The topic of ‘helicopter money’ recently arose in a family discussion. Helicopter Money, I guess, is the modern equivalent of digging holes in the road and then filling them up again (or, with extra redundancy, digging holes in the road, putting money at the bottom of them, filling them up again, then paying people to get the money…). Or something similar that Keynes may or may not have said in jest.
The government dropping money from helicopters would, of course, never run politically.
But the only slightly more ‘respectable’ notion of the government spending money (borrowed at current extra low interest rates, or maybe just created at the stroke of a pen (‘printed’), or collected by VAT-taxing pasties and caravans) on ‘infrastructure’, like roads, high-speed rail, new or modernised schools – or, indeed, anything that would (a) put more people to work and (b) have a long-term beneficial effect in its own right, might just be feasible politically. Though, laudable though this might sound, the chances are currently rather slim of it happening here in the UK.
The argument for doing this is that the private sector is in ‘saving’ mode – private individuals paying down debt, and companies sitting on their plentiful cash-piles (oh yes – this is true) and refusing to invest in new or improved products – because they fear there would be no demand – because, surprise, surprise, we are in a recession… So, if people will not spend, and companies will not spend/invest – how is the economy going to grow? Exporting does not offer salvation right now, with so many other countries battening down the hatches. Thus, only by the government spending and thus stimulating local demand by increasing the amount of money in circulation.
The notion that if the government cuts its spending this will ‘release’ businesses to invest/spend has proved to be wrong in this recession. Though it would be right in a situation where the government was competing for investment-money with the private sector. But it is not.
Thus the main argument against the government increasing its spending is that it will just cause inflation. The spectre of Weimar/Zimbabwe is invoked. I’m ignoring the cliched chant ‘you can’t borrow your way out of a debt crisis’ because it is truly meaningless – as it confuses a sovereign country with a household within a country – and they are not at all the same thing. What is true of a part is definitely not true of the whole in this case. Fallacy of composition. A household or a firm cannot create money out of thin air, but a sovereign country may do so to pay off its debt, or it may borrow at such advantageous terms for so long that the debt would be eroded over the long run by ‘normal’ levels of inflation (eg 2%). It may do the latter for as long as ‘the markets’ are willing to purchase its bonds at an interest rate that the government can afford to service.
But I want to get back to the issue of ‘inflation’.
I’m not going to get into Keynesian versus Monetarist versus Austrian versus Modern Monetary Theory versus Rational Expectations stuff here. Rather, I’m going to try to apply ‘Common Sense’. Common Sense is often handy. But it is also often dangerously misleading. I think it was Einstein who said something to the effect that it was nothing more than the sum of the prejudices we have acquired by the age of 18. It amounts to a series of handy simple algorithms – simple instinctive thinking which may or may not lead to correct answers, depending on whether the actual situation in which it is being applied does accurately reflect the situation which led to the creation of the algorithm in the first place. It is a sometimes useful quick alternative to thinking things through from first principles. So we need to keep the dangers in mind as I try to apply Common Sense.
So, inflation. I’m going to mainly use the definition of ‘too much money chasing too few goods/services’. What is ‘too much’? Enough money to cause the demand for the goods to exceed the supply. If the demand exceeds the supply, the price of the goods/services will increase. So the ‘value’ of the money (in terms of what it will buy) goes down. Ah… but while this must always be true in the very short term, for the less immediate term an increase in demand for goods and services will lead to an increase in their supply, as the sector supplying the goods and services aims to increase turnover and profits by supplying more goods/services to meet the increased demand. At least, it will do so if it has the capacity to create more of these goods/services (and it believes the demand increase is not just a short term blip). If, on the other hand it does not have this supply capacity, or cannot create it quickly, then we get persistent and probably runaway inflation. It becomes runaway (Weimar, Zimbabwe) when people demand higher wages to meet their day-to-day needs as the value of the currency ‘in their pocket’ has declined such that it will not meet their needs, and they believe that this will continue and get worse . A vicious spiral results. Inflation may also be imported, as when the demand for some internationally traded commodity (oil, energy, minerals, food) increases on the international markets to exceed the supply to the international markets. It is also imported if the domestic currency declines in value on the international money exchange markets causing prices to increase domestically. My common sense may deceive me if I fail also to take account of all this stuff.
OK – so let us look at the current UK situation. Helicopter Money or any other form of increased government spending will increase the amount of money in circulation, and, provided people are prepared to spend this money and not simply shove it under the mattress or put it in a bank (as they might under conditions of ‘deflation’, as a store of future wealth) will lead to increased demand for goods and services, which will lead to (at least) a ‘firming up’ of prices. The question is – does the UK economy have the capacity to increase the supply of goods and services to meet this increased demand? We do know that businesses – especially large ones – have the financial resources. They are sitting on a lot of cash. And borrowing for them is getting cheaper and easier. They also have under-used capacity. We can deduce the latter by the fact that UK productivity levels are currently rather low. And, we have historically high levels of unemployment. So – assuming all this spare capacity is not ‘structural’ (eg outdated/obsolescent plant, the unemployed labour not having necessary skills) it should be easy for UK PLC to increase supply. This will not always be the case as there are ‘hysteresis’ effects: make someone unemployed for long enough and their skills become outmoded, or they lose their skills and they become square pegs looking to fill round holes. We must assume this is already beginning to happen, but it is unlikely to be so serious yet as to cause us to say that our excess capacity is a mirage. So – there should not be any reason for UK PLC not to increase supply to meet the increased demand generated by the dreaded fiscal stimulus of government action. So we then get a virtuous circle of increased money supply leading to increased demand leading to increased supply and thus growth, more taxes being collected, less spent on welfare, etc, etc.
Ah, but I hear you say, what about the bond and currency markets? Won’t they lose confidence, causing the price of openly traded Treasuries to drop and the yield to increase unsustainably, while the value of the pound will drop causing the price of imported commodities etc to increase, leading to inflation which would then run away because of increased labour costs as workers demand and get more money? Here we come back to common sense… Why should this occur if the UK embarks on a fully fledged growth strategy? If the markets sense sustainable growth on the horizon they will cheer. True – there is often an unfortunate herd instinct in the markets, but in order for them to lose confidence they would need to believe that the government’s new strategy will squeeze private investment out, or that it will lead to nothing more than inflation. Which means that they believe in the wrong kind of common sense. Disproved by recent events. Only an external oil price shock could derail this strategy. Hello Iran? No, surely not…
Regarding the imported inflationary effects of a possible decline in the external value of the currency through running a budget deficit, that wise old coot, the Conservative-leaning Samuel Brittan, in a recent FT blog, quotes himself thusly: “A permanent secretary under an earlier Labour administration once asked me what I thought were the limits to permissible Budget deficits. My answer was: ‘Up to the point where the gains to output and employment are offset by the inflationary effects of a fall in the exchange rate.’ I thought it more important to state the principle than to give a spurious back-of-the envelope numerical estimate. Even the principle is slightly ambiguous. There could still be valid differences of opinion between those who regard inflation as an evil in its own right, to be weighed against any output stimulus, and those who worry mainly about the effects of raised inflationary expectations in offsetting the output effects of the stimulus.”