Will a helicopter drop of money stimulate aggregate demand?

I am happy to see Paul Krugman address the question.  He writes:

So why not forget about open-market operations, and just drop the stuff
from helicopters? Well, remember that at this point cash and short-term
bonds are equivalent. So a helicopter drop is just like a temporary
lump-sum tax cut. And we would expect people to save much or most of
such a tax cut – all of it, if you believe in full Ricardian

I hold a different opinion for two reasons.  First, cash and short-term bonds may be near-substitutes but they are not literally, strictly equivalent.  The nominal rate on T-bills is not exactly zero and furthermore you can't use a T-bill for every retail purchase.  The demand curve for real cash need slope down only slightly for a quantity theory result to hold.  After everyone spends the new cash balances, and prices rise, people end up with the quantity of real balances which they initially desired.  These equilibria have "knife-edge" properties, where "identical to T-Bills" and "nearly identical to T-Bills" do not bring the same results.  Tsiang showed this in a very good JMCB article on Friedman's optimum quantity of money, in the early 1970s and you might regard it as implicit in Bewley's Econometrica article on Friedman.

Second, after a helicopter drop no one need expect future taxes to be raised to retire the money (although maybe a sufficiently credible government could create such an expectation).  So there is no Ricardian motive to save the new cash, as Brad DeLong points out.  Indeed, if you think there is some chance that others will spend the money, raising the price level, you will want to spend your new cash soon, so as to preserve its value against forthcoming price inflation.  The resulting game-theoretic equilibrium, applying dominant strategies, again leads to higher prices, higher aggregate demand, and the desired quantity of real cash balances held.

Those are not the only possible cases (see the work of Fischer Black) but I take them to be the most sensible default cases.  Both indicate that a helicopter drop of cash will work fine in boosting aggregate demand.

The most likely scenario for no positive AD effect is simply that the helicopter drop is so small that no one expects a price level rise and thus no one expects an inflationary tax on the new cash, people (for bounded rationality reasons) treat the new cash as a transfer purely to themselves, the precautionary motive for saving is strong, and so the new money is simply held.  A larger helicopter drop should overcome that inertia, if need be.

Maybe these arguments are incorrect but they date from a consensus established in the mid- to late 1960s and early 1970s, much of it springing from Patinkin's book on money and the subsequent discussions thereof.  Krugman suggests this perspective is wrong, but he hasn't yet given me — or others — a reason to budge from it.


Furthermore, even if the money were all saved there could be a stimulus effect simply through more efficient resource allocation. Here I interpret "save" as pay off existing debts. This would free up resources for the consumer and also put the banks in better condition, possibly allowing them to step back from their restrictive loan policies to feed some of the current demand.

Views expressed are my own, and not those of my employer.

If the goal is to increase inflationary expectations without the crony-capitalism negatives of a "large helicopter drop of cash", why not just abandon the penny? All transactions could be rounded to the nearest 5 cents. I suspect that this would be very successful in generating higher inflation expectations -- and we'd even save on minting costs. But, politically, it seems to me that the inflation-mongers would rather direct the economy in a more statist way and then blame the "invisible hand" for any subsequent inflation.

Krugman fears deflation. A helicopter drop would help stave off deflation, preventing the real debt burden of American households from rising. That means less income will be used to service debt and more toward consumption or investment via savings. That should make Krugman happy. But he believes the Efficient Government Hypothesis, so he'll spin this anyway he can to conclude with more stimulus spending.

As an aside, a helicopter drop has potentially a different set of recipients (and thus entry point into the economy) than a lump-sum tax cut. To someone used to treating aggregate demand as one number, maybe that seems not to matter. In reality I think it matters a great deal.

I love the hypothetical and comments. I think the key issue here is that there are a lot of factors that impact the stimulative impact of the money drop. More than anything, the demographics of the drop site will change the way the money will be used and the speed in which it enters the consumer flow. The geographic location of the drop will also impact those factors. Money, in and of itself, does not necessarily create stimulation of the economy without further incentives to then "pay" it back into the system.

A great post, illustrating why so many of us prefer Cowen to Krugman.

I make my lunches for the whole week on Saturday.

Sometimes I am hungry on Sunday and eat Mondays Lunch.

On Monday I have a choice I can go hungry or eat Tuesdays lunch.

I can defer going hungry but not indefinately.

We have eaten Mondays lunch. How does eating Tuesdays lunch make
us better off in any way?

I have more appreciation for Hayek all the time maybe this just
has to work itself out. Tinkering with the economy implies we have
some deep understanding which we obviously do not have.

