A wacky-sounding idea with surprisingly conservative roots may be our best hope for escaping endless, grinding economic stagnation.
How would you like to get $2,000 in free money today, fresh off the government printing presses? And what if I told you it wouldn’t just be a nice windfall for you and your friends and family, but that we’d do it for all Americans on an ongoing basis, and that doing so would solve our crippling problem of mass unemployment?
I know what you’re thinking: it would be crazy. Either it would be a fast track to crippling inflation or it’s some Republican satire of an ultra-liberal government handout program. But it is not quite as radical as it sounds. The key idea behind such a program has a longstanding, bipartisan economic pedigree. John Stuart Mill argued in 1829 that mass unemployment was caused by “a deficiency of the circulating medium” relative to other commodities.
John Maynard Keynes used the idea in his 1936 book, The General Theory of Employment, Interest and Money, to lampoon the inherent silliness of gold mining, suggesting that old coal mines could be filled up with bottles full of banknotes, buried over with trash, then left “to private enterprise on well-tried principles of laissez-faire to dig the notes up again.” Milton Friedman suggested that monetary policy could never fail to cure mass unemployment, because as a last resort the central bank could just drop cash out of helicopters—an enticing analogy that former Federal Reserve chairman Ben Bernanke borrowed in a 2002 speech, earning himself the persistent nickname of “Helicopter Ben.”
And it hasn’t just been theorizing. In 2008, George W. Bush and Nancy Pelosi engineered the tax rebate stimulus, in which everyone received a check in the mail—paid for, eventually, with fresh new money. Studies have found that this stimulus worked quite well; it was just overwhelmed by the Great Recession, and we only received checks once. Mill, Keynes, Friedman, and even Bernanke might argue that we should revive a similar stimulus again—only this time, on a much bigger scale, and on an ongoing basis.
Why? Because the economy has evolved to a point where it is vulnerable to mild depressions. In fact, the one we’re in now could persist for decades, as similar conditions have in Japan and other countries. In order to avoid that slow, painful outcome, we need a policy that will jump-start our economy. After three straight years of political gridlock it’s clear that Congress is not going to provide the fiscal stimulus we need, and while the tools the Federal Reserve has at its disposal have helped, they’ve not done enough. If Congress could be persuaded to give the Fed a new tool, one that would let it distribute purchasing power to the broad mass of the population—to “drop money from helicopters,” so to speak—it might be enough to help us escape the nightmare of slow growth and persistent unemployment we’re in now.
The key economic idea undergirding this policy idea is something called aggregate demand, which, stated simply, is the total amount of spending in the economy. During a financial crisis, aggregate demand goes down, since newly unemployed workers have less money and people who manage to keep their jobs reduce their spending out of fear. When people spend less money, sales fall, and businesses are forced to lay off workers, who then spend even less money, and so on. In other words, money goes in circles: my spending is your income, and your spending is my income. If we all simultaneously cut back on our spending—if aggregate demand declines—then everybody’s income declines, too. That is, very crudely, what happened during the Great Depression, when there were millions of perfectly able workers desperate for jobs, while perfectly functional factories lay idle due to lack of customers. It’s also what has been happening, to a milder degree, in our economy since the 2008 crisis.
While depression economics has many strange features, the most important one to remember is this: with slack in the economy, it’s possible to have an economic free lunch. If our economy were running at capacity, new government spending, for example, would tend to create inflation because the capacity (workers, raw materials, and equipment) would have to be bid away from someone else, thereby raising prices. But during a depression that doesn’t happen. Instead, new spending brings idle capacity into production. To put that another way, the single-most-important underpinning of a functioning economy is to ensure that there is sufficient aggregate demand.
In order to do that, economists have relied for the past seventy years or so on two basic tools: fiscal policy and monetary policy. The first concerns how the government taxes and spends; the second concerns the action of the central bank (in America, that’s the Federal Reserve), which controls the supply of money. While both tools are complex, the main thing to understand is that they both have an accelerator and a brake pedal. If the economy is overheating, with spending overtaking new production of goods and services, resulting in a bidding spiral and increasing inflation, we can hit the brakes. If the economy is moving too slowly, with spending not keeping pace with the production of goods and services, we can hit the gas.
