Track the problem to its source

Central banks don't buy liabilities.

Steve Roth says

A a year or so back I highlighted David Beckworth’s great post on Helicopter Drops... I’ve been pinging ever since to see a response to that post from Market Monetarist opinion-leader Scott Sumner... I won’t rehash it all here but rather point you to Nick Rowe’s wonderfully successful effort to bring it all to conclusion, synthesizing Market Monetarist and New Keynesian thinking into support for a policy proposal that I think Post-Keynesians and MMTers would also jump on with gusto...

And that was pretty much it. I had to follow Steve's links to discover the topic. Started with Beckworth on helicopter drops:

Fiscal policy geared toward large government spending programs is likely to be rife with corruption, inefficient government planning, future distortionary taxes, and a ratcheting up of government intervention in the economy. So I will pass on this type of fiscal policy. Fiscal policy, however, that largely avoids these problems and directly addresses the real issue behind the aggregated demand shortfall--an excess demand for safe, money-like assets--I will endorse. And that form of fiscal policy is a helicopter drop, a government program that gives money directly to households.

Oh, says I. Giving money directly to households. Yeah, that reduces the debt-per-dollar ratio. That works. I like it.

I don't like Beckworth's reasoning -- that "the real issue behind the aggregated demand shortfall [is] an excess demand for safe, money-like assets". No. The problem did not begin with the sudden increase in demand for safe, money-like assets. The problem began when normal assets started getting "toxic". Or rather, the crisis began with toxic assets. The problem goes much farther back in time.

I went back to Steve Roth's and followed the link to "Nick Rowe’s wonderfully successful effort". Nick's post -- Oh! I read that one already. Read and commented on it I think... Yup. That's probably not good, if there is all this backstory that Steve and others have been following for "a year or so"...

Oh, well.


At WCI, Nick makes me shudder:

How much money should the central bank print and buy things with? As much as is necessary, to hit the NGDP target. And if it runs out of other things to buy, like government bonds, or commercial bonds, or......, then it should buy newly-produced things, if necessary. And if that means it is buying too much, and getting too big, then raise the NGDP target and the implied inflation rate and the implied tax on holding currency.

... If the central bank runs out of things to buy and needs to buy new bridges to hit its NGDP target, and if the government doesn't want the central bank owning bridges, the government should buy those bridges financed by issuing bonds, and let the central bank buy those bonds.

The central bank should just keep buying things, Nick says, until the path of NGDP is where we want it. Even if it has to buy bridges.

That's what I was responding to, in my comment:

No. If you have to say the central bank should buy "newly-produced things, if necessary" then I have to say you misunderstand the problem.

In the normal economy Nick would never say such a thing. Even two years ago, probably, Nick would not have said such a thing. But the central bank has been unable to solve the problem, so the human reaction function keeps turning up the pressure.

It is as if Nick knows the central bank should be able to solve the problem -- and that if it fails, the failure must be because the central bank wasn't trying hard enough. But this evaluation of central bank policy is based on the assumption that bank policy has been right all along, and we only need more of the same. I don't think that's the case.


When the central bank sells something, it takes money out of the economy and puts something else in. When it buys something, it puts money into the economy and takes something else out. When the Federal Reserve was buying up toxic assets, it was putting "safe, money-like assets" into the economy and taking the toxic assets out.

But if toxic assets seem to be the problem, then really the problem is whatever it was that made the assets toxic. You have to track the problem to its origin. You don't wait till the shit hits the fan and then say it's the stinky mess that's the problem.

Toxic assets? That was a result. You have to ask: What made the assets toxic? The assets became toxic because the liabilities became unaffordable.

When people could no longer afford to make the mortgage payments, mortgage-backed securities became toxic.

The problem is not that assets went bad. The problem is what made them go bad. Track the problem to its source. Liabilities became unsustainable; therefore, assets became toxic. Central banks bought up toxic assets, but left liabilities to fester.

The Federal Reserve's balance sheet is now almost five times its pre-crisis size, but still the problem is not solved. Nick says let them just keep buying assets until the problem is solved. But it did not work, and it will not work, and here is the reason: The problem is not in the assets. The problem is in the liabilities.

Central banks don't buy liabilities. So central bank policy has not solved the problem, and cannot solve the problem. The liabilities are still there. No matter how many assets the central bank buys, the liabilities remain.

That's why I like the "helicopter drop". It puts money into the economy. Some of that money goes directly into the hands of people who might use it to pay down their debt. That decreases liabilities and hopefully it decreases toxic liabilities. Pot luck, yes, but it's better than buying bridges.