Krugman is saying more than "helicopter drop won't work." He's saying there's nothing, I mean nothing, the Fed can do. I don't know whether he believes this, but I think he's decided he wants big fiscal action, and he's attacking any argument that doesn't leave fiscal stimulus the only thing to do.

People talk about helicopter drops as if this was some radical new surefire cure-all, when in practice it would just involve doing stuff that's already been done before (perhaps on a lesser scale). If you're going to send checks in the mail in the form of a tax rebate, or whatnot, why not call it by that name instead?

Obviously, you can't literally drop money into crowds, for reasons of liability and public security.

Here's an example, for yuks: http://www.youtube.com/watch?v=DlrC_IGruO (video). A Brazilian candid camera prank has an actor seemingly win R$10,000 (about US$ 5700) at a lottery outlet, but when he's told he has to take the subway to another office to collect the prize, he can't be bothered. He crumples the ticket and tosses it into a wastebasket full of other discarded non-winning tickets, in front of all the other customers... hilarity ensues.

The point is, any "helicopter drop" would surely have to be a piece of legislation, running the gauntlet of accusations of bias and unfairness and filibusters and political gridlock and endless delays, not something the Fed could simply plan and execute on its own. If a helicopter drop was needed during the latter stages of an election campaign, it might be outright infeasible. Or am I way off on the logistics of this?

@Outsider: the problem you illustrated is a supply problem. The current problem facing the global economy is a demand problem. Not at all the same thing.

@pj: It feels like a supply problem to the man on the street. He sees that he doesn't have enough lunches for the week and will have to go hungry. He would like to make sure he has enough lunches for the week, but he can't. Or does the man on the street see a different problem?


Yes, I'm liking Scott Sumner's idea more and more.

David Wright:

It does occur to Krugman to consider it, but he rejects it. Under the standard theory, there is no Ricardian equivalence with government purchases. In fact, it's just the opposite. If the purchases are temporary, they are more effective, because the eventual taxes needed to pay for them are small. Government purchases increase demand directly without having to rely on people spending more. If the government purchases are temporary, people will slightly decrease their spending to save for the eventual taxes, but not nearly enough to offset the government purchases.

The crucial thing is as Bernanke himself noted, "But the bank’s tools aren’t perfectly suited to reducing unemployment." Then some mumbo jumbo about global issues etc etc. He should have just left it at that. Open market ops go into the financial sphere, and stay there. The $1.5 trillion QE inflated many financial assets smartly. The jobs economy? It stopped the bleeding, sort of.

Damn it has been 20 years since non banks or the shadow banking system became the primary source of systematic credit. Little wonder banks, the Fed and it's banking partners, are crummy at transmitting money into the jobs economy.

If the Fed would do XX trillion in new QE, through the normal open market channels then we might get DOW 20K but jobs still wouldn't be on the way. Not here so much anyway. In asia maybe.

The only way for the Fed to transmit money directly into the real transaction for goods and services and jobs economy is to give it directly to the Treasury, and take their bonds directly.

This cannot happen on two counts. First it means more spending, and borrowing. Even if the nature of the borrowing becomes sort of nebulous. The second is that governments who pay their bills directly with money trucked across town from the central bank to the Treasury are considered bankrupt, or potentially bankrupt, if not financially then certainly morally, They lose their 'institutional credibility' based upon a few hundred years of the protocols of central bankers.

If and when that step is taken in significant size there could be a dislocation of the dollar and or the Treasury market.

"I always have the feeling Krugman is a bit dishonest and unfair in his columns in order to push public policy towards what is arguably considered by the concensus of economists as 2nd or 3rd best policies."

You have to recognize who he thinks of as his opponents. It isn't Tyler Cowen, even though PK and TC disagree about ideas. He considers his opponents to be people like Rush Limbaugh and the Chicago School - people who aren't really known for being intellectually honest.

The most likely scenario for no positive AD effect is simply that the helicopter drop is so small that no one expects a price level rise and thus no one expects an inflationary tax on the new cash, people (for bounded rationality reasons) treat the new cash as a transfer purely to themselves, the precautionary motive for saving is strong, and so the new money is simply held. A larger helicopter drop should overcome that inertia, if need be.

But the repeated Bush tax cut helicopter drops plus the Obama promise of tax cut helicopter drops seems to have created the same effect - instead of spending the tax cuts wisely on productive investment, the only thing done has been to use the continued helicopter drops as a way to fund the payments on increased debt to fund wasteful consumption, with the increased consumption being imported.

The Obama tax cut helicopter drops have funded a lot of imports of iPhones and iPads, but haven't created any jobs.