For fiscal policy, increased government spending or decreased taxation is our accelerator; the opposite, austerity, is the brake. These work to add or subtract the amount of spending in the economy. For monetary policy, the federal funds rate can act as either an accelerator or a brake. U.S. banks are required to hold reserves at the Fed, which pays interest on them, similar to a normal checking account. For a bank to loan money to a real person, they must find someone willing to pay an interest rate above the Fed’s rate. So if the Fed jacks up the interest rate, it discourages lending, as banks are paid better to park their money at the Fed. Lowering the Fed rate does the opposite. The use of these tools is commonly expressed as a trade-off between unemployment and inflation. Try to push unemployment too low, and inflation will speed up as companies bid for scarce labor, pushing up wages and sending spending surging through the economy. Conversely, allow unemployment to get too high, and a collapse in spending can cause a collapse of prices, which will lead to more unemployment, which will lead to less spending, and so on.
In the decades since the Great Depression, we’ve managed to avoid another economic catastrophe of that magnitude by using these two tools to prop up aggregate demand. So why can’t we just use them again to boost us out of the slump in which we find ourselves now? The answer has to do with the inequality that has steadily increased in our society since the 1980s.
Way back during the post-World War II era, the economy was booming. Unemployment was very low, productivity was up, and workers’ wages were growing steadily in real terms—that is, even after adjusting for inflation. Along with the cost-of-living adjustments written into many job contracts, that meant wage-price inflationary spirals were always on the horizon. As a result, for about thirty years, from the mid-1940s through the ’70s, the main problem for economic policymakers was not growth or unemployment, it was simply keeping inflation in check. Since it’s very hard to cut wages, the Fed did that by repeatedly inducing small recessions. The idea was to create enough unemployment to slow both aggregate wage growth and the ensuing spending. Despite the often-uncomfortable abruptness with which the economy bounced from recession to rapid growth, this was still the greatest economic boom in American history.
But it didn’t last. As the ’70s transitioned into the ’80s, several structural developments in the larger economy caused a qualitative shift in how monetary policy worked. First, more and more people got access to credit, in the form of credit cards and home equity loans. This boom in consumer credit meant not only that households had new purchasing power but that a substantial chunk of spending was happening through a channel—borrowing—that was sensitive to the Fed’s interest rate mechanism. If inflation was getting out of hand, the Fed could simply tinker with interest rates and, suddenly, a huge chunk of the economy, including consumer spending, would respond in kind. For the central banker, this was something of a revelation: it was no longer necessary to provoke recessions—a messy, blunt instrument—in order to restrain inflation.
This period was called the “Great Moderation.” While real GDP growth was substantially slower than during the thirty-year postwar boom, there were fewer sharp booms and recessions, mostly because the Fed no longer induced recessions deliberately. But there were a few more features of this new, more moderate economy that policy elites didn’t fully appreciate right away. The first was that income inequality began to take off. Starting in the ’80s, productivity gains were no longer shared with workers. Therefore, the wage share of the economy began to decrease. As a percentage of total output, wages have fallen from a high of almost 52 percent around 1970 to less than 43 percent today (see Graph 1). Meanwhile, inequality within wages also increased. The upshot? The rich began capturing nearly all the results of economic growth—the top 1 percent’s share of national income increased from about 8 percent in the mid-’70s to about 23 percent today.
Graph 1: Wage share of GDP, 1947-present
And that turned out to have some awful side effects, since the rich disproportionately save their money rather than spend it. But they don’t save by piling up huge pyramids of cash like Scrooge McDuck, they “save” by buying financial assets—which means that most of the fruits of economic growth have been channeled into asset price increases, rather than consumer price inflation. That partly explains the tendency toward bubbles. All of the recessions since the start of the Great Moderation were caused by collapsing asset bubbles: the savings-and-loan crisis of the late ’80s, the dot-com stock bubble in the 2000s, and the housing bubble in 2007. But that’s not the worst of it. After the early ’80s, the Fed’s interest rate tool seemed to become progressively less effective. While it was working, they had to keep turning the Fed funds rate down and down and down again (see Graph 2).
