most wealthy to see asset appreciation first, who then leverage their holdings even further. Rather than allowing it to trickle down, wages consistently don’t keep pace with this inflation because we live in a growth obsessed society (where we expect profit to increase at a healthy rate). This growth isn’t coming from increased productivity or technology… for the most part it is from this artificial expansion of money. Thus we raise wages/benefits to appease the masses but not nearly enough to keep pace with rising prices. Wages do grow, however, until they reach an uncompetitive rate and jobs are permanently lost. Which is where we stand today.

    Imagine a different world… say we didn’t target inflation and kept the monetary supply constant. Businesses would be forced to grow through savings, intelligent investment, and productivity gains. Wages would stay consistent because it’s very difficult to cut nominally. Assets would increase based on their intrinsic value rather than through bubbles or malinvestment. Take a look at the late 19th century or the 50’s and 60’s… we grew at astounding rates without this exponential growth in money.

    Now let me get back to your proposal… first of all, this is basically conducting the same policies leading to income inequality and poor unproductive investment but doing so on steroids. Aside from the fairness and legal issues (of which they are quite substantial), this is among the worst economic proposals I’ve heard. Perhaps you should consider some of these consequences:

    1) We have an unprecedented wave of the population hitting retirement age. Your plan essentially erodes all their savings and destroys any chance of successfully retiring.

    2) You encourage our savings rate to decline even further because any bad societal debt is immediately made whole by these regular large helicopter drops. At first, banks lend like crazy because everyone is creditworthy without bad debt. Then it spirals into a hyperinflationary environment because the money supply is increasing at such insane rates. At that point, banks wouldn’t want to lend a dollar. You’re creating volatility, which is exactly what you claim to try to avoid.

    3) The commonly cited reason for this mess is from poor lending standards. Why would I ever hold money for savings if I know it will be eroded over time from more printing. Thus my incentives are to start buying everything under the sun without regard for the future (because the central bank controls it rather than the individual). Think that helps bad investment and lending?

    4) Why would anyone outside this country ever accept a US dollar again? You’ve completely eliminated it as a store of value by creating a benefit only for our citizens. The dollar would literally collapse overnight.

    5) Nobody would ever purchase Treasuries again. Again, US debt and the dollar collapse overnight.

    6) Yes, you are definitely on to something with no incentive to work.

    7) You think consumption is the answer to all our problems… yet please tell me what more households need to purchase? Everyone already bought a new house, cars, plasma tvs, IPhones, granite countertops, stainless steel appliances, etc. Your solution of how consumption equals wealth is completely misguided. The way to improve our nation’s wealth is through value creating activities, not spurring more purchases we don’t need. The focus should be on clean technology, alternative energy, agriculture efficiency, transportation improvement, etc. These are activities that make ourselves more prosperous regardless of what currency is being used.

    8) You think this “even distribution of free money” actually helps the problem with income disparity??? It actually just exasperates the situation. Once people start consuming more as you say, your shares of Apple and MGM Resorts sure do increase… as do values of property and commodities. This does nothing for the income of ordinary Americans. Once again, wages increase but not at the rate prices increase (as we’ve seen over the past 30 years). The rich get richer with their asset appreciation and poor get poorer because real wages fall.

    With regard to all the other posters with variations of this plan and tax policy modifications… that does nothing either. Until we fix the problem of inflation and monetary growth, these things don’t improve employment, income disparity, the loss of value creating industries to overseas, etc. They are simply short term fixes to make people think the average person will be better off. Once the laws of economics have time to go to work, it results in the same process we’ve seen over the last 30 years in getting us into this mess. Seriously, wake up people and think about wealth in terms other than currency. If we were on a strict barter system or gold standard, these ideas would seem absolutely loony. Paper currency is no different than these systems (they’re all mediums of exchange). How people get the idea that random currency expansion creates wealth or any other economic goal is beyond me.

  38. Justin Weleski writes:

    This entire discussion assumes the necessity of a central bank which macro- or micro-manages the economy. Isn’t there another way?

    I remember all of my old economics professors telling us how deplorable a command economy is. “How can a few central planners possibly be able to regulate the billions of transactions that occur on a daily basis. Bah! They can’t!”

    Then, in the next breath, these same professors would extol the virtues of a central bank with the ability to determine interest rates, control inflation, etc., (i.e., the ability to set the course and directly impact those billions of daily transactions).

