By Karen Petrou
Progressive Democrats have recently touted modern monetary theory – i.e., that deficits don’t matter – to press social-welfare spending. Similarly dismissive of deficits, the Trump Administration and many Republicans now cotton to giant trickle-down individual tax cuts. But, deficits do matter not just for fiscal hawks, but also for equality advocates. A new IMF study takes an unprecedented look at U.S. public wealth since 1946, concluding that lots less public wealth undermines the ability of fiscal policy to alleviate economic downturns.
With fiscal policy out of ammunition, it’s over to the Fed for counter-cyclical firepower. Given that the Fed’s also out of ammo, the only possible path to counter-cyclical policy is helicopter money – i.e., Fed-printed dollars used to buy whatever assets the Fed’s models desire. What these assets are determines how equality fares in dire fiscal straits, but the odds of a soft landing are low and the inequality implications almost surely still worse.
The Busted U.S. Balance Sheet
The IMF study is a significant contribution to the fiscal-policy debate. It not only spans state, local, and federal accounts (including off-budget items such as pension liabilities and the GSEs) from the end of the Second World War to 2016, but then also judges forward-looking fiscal policy under the Fed’s macroeconomic stress scenarios. Looking at balance sheets instead of just raw debt numbers provides a much better sense of government solvency than the simple debt-to-GDP ratios long used in the austerity-versus-stimulus debate.
The paper’s analysis concludes that non-debt balance sheet effects under severe stress expose public-sector net worth to a negative impact almost double expected accumulation of debt, with the federal government’s student-loan obligations a particularly problematic liability under medium-term shock. However, even the IMF’s baseline scenario is scary: current financial and non-financial assets combined with future tax revenues are insufficient to fulfill all the promises made to constituents and creditors. For the U.S. as a whole to keep its word in terms of honoring guarantees, paying pensions, and continuing health care without turning the fiscal hole into a deep cave, the U.S. must either raise an additional 2.6 percent of GDP in revenue per year or sharply reduce unfunded commitments.
Theoretically, local, state, and federal debtors could handle at least some of these claims by a combination of tax increases and asset dispositions. However, there’s not much to sell given the transfer of public wealth to private hands – in 1980, public wealth was 35% of GDP; in 2016, it was -27%.
Turning quantitative easing into helicopter money has interesting balance-sheet impact and thus considerable counter-cyclical potential. QE as practiced since 2009 is, as the IMF says, a debt-management vehicle. The Fed buys USG/agency paper so that the assets backed by federal liabilities remain in house with no net balance-sheet impact. In helicopter money, the Fed prints the dollars it used to buy federal-backed assets from the private sector in QE, but then uses currency instead to buy private-sector obligations (e.g., corporate debt). This is a net asset transfer from private investors to the federal government without any additional federal liability, making helicopter money a net contribution to public wealth as long as the assets are private-sector obligations. Helicopter money is inflationary, but that’s another matter.
The Inequality Effect
QE’s economic-inequality effects derive not from any diminution in public wealth, but from the fact that Fed purchases deprive the private economy of safe assets and thus spark the yield-chasing we have seen instead of the economic growth the Fed intended. More QE through purchases of Treasury or even agency obligations thus has indirect inequality impact no matter their neutral public-wealth implications.
As a memo of mine earlier this year suggests, helicopter money might solve for the round-trip cycle and genuinely increase public wealth without additional inequality. This would occur because, as noted, the Fed would print money and use it to buy private-sector assets without any federal backstop. Federal liabilities would thus not increase because no new debt is issued to fund the Fed’s purchases – it’s all play money at the central bank’s disposal.
Hypothetically, helicopter money would not have QE’s adverse inequality impact because safe-asset supplies would be unaffected by Fed purchases, reducing yield-chasing incentives and the financial-asset valuation increases that increased post-crisis inequality. Actually, it’s hard to see the Fed purchasing anything other than the safest kinds of private-sector assets or, more likely, just diversifying the types of government-backed obligations it purchased – for example, the green bonds promoted by progressive Democrats as an ideal Fed investment. The more the Fed bought, the more public wealth might grow, but offsetting federal liabilities would cut into the net wealth transfer with ongoing inequality impact.
Only a risk-taking central bank willing to print money to buy the kind of obligations purchased by Japanese or ECB central banks might create larger federal reserves which could be sold under stress to support macroeconomic stability without still more federal debt. However, the very slow pace of Japanese and EU recovery despite all this helicopter money should give one considerable pause – experience to date suggests strongly that even money-manna from central-bank helicopters is an equality-costly response to fiscal profligacy.