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:

Figure 1:
Helicopter Drop of Currency: Effect on Balance Sheet of Currency Recipient
Assets
Liabilities and Equity
+ Currency
+ Net Worth

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.

Figure 2
Credit to Deposit Account: Effects on Balance Sheets of Recipient and His/Her Bank
Recipient’s Balance Sheet
Bank’s Balance Sheet
Assets
Liabs. & Equity
Assets
Liabs. & Equity
+ Deposits
+ Net Worth
+ Reserve Bal.
+ Deposit

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:

Figure 3
Open Market Purchase by Fed: Effects on Private Sector Balance Sheets
Fin. Asset Seller’s Balance Sheet
Bank’s Balance Sheet
Assets
Liabs. & Equity
Assets
Liabs. & Equity
+ Deposits
No Change
+ Reserve Bal.
+ Deposit
- Security

 

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:

Figure 4
Lending by Fed to Non-Banks: Effects on Private Sector Balance Sheets
Non-Bank Borrower’s Balance Sheet
Bank’s Balance Sheet
Assets
Liabs. & Equity
Assets
Liabs. & Equity
+ Deposits
+ Debt to Fed
+ Reserve Bals.
+ Deposit

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:

Figure 5:
Fed Lending to Bank: Effects on Bank’s Balance Sheet
Assets
Liabilities and Equity
+ Reserve Balances
+ Debt to Fed

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.

Figure 6
Effects of a Government Deficit on Balance Sheets of Recipient and His/Her Bank
Recipient’s Balance Sheet
Bank’s Balance Sheet
Assets
Liabs. & Equity
Assets
Liabs. & Equity
+ Deposits
+ Net Worth
+ Reserve Bals.
+ Deposit

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.

24 Responses to Helicopter Drops Are FISCAL Operations

  1. Perfect, Scott.I was interested as well to read about the “helicopter bond drop” variant in Pavlina Tcherneva’s paper, to which you referred me earlier.BTW, I hope to come back to you on those other issues at some point. I’m interested in trying to fit FTPL, the corporate equity analogy, and Ricardian equivalence into some sort of basic balance sheet framework, if possible. Don’t know if it’s doable or worth it.Also, I finally read your paper “Interest Rates and Fiscal Sustainability’ in some detail – deep and thorough. Among many other things, there are several true gems in there on operational details that I just haven’t seen described anywhere else. I hope to come back on that as well.

  2. How about the US Treasury issuing interest-free notes by spending them into circulation through infrastructure projects? I believe the main problem with the current monetary system is that money is only lent into circulation; only the principal of the loans is created in the system, the interest does not exist and can only be paid by someone else getting more money from another loan, which also must be paid back with interest. The result is a never ending ponzi scheme which inevitably leads to booms and busts. Under this system, for the money supply to contract, someone must default on a loan which leads to pain. Under a system where money can be lent and spent into existence, there doesn't have to be such pain. The money supply can be contracted by the government "extinguishing" money as it is received for payment of taxes.

  3. JKH . . . thanks. Would love to discuss all those things you've mentioned with you sometime.Alexi . . . government deficits, as I showed in Figure 6 and discussed in the paragraph following it, are the equivalent of what you are describing regarding "US Treasury issuing interest-free notes . . . ." Best,Scott Fullwiler

  4. Scott/JKH,Don't leave me out please on that discussion :)

  5. Scott,Excellent post. Like your going through a concept step by step. Very pedagogical. So in this logic, TARP is (was) a monetary operation because the Treasury got a stake in the banks and it didn't increase the net worth of the private sector. Funny, it was added to the fiscal deficit and in fact since the Treasury made a "profit" out of it, decreased some private sector net worth.

  6. Hi Ramanan,Thanks. Agree on the TARP, of course. We'll definitely have to include you in those discussions, though I admit I wouldn't know how to contact you . . . JKH, either, for that matter!Best,Scott Fullwiler

  7. Excellent post. But the flaw in your analysis is that you fail to consider the fact then when you are not obligated to pay back a loan, either because you are a crook or are not legally bound, it is NOT a monetary action, but a fiscal action, aka helicopter drop.When the Fed has loaned money to the banks or purchased financial assets in this crisis, it has basically just given money to the banks which they will never pay back, both because the Fed purchased worthless securities and/or because the people running the banks are common criminals.As such, these are not really loans. They are free cash, disguised as loans. It's like taking a "loan" from your father. Unless your father is a greedy capitalist like Warren Buffett, I think most people consider a loan from their father as more akin to a gift, than a loan. And the proof for the above is in the pudding: What is happening to all the money going to the banks? As we all know, it is going straight into the pockets of bankers in the form of bonuses, or it is being used to speculate in financial assets/commodities.I fail to see how the current case "of lending" doesn't increase net worth of the banking sector, semantics aside. The reality is that it does and the people running the banks have expanded their net worth dramatically during this crisis.