Graph 2: Effective federal funds rate, 1979-present
What was going on here? In a modern economy, consumer spending accounts for the vast majority of economic output. But with median incomes growing slowly, if at all, ever-increasing household debt was necessary to sustain aggregate demand. As household debt mounted, the Fed had to keep lowering interest rates to induce greater and greater borrowing (see Graph 3). In theory, that’s not much of a problem—so long as you can keep dialing down interest rates. But here’s the thing: you can’t.
Graph 3: Household debt as a fraction of GDP
The final nail in the coffin of the Great Moderation is what’s known as the zero lower bound, which means that the Fed funds rate cannot be pushed below zero (since, if there were negative interest rates, people would just hoard cash). In other words, the Fed’s interest rate accelerator has a maximum setting. And, it turns out, pushing the pedal all the way to the floor isn’t always enough to keep the economy going.
Take the early 2000s, for example. During the recession caused by the collapse of the dot-com bubble, the Fed lowered rates almost to zero, yet the stimulative effect was strikingly weak. Aside from today’s economy, the 2000s expansion was by far the weakest in postwar history, despite being driven by a housing bubble of world-historical proportions and enormous deficit spending. Then came the financial crisis in late 2007 and early 2008. When the economy fell into recession, the Fed started to lower rates sharply and reached near zero by late 2008. (For complicated reasons, the Fed refuses to go all the way to zero.) This action, coupled with the sizable fiscal stimulus of 2009, was enough to stave off a full-blown depression, but it was not enough to prevent mass unemployment, which spiked to over 10 percent and, more importantly, has come down at an agonizing pace. The prime working-age employment rate collapsed during the crisis, and has barely budged since (see Graph 4).
Graph 4: Prime working-age (25-54) employment rate, 1989-present
This is why income inequality is dangerous: it is a drag on aggregate demand. As inequality increases, as it has in the U.S., the drag grows commensurately. Stagnant wages mean that consumer borrowing must be steadily increased to keep the economy moving forward. Meanwhile, the fruits of growth flowing to the top mean a vast pile-up in savings and associated asset bubbles, and the recessions that follow are harder and harder to recover from. In other words, keeping an economy that suffers from galloping economic inequality pressurized and growing requires an economic policy regime that contains the seeds of its own destruction. And this leads us to where we are now: consumers today can’t stomach any more debt, interest rates have hit the floor, and a grinding, low-level depression is upon us. Welcome to 2015.
So what should we do? After “aggressively stabilizing” the financial sector, the Fed has been cautious about new policies, but it has tried two new strategies to restore employment: forward guidance and the dreaded “quantitative easing.”
Forward guidance consists of trying to reassure the markets that the Fed funds rate will stay low for a long time after full employment is reached, thereby calming fears that the Fed will step on the brakes the moment employment returns to normal levels. Quantitative easing is when the Fed uses newly printed money to purchase Treasury bonds and other financial assets, with the idea of pushing down longer-term interest rates and forcing money out into the economy. Economists and financial wonks can (and do) discuss the relative merits of these policies all day, but the one thing that almost everyone agrees on is that while they helped us avoid a full-blown depression, they did not restore full employment—or anything even close to it. Since the crisis, both output and employment growth has been weak.
Therefore, economists have been discussing the possibility of using more drastic tools. There are four major options under discussion.
The first is to push interest rates below zero. The idea here is fairly simple. If the problem with our economy is framed in terms of people trying to save too much relative to their spending, then negative interest rates would make saving money expensive. If you kept cash in a savings account with a negative interest rate, you would actually lose money. There are a few major problems with this idea, one of which is cultural. We Americans consider saving virtuous; a Fed policy that punished savers would simply not go over well. Another problem is that if interest rates on money were sharply negative, investors might just pour their money into commodities like wheat, oil, or copper as a store of value, which would keep those raw materials from socially positive uses and be tough to regulate. Yet another problem, which the economist Miles Kimball (an advocate of this idea) points out, is that if we really wanted to make this work, all money would have to be subject to interest rate fluctuations, which means we’d have to get rid of paper money. (If everything were electronic, there would be nowhere for savers to hide.)
