No Gratuitous Lunches Courtesy Of Helicopter Money

Although economists honey to tell themselves that economic science is a highly quantitative, empirical discipline, the reality is that when it comes to money, clear thinking goes out the window. Forcing banks to agree reserves at a below marketplace seat charge per unit of measurement of involvement is manifestly an imposition -- a revenue enhancement -- but it is somehow excused equally beingness some cast of a costless lunch, because reserves are "money."


In "Why Helicopter Money Is Influenza A virus subtype H5N1 'Free Lunch'", Biagio Bossone argues:

As such, the elimination of involvement payment on excess reserves (or its offsetting through the levy of an explicit accuse on commercial banks, equally suggested past times Bernanke) would entirely amount to eliminating (or compensating for) the policy-determined toll distortion discussed above. Consistently alongside this, the imposition from the fundamental banking concern of a non-interest bearing compulsory reserve requirement equivalent to the amount of the monetary expansion nether HM (or the levy of a accuse to offset the involvement internet payments to commercial banks) would non stand upward for a cast of revenue enhancement financing.

This declaration is at best misleading. If the declaration is that a "levy" is non actually a "tax," it is only a tidings game. Otherwise, if the fundamental banking concern increases the amount of reserves that are required to live on held past times banks, it is an imposition on the profits of banks, together with banking concern shareholders would correctly regard such "financial repression" equally a cast of tax. I explicate this inwards farther item below.

The apparent "free lunch" Bossone identifies is what is commonly called seigneurage "revenue" -- the amount of involvement cost saved past times replacing debt past times non-interest bearing "money." The annual amount of seigneurage revenue is calculated past times multiplying the monetary base of operations past times the curt charge per unit of measurement -- which is the involvement savings created past times replacing treasury bills/bonds past times "money."

If the monetary musical instrument nosotros are referring to is currency (notes together with coins) that are voluntarily held past times households, it mightiness reasonably live on viewed equally a costless lunch; the authorities gets a reduced involvement cost equally a final result of the determination to agree a liquid instrument. However, if banks are forced to agree instruments alongside a below marketplace seat charge per unit of measurement of return, this volition final result inwards an involuntary reduction inwards banking concern profits, which is undoubtedly a cast of a tax.

In whatever event, if forcing banks to agree reserves at a below marketplace seat charge per unit of measurement of involvement is somehow cost-free, forcing all investors to agree exceptional Treasury bills that pay a below marketplace seat charge per unit of measurement of involvement would likewise live on cost free. If the reader believes that this is the case, I would propose pitching that thought to some institutional investors to come across their reactions.

Required Reserves -- Influenza A virus subtype H5N1 Lunch Paid For By The Banks

 Let us assume that the prevailing short-term run a peril costless charge per unit of measurement is 2%, together with the fundamental banking concern forces an unlucky banking concern to agree $100 inwards non-interest bearing excess reserves.

The banking concern suffers an annual chance cost of $2, equally it could select held $100 inwards Treasury bills that would select paid $2 inwards interest.

That $2 loss inwards profits past times the banking concern is just equal to the seigneurage revenue that is generated past times replacing $100 inwards Treasury bills past times non-interest bearing reserves. That is, the banking concern is paying for what is allegedly a "free" lunch.

Meanwhile, forcing a banking concern to agree reserves cannot live on construed equally doing it a favour (as a final result of improving its liquidity position). If a banking concern is forced to agree $100 1000000 inwards reserves, that represents $100 1000000 inwards assets that are utterly immobilised. If it has a liquidity drain, it cannot describe on those reserves, it needs to sell something else (or borrow against something else) inwards lodge to expire on its reserve levels at $100 million.

The province of affairs is non greatly helped fifty-fifty if the liquidity loss is the final result of a reduction of deposits against which reserves are held. (Not all classes of deposits create a reserve requirement.) Reserve calculations are non done inwards existent time, together with then reserve requirements are fixed until the adjacent accounting period. (The drib inwards deposits would apply some relief inwards the adjacent accounting period; however, required reserves would entirely drib past times the reserve ratio times the deposit loss. For example, if the reserve ratio is 10%, $1 inwards lost deposits would costless upward $0.10 inwards reserves; however, the remaining $0.90 would soundless select to live on raised past times selling liquid assets.)

(UPDATE: My arguments hither are fairly touchstone MMT analysis, together with non viewed equally really original. The arguments are closer to the article "Helicopter money: The illusion of a costless lunch" by Claudio Borio, Piti Disyatat, Anna Zabai than I remembered (I had read the article a few months agone together with did non recall the details). The Bossone article was a answer to the Borio et al., paper, together with then ane mightiness inquire why my answer hither was non covered past times his discussion. The observation that increasing required reserves is non only a inquiry of involvement rates, but likewise creates immobilised assets which are effectively useless for liquidity management, was non not addressed inwards the Bossone article. I give cheers J.P. Koning for nudging me to expect at the Borio article again.)

Background On Interest On Excess Reserves

One indicate which may non live on clear to those who are novel to this topic is the inquiry of involvement on reserves. Since they expect similar a cast of "money," why should they pay whatever interest?

Since banks are non required to agree these excess reserves, they volition endeavor to merchandise them away. They would live on extremely probable to purchase Treasury bills, which are a liquid short-term instrument. The marketplace seat charge per unit of measurement on Treasury bills volition inevitably converge towards the involvement charge per unit of measurement paid on excess reserves.

If the fundamental banking concern does non pay involvement on excess reserves (like other forms of "money"), the implication is that curt rates would live on stuck nigh 0%. There would live on no agency for the fundamental banking concern to heighten involvement rates; that is, they volition select lost command of involvement rates. (The pre-2008 Federal Reserve was inwards this seat equally a final result of the prevailing institutional structure, where all reserves did non pay interest. This was changed, bringing the Fed closer to the operational practices of other fundamental banks.)

The Bossone article discusses this loss of command of involvement rates, together with it explains why he is suggesting to impose additional reserve requirements on banks (to compensate for "helicopter money"). The extra reserve requirements volition wipe out the "excess reserves," together with then marketplace seat involvement rates tin ane time over again live on decoupled from the charge per unit of measurement of involvement paid on required reserves. (I institute that parts of his give-and-take on this topic were somewhat unclear, then I wanted to add together some explanatory comments. UPDATE: This topic is covered inwards to a greater extent than depth past times the Borio et al. article linked above.)

Concluding Remarks

If money were non viewed equally some magical essence inside economical theory, nosotros would non live on having these discussions. It would live on obvious that obligatory reserve holdings is a revenue enhancement on the banking organisation (which of course of educational activity is going to live on passed on via lending spreads), together with nosotros would start bespeak ourselves whether such a revenue enhancement makes feel inwards the starting fourth dimension place. After all, economists howl nearly the "distortionary" effects of taxes; imposing a severe competitive disadvantage on the formal banking organisation versus the poorly regulated non-bank fiscal sector is an obvious distortion that ane should live on concerned about.

(c) Brian Romanchuk 2016