    It always seemed highly contradictory to me, and it still does. Now, I recognize the need to have a central clearinghouse for checks and an intermediary to facilitate inter-bank loans, but do we really need a crew of PhD economists to determine and enact policy?

    The determination and enactment of policy appears to be the realm of democratically elected legislators. If society wishes to enact the system you describe, why not enact it through legislation?

    I’m sorry, but I just don’t understand the (alleged) necessity of central bank macro- and/or micro-management.

  39. Justin Weleski writes:

    Also, one major weakness in your analysis is the contention that, “During booms, the rate of transfers should slow to a trickle.” In theory, that makes quite a bit of sense (assuming we adopt such a policy). In practice, most people don’t recognize we are in a boom until after the fact. The Great Recession is a perfect example of that. Right up until the end, the overwhelming majority of PhD’s, commentators, analysts, etc., argued vociferously that the economy was fundamentally sound. As we all know, their optimism wasn’t warranted.

    Practically speaking, rates of transfer would slow to a trickle when those in power believe we are in a boom. That never happens. As a result, your proposed transfer payments would blow more air into the bubble (or add fuel to the conflagration).

    In theory, your proposal may be a good idea (and even that is debatable), but in practice, I can’t help but conclude that it would be an abject (pro-cyclical) failure.

  40. 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.

    Stopgap, why not? It’s similar to Steve Keen’s suggestion to write off bad loans and add equivalent amounts to those who are prudent and did not take on loans. What next?

    No central bank policy can ameliorate a deteriorate … out current energy ‘situation’. The cheap credit of the Great Moderation was an energy hedge. It failed and any other money/fiscal approach to the energy problem will also fail. We are running out of the cheap stuff and the way the ‘waste- based’ economy is structured the expensive stuff is unprofitable/unaffordable. This is our crisis!

    The central pier of any 21st century policy MUST be significant energy conservation. Nothing else will do. The fallout from that – perhaps a 50% reduction in consumption – must be faced. What must subsititute is human labor for machines and a skill/craft/artistry based economy. There is no other way, but chaos.

    Since the outcome would be a USA that is much like Tuscany without cars rather than a bankrupt, dusty and polluted Beijing it should be a no- brainer …

  41. Digger writes:


    What a fun trip! Until you got to the lottery part, I thought I had fallen down the rabbit hole and emerged in the 30s and was listening to Major Clifford Hugh Douglas propose a social dividend. His book available at

    Richard C. Cook may be the best-known modern proponent of Douglas’s ideas. See

    Robert Heinlein used Douglas’s ideas liberally in his first and long-lost novel For Us The Living as well as the later Beyond The Horizon. Too bad he turned into such a fascist in later years.


  42. Nick writes:

    free money into bank accounts? It would sure fire up the immigration debates . . . also, some of the elements of this idea are relevant for soemthing that has been more widely explored: the payment of direct dividends equally and individually to citizens of mineral-producing countries. alaska has a limited form of this already. maybe that could be a source of ideas and experience if you’re planning to flesh this out.

  43. Steve Roth writes:

    Hi Steve:

    First I have to acknowledge that the first paragraph is quite opaque to my untutored self. Don’t completely understand the concept of “buying” a marginal unit of CPI from wages. (I assume the Fed is the buyer?) A one-sentence explanation is possible, I suspect, and would be much appreciated.

    But nevertheless the gist is clear, and the argument is profoundly compelling. I especially like the implicit acknowledgement that fiscal and monetary policy are much the same thing, in different guises. Both are based on printing or shredding money and distributing it in various ways into the economy.

    I think the disincentive to work is the strongest counterargument to your proposal –certainly politically, but also economically.

    To address that, suppose the helicopter drops were effected via a greatly expanded Earned Income Tax Credit? (Aid for those unable to work could continue through other programs, notably SS disability.) As you say: “supplementary” income.

    Benefits in addition to those you detail here:

    o Workers are given an incentive to work (though as people move into the phase-out income range, that incentive would be somewhat reduced due to the effective increase in marginal “taxes” per hour).

    o Employers are able to hire employees that they couldn’t afford otherwise. (IOW, the effective incidence of the EITC benefits not only workers, but employers.)

    Now: suppose EITC payments are indexed to (some measure of) the unemployment rate? It’s a well-measured metric that does a pretty good job of representing capacity utilization (along with unimportant things like suffering). As that utilization declines, stimulus increases.

    Both incentives to work and employers’ ability to hire would be greater in times of higher unemployment.