The second major policy option, championed by International Monetary Fund economist Olivier Blanchard, is functionally very similar to the negative interest rate proposal, although it’s a little sneakier. Right now, the Fed targets inflation of 2 percent. Raising the target to 4 or 5 percent (assuming it could be achieved) would discourage savings and promote spending in the same way that negative interest rates would, but without the probable outrage at having money subtracted from one’s bank account.
The third policy option is known as nominal gross domestic product targeting, the major proponent of which is the economist Scott Sumner. The idea is all about self-fulfilling expectations. Recall that the central bank owns the printing press, so it can create arbitrary quantities of dollars. By making a pre-commitment to keep the economy on a particular spending trajectory, self-fulfilling collapses in spending would not happen. Something similar to this policy seems to have kept Australia and Israel out of the Great Recession. But in order to sustain such a policy, the Fed might have to intervene in the economy quite frequently, and then the distributional consequences could be serious. Quantitative easing, for example, helps push up asset prices (the stock market has regained all the ground lost since 2009 and then some), which disproportionately benefits the wealthy.
The fourth and final policy proposal on the table is what I’ll call the “helicopter money” option. It too is fairly simple. Under such a policy (which could be combined with aspects of the first three), every U.S. citizen would receive a regular payment, in the form of, say, a check from the Internal Revenue Service. The amount of each check would change depending on the health of the economy, but it could be fairly substantial during times of economic slack. To jar us out of our current slump, for instance, I’d start with payments on the order of $2,000 per person. These checks would arrive on an as-needed basis, depending on the state of the economy.
Again, that may sound crazy. But the idea is to address the lack of aggregate demand in the economy in the simplest, most mechanical fashion: if the economy needs more aggregate demand, you give people money to spend, since when people (especially non-rich ones) have more money, they spend more money, and therefore aggregate demand increases. People who don’t spend the money outright might choose instead to pay down debt, leaving them more willing to use credit for future spending, and people who worry that the policy will create inflation will move their money from cash and savings to spending on durable goods. (And, remember, the policy won’t create excessive inflation so long as there is slack in aggregate demand.)
The Fed would then “pay” for it by creating new money. That new money, by the way, would be added to the monetary base, not the deficit. While this concept gets into arcane government accounting conventions very quickly, the point is that the Fed has the power to create infinite cash. Indeed, such mass money creation is hardly new: the quantitative easing program has already been carried out in a similar way—with trillions of dollars in new money.
At any rate, the only thing standing in the way of the helicopter money plan is the way the Fed’s charter is written. Namely, it’s illegal: the Fed does not currently have the power to hand out checks to the American people; Congress has to do that. But laws can be changed.
On the straight economics, this solution is nearly identical to the 2008 Bush/Pelosi stimulus. In that case, Congress sent money to everyone and paid for it by issuing debt. Later, the Fed bought more than that amount’s worth of Treasury bonds. (In this case, we would simply avoid that two-step process: Congress would hand over the reins directly to the Fed.) This similarity leads many economists to be skeptical of the helicopter solution as redundant. “I’m all for fiscal and monetary stimulus,” Paul Krugman told me in late January. “But I don’t see helicopter money as adding anything substantive to the menu of policy tools, or as making the politics any easier.”
Krugman is right that helicopter money isn’t fundamentally innovative economically. The argument here, however, is not economic; it’s institutional. Instead of Congress being in charge of distributing resources according to its erratic whims and halting ability to compromise, the Fed would do it. The Fed would watch aggregate demand closely (indeed, it already does this) and make quick, proactive decisions on whether to send everyone money, and how much, without having to wait for Congress to deliberate over a stimulus bill.