  8. Dear Anonymous @422amThanks. Actually I did address your point and agree regarding the effect on net financial assets if that does occur. Here's what I said in the third-to-last paragraph:"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;"That obviously goes for default on loans, too.Best,Scott Fullwiler

  9. Hi Scott/JKH,(Sent a mail to Scott.) Maybe we can continue at Billy Blog or your blog, but I guess sometimes blog discussions fade for no good reason. I think because of time zone issues the comments/replies appear late and I guess since there are all sorts of spam, all comments have to be approved and this creates some sort of delay. I want to be more of an observer in the discussion and interrupt if I want to know more of something. Maybe we can create a fake blog for comments in wordpress and then later post the discussion on Billy Blog where it started or maybe I am complicating :) What do you think ?

  10. THanks for the article – that's a point I did not understand about endogenous money while reading Foundations of Post Keynesian Theory (Marc Lavoie)

  11. Ramanan, Scott:Sounds good -I was hoping to spend a period of time pondering the particular subject in question. I think I’d need to do that before any useful contribution was conceivable on my part. But I’m intrigued by the aspect of attempting a balance sheet interpretation of it.Then my thought was possibly to segue way into it at some point, somewhere like Bill Mitchell’s, Mosler’s, or even Nick Rowe’s. I think the opportunity would come up fairly naturally, given that we tend to check in at the first two at least fairly regularly. And it doesn’t have to be a particularly long discussion. For my part, I was thinking of trying that and maybe introducing it sometime over the next month or two, assuming I get my own thoughts together on it.BTW, I thought you might be interested in this, if you didn’t see it:http://www.debtdeflation.com/blogs/2009/12/31/2009-retrospective/?cp=8#comment-19773Comment # 385/6Written fairly quickly, and a bit bristly as a result perhaps, but trying to make a fundamental point about the power of accounting logic

  12. Winterspeak commented on this at his blog, too. The way I understand it is that if it affects NFA then it is fiscal. Since this done through reserves, it is also monetary, so all fiscal policy is a subset of monetary policy. Monetary policy also includes things that don't affect NFA, like OMO, so not all monetary policy is fiscal. Monetary is a wider concept than fiscal and includes fiscal. So, for example, Understanding Modern Money is about monetary policy, which includes fiscal policy.

  13. Scott,Thanks for clarifying this. Here's a question for another post. It would be helpful to have the MMT answer to this, since it is going around the blogosphere. I asked it at Warren's place too, since he is in political mode and this speaks directly to that. In fact, there is some overlap here between conservatives and libertarians who are concerned with the intrusion of financiers into money creation, and liberals and progressives who want more direct funding of social programs. I've summarized it below as I understand it.**********All the money in the economy is either currency of issue or bank money (credit money that nets to zero). The problem with credit money is that pulls demand forward and creates an interest obligation. History shows (Steve Keen, Michael Hudson) that over time, increasing debt is financial poison.Some are suggesting (Ellen Brown) that it is more desirable for the government to fund public goods directly, like education, health care, infrastructure, basic research, and a job guarantee, just as it now funds the DOD. This would not only make more public goods and services available, but also reduce the need to compound debt in society, interest being a rent imposed by rent-seekers on workers as a hidden private “tax” on their future income.There are two objections as far as I can see. The first is that spending must be funded by taxing or borrowing, which is erroneous in a fiat system such as ours.The second objection is that this much spending would be inflationary. However, that seems to rest on the false assumption that simply increasing monetary aggregates increases inflation, when inflation only results when nominal AD exceeds real output capacity.All of the spending on public goods results in increased production of goods and services, some which are provided by the private sector, since the government would function mostly as a contractor hiring subcontractors. This would increase real output capacity, GDP, and national prosperity (by lowering the Gini coefficient). Automatic stabilizers could be used to stabilize NAD relative to real output capacity to maintain price stability by altering spending and taxation appropriately.Anything wrong with this picture that I am not seeing? Or is it just obsolete thinking that has us stuck where are are?

  14. Thanks for your comment concerning "financial assets that turn out to be worth less", I didn't notice that paragraph. But, I also think this needs to be stressed forcefully, as it's not a case of if the assets turn out to be worth less, they are worthless. These are securities that were conceived in fraud. It is simply incredible that the lender of last resort function has now been extended to cover fraudulent securities and backstops. Anyway, this is really an incredible blog. Keep posting. You are the only economists I bother reading anymore. Thanks for insights.