    The positive incentives of the EITC could also be greatly enhanced by increasing its salience, by delivering the EITC payments on each paycheck, rather than annually (this assuming we want to incentivize consumption over savings). This is actually an option right now for EITC recipients, but for reasons I’ve been unable to discover, only about 1% take advantage of this option. I assume it’s not well-publicized, perhaps it should be.

    Finally, I think “slow to a trickle” in good times is wrong, for reasons you and I have both discussed. But reduced in good times, increased in bad times, that makes all sorts of sense.

  44. JKH writes:


    The public purpose demands that you publish your thoughts on the Treasury meeting.


  45. 0ut0f0rder writes:

    I remember seeing a discussion on the shortage of resources and people competing for those resources on a Facebook community page

    Why do we have a tendency to fight one another when we know sharing results in the most optimum outcome for everyone? Why does our biology cause us to hurt the ones we love, hoard resources and compete with one another?

    Heres the link to the video

  46. Oliver writes:

    SRW, thanks for great post!

    This is from a link which commenter OGT provided in #50 of your last post (

    from page 16:

    Why are output losses so large today despite more activist policies? Some other forces
    might be at work here. Governments have made more efforts since the 1930s to prevent negative
    feedback loops in the economy and have sought to cushion the real and nominal impact of
    financial crises through policy activism. But at the same time the financial sector has grown and
    increased leverage, expanding the size of the threat even as the policy defences have been
    strengthened. As a result the shocks hitting the financial sector might now have a potentially
    larger impact on the real economy, absent the policy response. Still, a complete diagnosis has to
    recognize the potential reverse causality too: it is an open question to what extent implicit
    government insurance and the prospect of rescue operations have in turn contributed to the
    spectacular growth of finance and leverage within the system, creating more of the very hazards
    they were intending to solve.

    So, if one assumes the latter, namely that steadily increasing financialisation is just the logical consequence of our ability / willingness to smooth financial cycles, then the Great Moderation, by passing the growing piles of risk in all directions, preferably down the income ladder, is just the final, cynical act of a play which began after WWII. With respect also to your previous post, I wonder whether redesigning debt contracts to behave more like equity would not in fact be a further notch in what amounts to an ever greater risk-concealing edifice? And whether the logical reaction should not in fact be to increase, not decrease the friction between borrowers and lenders, thus adding an incentive to rebuild our top-heavy edifice from the bottom, instead of devising ever more intricate ways to rebalance its drunken head? Your proposal above would fit in well with this, although I wonder whether it shouldn’t also be part of a larger plan to replace some of what’s fallen off the top permanently instead of just sporadically relieving the pain it causes when it hits us, i.e. higher wages to replace the need for private credit.

    I admit that sounds a bit nostalgic, but I guess with such new tools as you and others dream or dig up, a step back into yesterday’s problems seems like a good idea, especially considering the lack of alternatives that Austeria® promises to deliver. So three cheers for functional finance, I’d say!

  47. earthday writes:

    It seems to me that what you’re really saying is that the problem that needs to be addressed is the distribution of income and/or wealth. This seems like a rather convoluted way of achieving that. The fact is, fiscal policy is the avenue for achieving this. What needs to change in America is the minds of the people to accept that goal and the political system to allow for that kind of policy to be implemented. It just isn’t possible right now. Trying to find a way around the legislative process is just going to create more problems.

  48. Andy Harless writes:

    My concern about this proposal is that it might lead to an excessive fraction of our output being devoted to consumption. In the short run (and even the medium run) that’s not a problem, because we’re going to be below full employment anyhow, so there will be resources left over for investment. But in the longer run, I would be concerned that, if the Fed operates by giving money to households rather than by bidding up asset prices, it is creating an incentive to consume rather than invest.

    It’s essentially the same as a money-financed tax cut (although “taxes” would end up negative for many people). Back in the 80’s and 90’s, my view was that high taxes and easy money were the way to go, because they encouraged investment rather than consumption. And that idea did seem to work out pretty well for most of the 90’s. There was a bit of froth at the end of the 90’s, but a lot of good came out of that. I subsequently started to favor tax cuts because I thought we were headed for a liquidity trap. And I think, properly interpreted, history bears me out: if not for consumption spurred by tax cuts, then even lower interest rates, at best, would have led to an even more extreme housing boom, and quite possibly instead the boom would have proven insufficient to use up our excess resources and we would have gotten into this liquidity trap sooner. So under the circumstances that we have been for the past decade, I think you’re proposal is a good (if slightly wacky) idea. (Actually, as I think one or two other commenters may have pointed out, it doesn’t need to be quite so wacky: the Fed can finance government transfer payments that show up on its balance sheet as government bonds, and the effect would be identical.) But the conventional economist in me wonders if we may some day return to a world where we can have near full employment without extremely low interest rates, and in those circumstances, I would be back to my 80’s and 90’s self that is troubled by your proposal.

