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MMT and helicopter money: A contrived association

Critics do not realise that bond sales and purchases are a monetary policy operation and not a method of funding fiscal deficits whether with self-imposed budgetary constraints or infamous helicopter money drops by the government

July 30, 2020 / 08:50 AM IST

While Modern Money Theory (MMT) has been receiving a great deal of attention in the ongoing economic crisis unleashed by the Covid-19 pandemic, it has naively and incorrectly been linked to notions like “helicopter money” and “printing money” and with it, inflation , even hyperinflation, as an imminent and dangerous consequence.  It is not only unfair but also unprofessional when critics of MMT ignore the works of its major proponents including Warren Mosler, Randall Wray, Scott Fullwiler and Eric  Tymoigne on the operational realities of fiscal deficits and their repeated counterarguments to such simplistic contrivances.

The two components of fiscal policy, namely taxation and government spending, impact the quantum of reserve money available with commercial banks.  In turn, these reserves (liquidity) serve two important functions in the monetary system.  First, adequate reserves are required for interbank transactions to support the bank clearing and settlement system.  Second, the quantum of reserves in the system also influences the interbank money market interest rates, which the central bank as part of monetary policy must keep within fixed upper and lower bounds so that it can achieve the final inflation target, usually jointly agreed upon by the government and itself.

Government transactions take place throughout the year.  Money flows into (through taxes) and out of (through spending) government accounts.  The net effect will either be an increase or decrease in reserves in the system.  Helicopter money, printing money or monetizing the debt refers to the operation wherein the government sells bonds (securities, in general) directly to the central bank in exchange for a deposit (credit) in its account held at the central bank (or at select commercial banks).  When the government spends this money it will be credited to an account held by private sector households or firms while at the same time increasing the reserve balance of commercial banks held at the central bank.  If these are substantially more than the drain of reserves happening at the same time from tax collections, there will be a net reserve-add in the system which could then drive money markets rates possibly all the way down to zero.  There is no reason to believe that excess reserves will automatically cause a credit boom although low interest rates could trigger lending and borrowing for projects with higher risks.   However, if the central bank has a positive money market interest rate target these excess reserves must be drained out.  One method to achieve this is through sale of bonds to banks, dealers, firms and/or households.  The net effect of this will be the creation of a financial liability by the government (bond) and a corresponding financial asset for the private sector (the same bond).  It is important to emphasize that bond sales to the private sector are not a funding (fiscal) requirement.  Rather, they are carried out by the central bank as a monetary policy instrument to achieve the desired interest rate target.

The non-inflationary alternative to helicopter money is considered to be when the government adheres to the self-imposed constraint that it must first “borrow” money from the private sector through issue of bonds and then spend from the amount raised.  To make this constraint even tighter, assume that banks do not hold excess reserves.  The operation is then carried out as follows: the central bank undertakes a repo with primary dealers (PDs) with old bonds that are already in existence wherein their deposit accounts held at commercial banks are credited along with a credit of reserves held by these banks at the central bank.  These old bonds swapped by PDs will be held by the central bank.  Banks are now flush with reserves.  An auction of new bonds issued by the government is announced.  PDs subscribe for these bonds and reserves are once again drained out of the system as government accounts are credited with the proceeds.  When the government spends there is again a reserve-add to the system, which is subsequently drained out by completing the repo between the central bank and PDs with old bonds.  These complex operations ensure reserve balances in the system are maintained to achieve target interest rates.  Working through the balance sheets of all economic agents involved in these operations, the resultant net effect is exactly the same as the in the case of the mythical helicopter drop with the subsequent bonds sale to hit the positive interest target set by the central bank; a net financial liability of the government (bond) with a corresponding financial asset (bond) held by the private sector.

Ignoring the detailed balance sheet analysis in the MMT literature, critics and commentators do not realize that bond sales and purchases are a monetary policy operation and not a method of funding fiscal deficits whether with self-imposed budgetary constraints or infamous helicopter money drops by the government.  For a long time now, MMTers have argued that the natural rate of interest with fiscal deficits is zero. Bond sales are not required per se.  Interest paid by the central bank on reserves held by commercial banks could suffice in raising bank lending rates.  Another way to control excessive risky lending and borrowing could be enhanced regulation on credit quality as well as higher margins of safety.  Government bonds, however, do provide a safe risk-free asset for private sector savings.

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Sashi Sivramkrishna is author of the books, In Search of Stability: Economics of Money, History of the Rupee and Maximum Government, Maximum Governance: Reframing India’s Macroeconomic Discourse. Twitter@sashi 31363​
Sashi Sivramkrishna
first published: Jul 30, 2020 08:50 am

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