Right now, Congress has the power to directly spend its way to full employment, but it’s not doing it. And neither are the state governments. In fact, since 2010, Congress and most of the states have been doing the exact opposite, sharply reducing spending. After the Great Depression, it took World War II to break the political deadlock and get Congress to dump money into the economy, but today, nothing similarly jarring is in sight. If the Fed took over, it would respond directly to the needs of the economy, without getting bogged down in endless politically charged debates about the virtues of austerity or the moral peril of government checks (recall how Senate “moderates” forced the Obama stimulus to be too small). Instead, it could respond, quickly and efficiently, to fluctuations in aggregate demand.
Handing the reins to the Fed could be a good idea for another reason: it would give the Fed a policy tool that shares the fine-tuning properties of the interest rate mechanism, but without the constraint of the zero lower bound and the tendency to create skyrocketing household debt. When the economy is running hot, threatening inflation, the Fed could slow deposits to a trickle (or raise rates), but when recession strikes, it could speed them back up again, quickly and easily. After all, in order for macroeconomic stabilization policy to work, it must be adjusted frequently and quickly—especially in the computer age, when recessions can gather force with astonishing speed.
What’s more, there is no reason to think that our aggregate demand problem will be cured without some kind of aggressive change. The economist Brad DeLong has calculated that reasonable estimates of the current and future damage to our economy from the present crisis are greater than those from the Great Depression. “Unless something—and it will need to be something major—returns the U.S. to its pre-2008 growth trajectory, future economic historians will not regard the Great Depression as the worst business-cycle disaster of the industrial age,” he wrote in the journal Project Syndicate. “It is we who are living in their worst case.” Already our current weak economic expansion is near the length of the postwar average, and a new recession may strike at any time, which would erase the pitiful gains of the past five years. (God only knows what is cooking in the dungeons of Wall Street.) If we change nothing, we could be stuck in our current situation for decades. Japan has been mired in a similar trap for almost thirty years.
Why hasn’t the helicopter money option already been enacted? The main reason is simply that until very recently we thought we had cured chronic shortages of aggregate demand, so no one was really thinking about these issues. The other reason is that Congress has not yet gotten it together to pass a law allowing the Fed to cut checks to the American people.
But there’s no reason why they shouldn’t. Democrats should be for it because it is straight-up economic stimulus, writ large. And Republicans should be for it because it is the stimulus option that’s most in line with conservative values. To be sure, a whole lot of right-wing conservatives will object to the very notion—government checks give them the willies. And for conservatives with the strongest tendencies toward gold buggery, who are already freaked out that the Fed’s quantitative easing is debasing the currency and setting us up for hyperinflation, the idea will never be in favor. But what conservatives really objected to about the Obama stimulus and all subsequent Democratic proposals for fiscal pump priming was not so much the fiscal consequences, despite what they said—after all, they favored the Iraq War and the Bush tax cuts, which drove up the debt, and voted for Paul Ryan’s budget, which would have done the same. What really infuriates them about Democratic stimulus measures is that it is spending by government, meant to achieve government priorities, and delivered through government channels in ways that enhance the reach and influence of the government.
The Helicopter money policy, by contrast, keeps government almost completely out of the picture. It distributes resources directly to citizens, with no limits on how they can spend it, thereby strengthening individual choice and the private sector, not government bureaucracies. It’s a stimulus Milton Friedman could love. And if everyone gets the same-sized check, there’s not even a concession to the god of progressivity—it’s like a flat tax in reverse! There will be a Republican president again someday, and as we’ve seen, it is highly likely that government will face the same weak growth and high unemployment we face today. This is a tool as friendly to the conservatives’ ideology as they are likely to find.
In any case, we shouldn’t forget the relative simplicity of what’s wrong with our economy right now: it’s a simple divergence between incentives for production and those for consumption. The money supply is a very powerful tool to fix that misalignment of incentives, and its power is communal. It comes from the fact that it is accepted as a medium of exchange by all 310 million Americans. We should not fear to use that tool, and to provide badly needed help to millions of people in the process.