  49. Digger writes:

    JKH @ 8,

    “The big gap on the asset side of the consolidated GCB balance sheet – negative equity – could just as easily be relabelled as the inherent value of state provided liquidity.”

    Is this not what Frederick Soddy called Virtual Wealth?

    “It is true that the nation must act, and continue indefinitely to act, as if it possessed more wealth than it does possess, by the aggregate purchasing power of its money, but the important thing is that this Virtual Wealth does not exist. It is an imaginary negative quantity – a deficit or debt of wealth, subject neither to the laws of conservation or thermodynamics… It is the quantity of goods that the community abstains from possessing that is definite, and the number of units this definite quantity is worth is all the money, whatever that all may be. “It is the virtual wealth which measures the value of the purchasing power of money, and not money which measures the value of wealth.”

    More Soddy:

  50. JP Koning writes:

    SW: “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.”

    Yes, but no. A central bank can indeed produce cash at will, giving it some semblance of infinite liquidity. But there’s no guarantee that the people on the other side of the transaction will forever take that cash. Especially if its relatively shitty money, which is essentially what you are setting out to create via free gifts and various accounting shenanigans (placeholder asset? C’mon…. Enron shoulda tried that one).

    It is these naysayers – and there will be quite a few, given the layout of your scheme – who will eventually destroy the infinite liquidity of your central bank by asking for some sort of alternative form of payment than your central bank’s liabilities. Now the central bank can throw as much force (read: police with big guns) at the problem; a few bullets will coerce a few people some of the time to accept bad money. But in the end the problem of refusing bad money will be too big to police, no matter how much ammo you want to throw at it. Exchange is everywhere and all the time, you can’t stop it. Your central bank will go bust.

  51. pebird writes:

    I think this idea makes sense, but not necessarily through cash issuance, but some new type of asset that motivates behaviors which allow a more considered choice between consumptive and productive activities.

    To illustrate, a tax cut does not necessarily put more cash into the economy on a $1:$1 basis – taxation reduces net financial asset positions – someone might need to liquidate an asset to pay taxes, whereas the tax cut leaves the asset in place.

    Similarly, some other form of monetary distribution besides cash might create more effective outcomes or more democratic processes. Since we are engaged in thought experiments …

    So, say each citizen could form their own personal banking/financial services corporation, the Fed could issue them “citizen” reserves, (in exchange for some universal populist certification-form). These reserves could not be directly converted into cash, they could be saved, or be expended in certain manners. For example, to extinguish long-term debt (say, anything older than 5 years) but could not be used to directly create additional private debt. They could not be used for extinguishing tax liabilities, but would also not be taxed. Personal reserves could be invested in certain forms of investment over a medium-term, such as a 3-year CD or certain types of ventures (say, alternative energy start-ups).

    I understand the issue of creating aggregate demand – but I also think liquidity (being able to pay) is a powerful constraint on direct spending. Of course, cash provides both liquidity and spending power – and maybe it’s best to let individuals sort it out, but I am attracted to the idea of addressing liquidity to establish a different popular time-frame mindset – kind of like a reverse credit card. Financial institutions want to make credit universal, so lets make debit universal – personal reserves.

  52. Tom Hickey writes:


    JKH: “The net result is that prior deficits are offset with currency instead of debt. ”

    VJK: No. The net result is increase in superfluous bank reserves. The treasury account is not affected so no offset can possibly take place. Thus, at the FFR at almost zero — the knob does not move any more counterclockwise, the Feds’ “writing check on itself” has no effect on credit money demand and cannot be considered fiscal spending either –no money is getting into the private sector’s pockets — unless having bloated reserves and subsidizing banks by paying interest on the reserves can count as such.

    What VJK says is my understanding, too, but I am also well aware that JKH knows whereof he speaks. In reading WRW’s post, I was also wondering in what sense the Fed can use helicopter money to credit bank accounts, thus increasing nongovernment net financial assets. I thought that only the Treasury can do this in response to fiscal appropriations under current law.


  53. Detroit Dan writes:

    Excellent post and brilliant commentary! Interfluidity has just been added to my must-read list. It all seems theoretical now, but someday soon there will be a big change in the conventional wisdom…

  54. JKH writes:

    Tom (# 52),

    My exchange with VJK starts out with my response at # 12 to his comment at # 10.