It seems the credibility of government to pay for the tax cut helicopter drops is extremely low, so why should anyone seek out investments that are sheltered, and their are green energy shelters and lots of cash available to support the investment.

But the political climate is such that the green energy tax cuts are going to be eliminated in favor of fossil fuel tax cuts, and then continuing the Bush tax cut helicopter drops, so no needs to look at the helicopter drops as a windfall to invest for future gain. The Bush tax cut helicopter drops have turned into the daily free lunch expectation to fuel daily life, not as an incentive to invest.

As oil is going to be imported in increasing volumes no matter what, and the price will be ever higher, the tax cut helicopter drops will help the US compete with the government subsidized oil products in China, Iran, Saudi Arabia, etc.

Even if Obama were to try to end the Bush tax cut helicopter drops, the political mood ensures Congress will do everything possible to force Obama to keep the Bush tax cut helicopter drops running everyday, and if he stops them, the expectations is a conservative will be elected on the promise of restoring the tax cut helicopter drops which are a Reagan entitlement.

The problem at the moment is more goods and services for sale than there is money to buy them. Just ask any new car salesman about that as he bitterly observes his lot full of unsold cars eating up his floor plan. Why *wouldn't* more money result in more sales? If the Fed mailed a check for $12,000 of freshly-printed money to every American, i.e., the new high-tech definition of a "helicopter drop" a'la Milty '48 or Bernanke 2002, we can guarantee that at least 50% of that money would end up in the hands of people with a propensity to spend (that is, those who are below the 50th percentile on the income scale, who are most likely to be living paycheck to paycheck and least likely to save any money they get but, rather, will more likely spend it on deferred needs such as, say, a new car to replace their old clunker or on braces for the kid). That is, I wouldn't expect a $12K per capita burst of economic activity, but I gotta say, Krugman's not clicking on all cylinders if he thinks a helicopter drop wouldn't create *any* economic activity.

Please note that the term "helicopter drop" in relation to monetary policy typically in monetarist terms is used to describe dropping freshly-printed money from the central bank into individual's hands, *not* issuing U.S. Treasuries to do this. I.e., Bernanke, rather than the Obama administration, would have to do this, and I have seen no indication that Bernanke has the cajones to go there even if he did go there back in 2002. But even *if* we did issue U.S. Treasuries, the money multiplier is currently below unity -- that is, more money is under (virtual) mattresses as cash or cash equivalents as reserves in the Fed's virtual vaults than is actually circulating in the economy. Money under mattresses is basically useless as far as the economy is concerned -- it is fostering no (zero) economic activity. Issuing Treasuries in this situation is basically just trading T-bills for money under mattresses and putting that money under mattresses back into the economy again. Even if the money eventually ends up back under a mattress somewhere, at least *some* of the money ought to get spent.

Of course, the *best* stimulus is one that requires that *all* of the money be spent -- i.e., is targeted at things like food stamps (where anything left on the food card at the end of the month goes away), infrastructure projects (which require it to be spent on concrete and steel and other stuff that employs people all up the supply chain all the way to steel mills, thus causing economic activity to ripple through the economy), and so forth. That guarantees that the money makes at least *one* circuit through the economy before disappearing under a (virtual) mattress somewhere. But I've seen no indication that Obama has the cajones to go back to the well for a Round 2 of stimulus... short of the Federal Reserve suddenly deciding to go into the infrastructure direct lending business (with all that money currently shoved under their virtual mattresses as reserves, nachurally), which would require cajones on Bernanke's part that we've already validated aren't there (he ain't got ones that clang, more like marshmallows, it seems), it seems unlikely.

- Badtux the Mattress Penguin

Tyler, you're wrong but this doesn't mean that anyone else is right. You take Don Patinkin's framework for analyzing monetary policy (you should have taken the framework as expanded by Julio Olivera to analyze different specifications of the supply of money) and --leaving aside the fundamental weaknesses of this framework-- you apply it to a situation that everyone agrees is a disequilibrium. Equilibrium models are good at best to do comparative analysis of equilibrium positions --this is the reason you quickly jump to the conclusion that the QT of M will hold in the case of a helicopter-exogenous increase in the supply of money. Unfortunately, and Patinkin and Olivera were fully aware, their models are useless to analyze how the economy will react to policy shocks in a disequilibrium (their models do not allow us to identify what is going on in a disequilibrium --we can speculate but any speculation will be outside their framework as shown in most of your own posts about the economy). In addition, whatever the value of Friedman's helicopter to teach monetary theory and policy, Lucas' critique applies also to the prospect of a sequence of helicopters dropping different, random quantitites of "money" (regardless of your definition of money) and to make things worse public choice theory tells us to expect this sort of policy to be costly enough to hardly pass any cost-benefit analysis.