  15. Thank you Scott for another very informative post. Clearly the purchase price of private sector financial asset is of critical importance in determining whether this action will result in an increase in government deficit and in the net worth of the non governmental sector. Given the cosy relationship between bankers and the Fed, this could actually be a likely outcome. Assuming in an extreme scenario that the private sector financial assets purchased by the fed are worthless, would I be correct in stating that the action from the fed amounts to a helicopter drop?

  16. I know this is a big question, but I am curious about the effects of +net worth on the helicopter drop recipient, because that net worth might be more than the economy can absorb eventually, and now there is a problem of inflation. You'll probably say then tax it away, but tax increases might make it hard for businesses and individuals that are in debt to repay their debts. So what could happen is high inflation, without the ability to tax enough?

  17. Hi TschaeffYes, inflation is the "constraint" on fiscal policy actions, as we like to say. The "solution" is twofold: first, when the economy picks up, incomes rise and so do tax revenues–the automatic stabilizers; second, more stimulus than that must be withdrawn before your scenario arises–as you state, it's difficult to tax away. And, of course, even with a deficit at 10% of GDP in 2009 (though actually a bit smaller since the TARP shouldn't count) we're not even close. Mosler's proposals for stimulus, for instance, are all measures that can rather easily be monitored–payroll tax holidays can be ended and tax rates restored, or per capita block grants to states that similarly can be ended when desired. Finally, the job guarantee, if implemented appropriately (granted it's not a given this would happen given difficulties associated with administration and politics) would be a very strong automatic stabilizer that would automatically add/subtract NFA as as private sector employment varied cyclically. I simulated this in my paper "macroeconomic stabilization through an employer of last resort" at http://www.cfeps.org.Best,Scott Fullwiler

  18. Scott:The view I have always taken (and it's the standard orthodox view) is that helicopter money is BOTH fiscal and monetary policy. It's a money financed transfer payment, and since a transfer payment is equivalent to a tax cut, it's a money-financed tax cut. The increase in the money supply makes it monetary policy, and the tax cut makes it fiscal ploicy. It's both monetary and fiscal policy.Another way of looking at it: helicopter money is equivalent to a bond-financed transfer payment (fiscal) plus an open market purchase of those same bonds by the central bank (monetary).JKH: It's simple to add Ricardian Equivalence to the balance sheet. Just add the Present Value of future tax liabilities on the liability side of households' balance sheets. Then helicopter bonds (which are equivalent to a bond finaced transfer payment) do not affect households' net worth, because their holding of bonds go up by the same amount as their tax liabilities.Also, if you believe in Ricardian Equivalence, then an open market purchase of bonds by the central bank is equivalent to helicopter money. Money up, bonds down, on the asset side, but PV of taxes down on the liability side. Therefore households' net wealth increases by the increase in the supply of money.

  19. Scott – I hope that your still "monitoring" these posts – seems I have come a little late to this post and MMT in general. Before my question, just to say I appreciate what has been written, and I am coming around to the MMT point of view. I am with the idea that deficit spending is a matter of crediting bank reserves, but what I can't get my head around is the following: Assume the Fed (and all other) balance sheet is in equilibrium, and the Government spends by increasing bank reserves, ie the liability side of the Fed's balance sheet increases, what happens to the asset side of the Fed's balance sheet? Without a corresponding increase in its assets the fundamental accounting equation does not hold. Im sure I must be misssing something … Thanks in advance and kind Regards Stuart

  20. Hi Stuart,Thanks for the nice comments. Regarding your question, when the Treasury spends, there is a debit to its account at the Fed, a Fed liability, and a credit to the reserve account of the spending recipients' bank, also a Fed liability. So, total Fed liabilities remain unchanged, only their composition changes, and therefore total assets also remain unchanged.Under current procedures, the Treasury will then call in balances from its tax and loan accounts at the commercial banks, which will reverse the Fed balance sheet effects of the spending. And, if the Treasury doesn't have enough balances in those accounts to call in (or anticipates this in the future), then it issues Treasury securities, which have the same effect.Hope that helps!Best,Scott Fullwiler

  21. Pingback: interfluidity » A quick note on “helicopter drops”

  22. Pingback: Drop It: You Can Call for Helicopter Money but Drop the Call for "Coordination" | New Economic Perspectives

  23. Pingback: Drop It: You Can Call for Helicopter Money but Drop the Call for “Coordination” | Fifth Estate

  24. Pingback: Krugman, Helicopters, and Consolidation | New Economic Perspectives