    My response at # 12 begins:

    “The normal central bank balance sheet features government debt as assets for the most part, with reserves and currency constituting most of the liabilities.”

    So throughout the thread, I’m referring to “the normal central bank balance sheet”, which among other things means no quantitative easing.

    The absence of quantitative easing means that the quantity of reserves is binding on the central bank’s manoeuvrability in targeting the trading range for the policy rate.

    For example, when banks come to the Fed to replace their currency inventories, they pay for newly issued currency with a debit to their reserve deposit account. On the Fed’s balance sheet, reserves are replaced with currency.

    That transaction alone leaves the system short of the reserve deposits it requires in order for Fed funds around the policy target level. Without further adjustment, it means that the Fed has (inadvertently) tightened policy for the banking system, by replacing reserve deposits with currency. That’s because the quantity of reserve deposits at the Fed is binding on the fed funds trading range, when the balance sheet is in normal mode.

    Therefore, the Fed has to replace the reserve deposits it has debited, at the system level. It does that basically by expanding its balance sheet. And it does that by acquiring treasury bonds, which creates the replacement reserves. The net effect is that as new currency is issued, the Fed’s balance sheet expands, with the secular increase in currency matched by a secular increase in bond holdings. New currency issued flows first into the currency inventories of the banks, and then gets distributed out to the public as the economy grows and the public comes to the banks to replace some of their bank deposits with the desired level of currency stock.

    As part of the exchange, VJK in # 26 refers to my comment at # 14. My entire comment there, to which VJK refers, was:

    “I haven’t merged operations. Under current institutional arrangements, the independent central bank buys back government debt when it issues currency. The net result is that prior deficits are offset with currency instead of debt. That’s a fiscal financing arrangement.”

    The second sentence refers to the process I just described, whereby the central bank increases its holdings of government debt, in tandem with the increase in currency issued.

    Then, I say “The net result is that prior deficits are offset with currency instead of debt”. By that I mean the following: The bonds that the central bank buys to offset currency issuance are bonds previously issued to finance previous deficits. Therefore, the bonds that the central bank holds in total, which are the offset to cumulative currency as described, are bonds that correspond to prior deficits. Hence, because those bonds also now correspond to the cumulative currency issued by the central bank, prior deficits in that amount have effectively been “financed” or offset by that amount of currency issuance.

    The entire thread was written on the basis of my opening premise of “the normal central bank balance sheet”.

    I specified that normality, because the special case of quantitative easing requires its own qualification of balance sheet relationships relating to government bonds, reserves, and currency, and I was not making a point about quantitative easing as a special case.

    In the special case of quantitative easing, the quantity of reserves is no longer binding on the trading range for the funds rate. There are currently $ 1 trillion in excess reserves at the Fed. Clearly, in that balance sheet situation, the Fed does not have to replace the reserves that are debited when banks come in to acquire new currency. It doesn’t have to do that, because the trading range for the funds rate doesn’t depend on it doing so.

  55. Tom Hickey writes:

    Thanks for the detailed explanation, JKH. I greatly appreciate your willingness to share your considerable knowledge and experience.

  56. […] wait, it gets even more complicated than Rajan suggests. As another savvy financial commentator, Steve Randy Waldman, explained way-too-briefly last week, inequality — or at least the declining power of labor that it represents — turned the […]

  57. VJK writes:

    JKH @ 54:

    “For example, when banks come to the Fed to replace their currency inventories, they pay for newly issued currency with a debit to their reserve deposit account. ”

    (1)When the bank comes to the Fed to replace worn out notes for new ones, the bank does not pay anything other than transportation costs — no new currency creation by the Feds is needed.

    (2)The bank activity pattern may be such that its currency outflow balances with currency inflow through the natural depositary mechanism — no new money creation is needed.

    (3)The bank activity pattern may be such that currency outflow exceeds inflow. That would mean that some other banks would have excess vault cash, acquired through their depositary network, that they ship periodically back to the Feds. The bank experiencing vault cash deficit will have to purchase additional notes by funding such purchases usually, but not necessarily, through the liability side of its balance sheet — demand non-cash deposits, federal funds borrowing, brokered deposits, etc, as part of its general asset-liability management activity.
    Since the overall level of liquidity/reserves in the system is unchanged, mattress cash aside, no new money creation is needed in this case either. Possible interbank market disturbances caused by liquidity re-balancing amongst interbank market participants are usually smoothed out through temporary OMOs such as repos.