These comments are incredibly stupid. Printing dollars and handing them out lump-sum to everyone has NO effect. It is like the suggestion of turning pennies into nickels, it cannot have real effects unless

a) they are handed out in a non-lump-sum fashion
b) they are not publicly known

Good God people, take an economics class. That goes for you too, Cowen.

If you want to stimulate the economy via Keynesian techniques, why not just declare a tax holiday for 5 years? No individual or corporation has to pay income tax for 5 years.

How about refunding the tax payment two years earlier in any year the rate of employment falls year over year as determined at the end of the next tax year, and if the rate falls two years in a row, refund twice, and if three years, three times?

In April 2009, everyone would have gotten not only a refund of the taxes they paid in 2007. In April 2010, you would have gotten a refund of twice the taxes you paid in 2008.

The incentive is to report and pay taxes on as much income as possible two years before a recession, and even more tax in the first year of a long recession.

If dollars are created in order to stimulate, everybody pays higher prices because of inflation. Demand has merely been moved, a little from everybody in random amounts, depending on what they by and where the stimulus is spent, becomes a lot for whoever is handed the stimulus first.

There's no magic. Nothing is created. Those very small amounts are very difficult to measure. The constant small changes happening in markets hide the tiny losses the stimulus creates via price changes.

If you were the person handed those stimulus dollars and you decide to burn them instead, no one is affected. The creation and the dollars balance each other out.

But there are real effects of stimulus. There is the loss of the labor of those who would have had to work to produce the free stuff they're getting because of stimulus. There's a real decline in the total amount of capital when capital is invested in unproductive things that people are not willing to pay for and that do not result in the capital being paid back and even increased.

If you don't spend the dollar bills you have, they don't compete with other dollars and prices are slightly lower for everyone. Which is actually what's happened since the housing bubble collapsed and everybody's reduced their spending. They are getting a lot more for their money whenever they spend.

Exactly this whole discussion seems to be a*se about face.

The Fed/Treasury has no control over where the new dollars go, and furthermore has implemented no new policies that even begin to address this issue.

Earlier today I read this sentence
"Perhaps someday someone will conduct a study that credibly measures the macroeconomic effects of this particular fiscal stimulus"
It was written by G. Mankiw as part of a comment on the CEA's last attempt to assess the effects of the fiscal stimulus act passed last year.
You seem to believe that we can ex post easily assess the effects of any policy. Unfortunately this is not true. It's very difficult to identify the contribution of each of the several forces that might have contributed to a particular outcome. I believe it's harder than to assess ex ante the effects of alternative policies. Tyler's post is a good example of how difficult it's to assess ex ante a particular alternative: in an earlier comment I argued that he was wrong because his application of Patinkin's model is irrelevant to assess the effects of a helicopter-exogenous increase in the supply of money in a situation of disequilibrium.
You ask about the effectiveness of the 2008 tax rebate. You don't say for what specific purpose the rebate should have been effective, but the assessment of any policy must take into account all its benefits and costs, not just one particular benefit or a particular cost. For example, you mention a direct fiscal stimulus purchasing US goods and services but ignore the particular goods and services that you are purchasing --remember that during the Great Depression some governments used to buy and destroy agricultural commodities to control their prices and many others used to build infrastructures, some in great demand but others were bridges to nowhere.
In sum, the ex ante and the ex post analyses of policies pose great challenges and we can expect the debate about the policies implemented and the policies that could have been implemented today to continue for decades. Can we move the debate forward? I don't think so: even ignoring its fundamental weaknesses, macroeconomics does not provide a framework to analyze what to do in disequilibrium (attempts to develop disequilibrium macroeconomics have failed and macroeconomists play games with comparative statics analysis). Frankly I doubt we will ever have credible measures of the effects of macroeconomic policies.

with regard to stimulus:


The last helicopter drop had the effect of making it really hard to determine what personal consumption spending would be without it, making it more difficult to forecast the recession.

I just wrote that a helicopter drop would work - but that doesn't solve the jobs problem, so here's another view. The government could go all out on infrastructure spending to shore up our roads, bridges, pipes, sewer systems, energy grid, schools and whatever else. Between all of those sectors, there are jobs for every person who doesn't have one - and then some.

Either way, if money doesn't get to the people, the economy won't recover.

Share the wealth than give to only an entitled bunch and conserve on the other hand. www.makenaturalpower.info

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