Helicopter Drops Are FISCAL Operations

By Scott Fullwiler

Given all the chatter in the blogosphere about “Helicopter Ben” Bernanke, it’s probably time to look more carefully at the actual accounting behind so-called “helicopter drops of money,” made famous years ago by Milton Friedman. As most everyone knows, the idea behind a hypothetical helicopter drop is that the central bank would essentially drop currency from a helicopter in an effort to stimulate aggregate spending. One could modernize the story and presume that the central bank credits X number of dollars to the bank (deposit) accounts of all (or even some) individuals. And while traditionally it’s been presumed that it would be the Fed that would be dropping money from the helicopter(s), it could just as easily be action taken by the Treasury – e.g. by requiring the Treasury to take an overdraft on its account at the central bank via mandate from Congress and the President.

Let’s look at both of these scenarios—helicopter drops of currency and credits to deposit accounts—to see how they affect the balance sheets of a representative private individual that is the recipient of the increased currency or deposit.

First, the helicopter drop:

So, we see that the increase in currency holdings has raised the net worth of the private individual.

Next, let’s see what happens when the Fed credits bank accounts instead of dropping actual currency. The credit to the individual’s deposit account begins with a credit to his/her bank’s reserve account and an instruction (from the Fed) that the bank increases the size of its customer’s account(s). Figure 2 shows the (resulting) effects on both the individual’s balance sheet and that of his/her bank.

Again, there has been an increase in the net worth of the private individual (once the bank received a reserve balance and was simultaneously instructed to credit the account of the recipient).

We can compare this outcome with the more traditional open market operations in which the central bank purchases a Treasury (or a financial asset originally issued in the private sector) or lends a private bank or non-bank entity. First, here’s what the open market operation looks like, again considering the balance sheet effects for both the private entity selling the asset and also for his/her/its bank:

So, here we see that the open market operation has NOT affected the net worth of either the private entity selling the security or the entity’s bank. This is simply a swap of financial assets. If the financial asset in question was privately issued, then now the issuer has a debt to the Fed, and this is still a simple asset swap with no change in net worth (of course, some would argue that the financial asset could turn out to be worth far less than what the Fed paid for it—which could happen with treasuries, too, of course, if interest rates rise—and I will discuss this caveat below).

Similarly, if the Fed simply lends to banks or to private non-bank entities, there is clearly no increase in net wealth for the borrowing banks or the borrowing non-bank entities and their banks. Fed lending to non-banks is shown in Figure 4:

Obviously neither the borrower nor his/her/its bank has seen an increase in net worth. Figure 5 shows the effects of a Fed loan to a bank on the bank’s balance sheet:

Again, even without Figures 4 and 5, it should be obvious that lending by the Fed doesn’t increase the net worth of the non-government sector.

As anyone who has paid attention to the Fed’s actions in the recent crisis should know, the Fed’s operations in the recent crisis have been loans to banks and other financial institutions, and purchases of financial assets, as in Figures 3, 4, and 5. There has been no increase in the net worth of the non-government sector as a result of these actions, unlike that created by a helicopter drop in Figures 1 and 2. Further, while the Fed’s actions since September 2008 have raised reserve balances, these do not enable any greater quantity of credit creation than could be had without the reserve balances (see here, here, and here, for instance). Anyone using the label “Helicopter Ben” to describe the actions of our Fed President simply demonstrates his/her lack of understanding of monetary operations and basic accounting as shown here.

On the other hand, consider fiscal policy. Figure 6 shows balance sheet effects for a representative recipient of government spending and for his/her bank.

Note that a government deficit induced by a cut in taxes would have the exact same effects, with the private individual keeping more deposits and thus more net worth than otherwise. Furthermore, as I explained here, whether the Treasury sells bonds when it runs deficits doesn’t change the fact that the deficit has raised the net worth of the non-government sector—since, again, a bond sale is simply an asset swap of reserve balances for a Treasury security (and this is the case regardless of whether one prefers to believe that the Treasury sells bonds before it runs deficits . . . the increase in the non-government sector’s net worth created by the deficit remains).