    “On the Fed’s balance sheet, reserves are replaced with currency.”
    The actual composition of the bank reserve is immaterial since the commercial bank currency holdings are counted as part of its reserve.

  58. JKH writes:


    I’m not talking about banks replacing worn out notes. I’m referring to bank currency inventories otherwise subject to gradual depletion due to net customer end demand. I thought that was self-evident, when I said:

    “The net effect is that as new currency is issued, the Fed’s balance sheet expands, with the secular increase in currency matched by a secular increase in bond holdings. New currency issued flows first into the currency inventories of the banks, and then gets distributed out to the public as the economy grows and the public comes to the banks to replace some of their bank deposits with the desired level of currency stock.”

    So I’ll restate it:

    Commercial banks distribute currency to customers from their inventories, in exchange for debiting customer accounts. The public holding of bank notes increases steadily in value over time. Currency in circulation has increased $ 36 billion over the past year. Commercial banks are the conduit for net currency expansion over time, in order to meet non-bank customer end demand and the banks’ own desired inventory levels.

    Replacing worn out notes is just a subset of that process. Banks ship old notes out to the Fed and take new ones in order to maintain their desired inventory levels with currency of acceptable physical quality. They get reserve credit when they ship old notes out and reserve debit when they take new notes in. Over time, due to net expansion of currency in circulation, there is a cumulative net debit.

    The composition of reserves is relevant when the Fed is in normal non-QE operating mode, insofar as it includes changes in the level of reserve deposits held at the Fed. Although the note component is determined ultimately by public demand, the system reserve deposit component is determined ultimately by the Fed, after taking into account various factors, including the reserve deposit effect of net currency flow between the commercial banks and the Fed. When the Fed is in normal non-QE operating mode, the system reserve deposit is the channel used for monetary policy in terms of interest rate control.

    Any change in commercial bank note holdings is recorded with a lag for reserve accounting purposes. But any reserve deposit change attributable to payment or receipt of funds in exchange for issuance or redemption of currency has immediate effect for reserve accounting purposes.

    So any net shift between reserve deposits and reserve notes bites on recorded reserves immediately, and therefore on monetary policy and interest rate control when the Fed is in normal non-QE operating mode. It is relevant information for daily monetary operations and policy in non-QE mode.

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  60. editec writes:

    Seems to me that as long as our macro-economic banking system is classist, that is to say that only the banksters can borrow at the lowest possible rates, and then they lend to the consumer/supplier classes at some higher rate of interest, our system will always be inherently unfair to anyone who actually creates something of true wealth.

    There’s a lot of ways to skin that classist cat, of course.

    A truly FEDERAL BANK — one where every borrower is inventing the money (by borrowing) at the RATE of interest — seems one way to deal with this problem.

    Of course, the argument can be made that different borrowers have different credit worthiness, and I certainly do not deny that.

    But so what?

    So too does every bank that goes to the discount window of the FED have a different credit-worthiness, but they still borrow at the same current rate at that window as banks with superior or inferior credt-worthiness.

    My point here is that the banks that ultimately lend to the retail borrower essantially serve no honest purpose.

    They are taking money at low interest and lending it to the creaters of wealth at a higher rate. What wealth are they TRULY creating?

    And as we have seem with TARP, they are not being paid for assuming any real risk, either.

    Even when they are wrong about the creditworthiness of those to whom they lend, (as in their NINJA loans) they suffered no loss because they foisted the risk off to BOND BUYERS by lieing about the true risk of the bonds they’d created.

    No, the public, which lent them they money they mismanaged, then bailed them (and the bond holders) out, while abandoning the needs of the ultimate borrowers who are expected to repay these loans at interest.

    I’d much rather borrow to buy my home for the PEOPLE of the USA directly, and repay the PEOPLE of the USA directly, than to borrow it from the banks which borrow it from the PEOPLE to lend to me.

    What purpose are these intermediate banks serving, exactly?

    None that I can see, other than being the class that gets this largess of inventing money to lend (at interest) to the REAL creators of wealth.

    They have truly become a parasitic and protected class whose activities serve no real purpose.

    Now we can, as suggested, just hand money to people, too.

    But why?

    Why not give every citizen the right to borrow money (from the ir fellow citizens) at a decent rate of interest and eliminate the middlemen who create no wealth and who have proven that they are no more credit worthy than the retail borrowers.

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