Heli-drops: the most effective tool at managing expectations

Under policy tools such as quantitative easing (QE) the fed is trying to stimulate the economy by expanding the monetary base (MB). The fed has expanded the MB at an unprecedented pace and still has not reached its target inflation rate. Some people say it is because of some actual risk of expanding the MB further which may or may not be true. Others say there is no risk and the central bank should just further expand the MB and it will hit its target inflation rate. These people also say that the fed isn’t expanding further and hence lowering its inflation target because it may be perceiving a risk that doesn’t actually exist.

This is where helicopter drops as a policy tool are superior. In order to achieve the same rate of inflation as is currently being achieved the MB would of only increased at a moderate rate far below what we have observed since QE began. Therefore risks whether perceived or real as a result of a massive expansion in MB wont exist and the fed wont lower its inflation target.

Money demand amongst the general public is more stable when compared to the current counter-parties at the zero lower bound (ZLB). This is because at the ZLB central bank counter-parties have very little or no opportunity cost when holding money due to low investment returns. The overall public on average have a higher opportunity cost when holding money at the ZLB due to foregone utility from consumption or other spending. Banks are oriented towards realizing profits from investing and inter-mediating whereas people gain greater relative utility from consuming. Individuals which are unemployed or of low wealth have very stable and low speculative money demand. Therefore expansions of funds to people broadly would more effectively affect expectations, create inflation and spending growth at the ZLB.

Heli drops are more effective at managing expectations compared to interest rate targeting. The effectiveness of a reduction in interbank interest rates in affecting expectations is dependent upon people’s willingness to borrow and bank’s capacity to make loans or investments. Factors such as debt to GDP levels and balance sheets of debtors and creditors can severely hamper the effectiveness of interest rate targeting as a policy tool.The limited direct reach of this instrument is one of its main shortfalls. Adjusting interest rates only directly affects entities which are currently indebted and others who wish to borrow. Interest rate targeting will also be ineffective in instances where the demand for credit is low or in circumstances of disintermediation. Heli drops affect all people not only the indebted or people wanting to borrow.

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