So, here we have an interesting fact: UNLIKE EVERY OTHER monetary policy operation, BUT LIKE EVERY OTHER fiscal policy operation (with or without bond sales), helicopter drops of “money” as shown in Figures 1 and 2 raise the net worth of the non-government sector. Therefore, I (and my fellow bloggers on this site) argue that it is more appropriate to label helicopter drops as FISCAL operations, NOT monetary operations.

To update the helicopter drop story for actual monetary operations in the real world, let’s realize further that helicopter drops as shown in Figures 1 and 2 are not actually operationally possible unless the Fed pays interest on reserve (as it does now) balances at its target rate or provides term-deposit accounts to banks (as it proposes to do shortly) or otherwise engages in open market sales of financial assets on its balance sheet. Consider Figure 1 . . . as individuals place their new currency in their bank accounts (or spend it and then the businesses selling their products/services put the currency in their bank accounts), banks find themselves with far more currency than necessary to meet normal withdrawal demands. So, they sell the currency back to the Fed for reserve balances. But this rise in reserve balances lowers the federal funds rate below its target, requiring open market sales by the Fed to drain the reserve balances. The progression is much quicker to the same outcome in Figure 2, as the crediting of deposits has resulted in the direct creation of excess reserve balances that again must be drained in order to sustain the federal funds rate at the Fed’s target.

Furthermore, consider now what the effects are, following the Fed engaging in a helicopter drop as in Figures 1 or 2 AFTER it has exchanged reserve balances for financial assets or term deposit accounts OR instead paid interest on reserve balances at the target rate. Note that the Fed is legally required to credits almost all of its annual profits to the Treasury’s account at the Fed. But by selling Treasuries, instead of the Treasury paying interest to the Fed and then having it credited back to its account at the end of the year, the Fed no longer has the interest income it would have received and that income instead goes to the non-government sector that now owns the securities. Similarly, by paying interest on time-deposits or reserve balances held by banks in their reserve accounts, the Fed’s profits that it returns to the Treasury are reduced. And increased Treasury outlays or reduced revenues for the Treasury are changes in the government’s deficit, otherwise known as . . . FISCAL OPERATIONS. Lastly, if the Fed purchases private sector financial assets that turn out to be worth less than the original purchase price due to defaults, this again reduces profits sent to the Treasury, thereby raising the government’s deficit and the net worth of the non-government sector; increases in private financial assets held have the opposite effect of reducing the government’s deficit and reducing the net worth of the non-government sector.

(As an aside, it’s also highly doubtful that the Fed can carry out helicopter drops as in Figures 1 or Figure 2 absent legal blessing from Congress and the President given the effects on its own capital account. That is, the increase in currency (in Figure 1) or deposits (in Figure 2) would be accompanied by a reduction in the Fed’s capital, as there is no rise in the Fed’s assets. Given the already almost negligible quantity of capital held by the Fed—since it has always been legally required to turn its profits over to the Treasury instead of retaining its earnings—the Fed’s capital would turn negative very quickly were it to engage in helicopter-drop like actions, and the political fallout could be disastrous for the Fed. While there is no problem operationally with the currency issuer having negative equity, the politics of such an outcome are otherwise.)

In closing, this post hopefully provides some insight into the MMT or Chartalist taxonomy for monetary and fiscal policies. We define fiscal policy actions as those which alter the non-government sector’s holdings of net financial assets (net worth in the figures here), since that’s what EVERY fiscal action actually does. Monetary policy actions in Figures 3, 4, and 5 typically do not change the net worth of the non-government sector but are instead loans or asset swaps related to setting interest rate targets and managing the payments system. Hypothesized helicopter drops have nothing in common with typical monetary policy operations, but the balance sheet effects are IDENTICAL to those of fiscal operations. Other central bank actions certainly can affect the net financial assets of the non-government sector, such as the interest payments between the Fed and banks, or capital gains/losses from open market operations, but it should be recognized that when these changes to the net worth of the non-government sector occur they simultaneously bring the exact opposite effect on the federal government’s budget.