What creates inflation?

[Obvious Leo]

it is genuinely likely that helicopter money will be the response to the next big financial meltdown.

I heard a passing reference to this the other day on the radio but I missed most of the conversation. Could you elaborate on exactly what helicopter money is supposed to do?

[bobevenson]

Yeah, I'd like to know that, too, since it sounds like total bullshit. Money is merely a medium of exchange of property, property being defined as anything with intrinsic market value.

[FlashDangerpants]

The general problem of all economic policy - fiscal or monetary - is how to get as much as possible of the desired effect with as little as possible of the shitty downside. This is made worse by competing shitty downsides, the best economic policies are morally scandalous, the policies that voters approve are fiscally ruinous.

In this instance, the objective of the policy was to compensate for the fact that interest rates of effectively zero were not making money cheap enough. So diluting the currency with fresh money was the next best thing. But the underlying mission isn't to make money cheap or have a certain rate of interest, it's to make money move around. Money that sits around doing nothing is having no effect. It's only when it gets spent on something that it contributes to prices, so having as much money spiralling around as quickly as possible leads to higher prices. When we want to do the opposite, we raise interest rates so that everyone has to stuff their cash into the bank to slow it down.

So QE is one way of cramming money into the system, which dislodges some other money, that wanders off and becomes somebody's income and then some of it gets spent. But it takes a lot of imaginary money to do so, enough that it could come back to bite us later and cause a dirty inflationary spiral. If the Bank doesn't choose to destroy the money when the bonds it bought mature, the government can turn a profit on QE and maybe they will spend it on a hospital and get some votes. But do enough of that, and you have endorsed the most dangerous thing known to economics - monetary financing for fiscal objectives. So the whole QE policy uses a lot more money than is theoretically needed - and it probably relies upon future bank governors and politicians to show great discipline.

Helicopter money might be the solution to that problem. The idea is that instead of using the complex interactions between banks and the multiple markets they serve (bonds, equities, forex), just print a bunch of fucking cheques and hand one to everybody. The money printed for QE in the UK amounted to several thousand quid for every man woman and child. But every stage along the line dissipated and slowed it down. If you give a butt load of money to poor people instead of fat cats, they will get out there and spend it right now. So you can get the same price increases with half the amount of fake cash. Extra benefit - there's no worry about what future politicians and bank governors will do because they can't undo helicopter money, so they will have to raise interest rates to punishing levels one day and thus nobody gets an unpleasant surprise (it may be unpleasant, but it isn't a surprise).

The exact mechanism of how to do helicopter money is almost certainly a huge problem. If you give a big lump sum to people they will tend to squirrel it away long term (great for them, disaster for you). If you send everyone a hundred pounds a month for two years, too many of them will save up for something big when you want them to spend right away. If somebody works out a formula for efficiently pumping money into the economy this way (where minimum new currency equals maximum spending), I guarantee it will be highly sensible but morally revolting to all (my guess is it would use random sums of cash equivalent to lottery cards).

[Obvious Leo]

Thanks for the explanation, which accords roughly with what I thought. This helicopter money strategy was the one adopted by the Australian government at the time of the GFC. Every single Australian taxpayer who had submitted a tax return for the previous year was sent a cheque for 900 odd bucks and urged to get out there and spend it quick smart instead of saving it or using it to pay off debt. The government also instituted a few infrastructure projects which could be got off the ground quickly to keep the cash moving through the economy. Australia was one of the few countries which successfully avoided going into recession after the GFC and economists are unanimous in their view that it was these measures which played a big part in this.

Unfortunately there is a downside. We now have a government debt where previously we had almost none. This wouldn't have been too much of a problem if commodity prices had remained high because this was causing gold bars to rain into the taxman's pocket. The golden goose is off the lay and now we face having to deal with this debt through fiscal constraint because the current account figures are heading the wrong way. Ultimately this will cost Joe Ordinary a lot more than his original 900 bucks (which he's already spent). Mammon giveth and Mammon taketh away.

[bobevenson]

Every single Australian taxpayer who had submitted a tax return for the previous year was sent a cheque for 900 odd bucks and urged to get out there and spend it quick smart instead of saving it or using it to pay off debt.

Anybody who looks to the government for advice on financial matters, advice from bureaucrats who most people wouldn't ask the time of day from for fear of getting the wrong answer, that person is not only a fool, but a damned fool at that!

[bobevenson]

Bob. Elected governments have a duty of care to the people who elected them.

Elected government officials have a duty of care? Jesus Christ, where the fuck are you from? It must be some heretofore mystical country where all the candidates for political office were related to Mother Teresa!

[Greta]

Inflation is caused by the dark energy coming from the big bank ...

[BigWhit]

Bob. Elected governments have a duty of care to the people who elected them.

Elected government officials have a duty of care? Jesus Christ, where the fuck are you from? It must be some heretofore mystical country where all the candidates for political office were related to Mother Teresa!

If you've read "The Missionary Position" by Hitchens one might think politicians and Mother Teresa have more in common than is popularly believed.

[Science Fan]

While I agree that inflation is a result of an increase in the money supply, it is not entirely correct that only the government creates money. The government, long ago, originating in England centuries ago, gave banks the ability to create money as well. Most people are familiar with fractional-reserve banking: where a bank has to hold a certain percentage of deposits in reserve and cannot loan this money out. Most people, however, are confused on what the reserves actually consist of. Let's say a bank has a 10% reserve requirement and a depositor deposits $1,000,000.00 with the bank? Most people think that the bank then keeps 10% of this deposit in reserve, $100,000.00, and then loans out the remainder -- $900,000.00. This is not what happens. Instead, the bank will use the entire $1,000,000.00 amount as its reserve, which allows it to loan out $9,000,000.00. This is one reason why banks are a weak point in the economy, as they can cause a positive feedback loop when the economy is doing well, by literally increasing the money supply on their own and adding to the increased boom.

[bobevenson]

While I agree that inflation is a result of an increase in the money supply, it is not entirely correct that only the government creates money. The government, long ago, originating in England centuries ago, gave banks the ability to create money as well. Most people are familiar with fractional-reserve banking: where a bank has to hold a certain percentage of deposits in reserve and cannot loan this money out. Most people, however, are confused on what the reserves actually consist of. Let's say a bank has a 10% reserve requirement and a depositor deposits $1,000,000.00 with the bank? Most people think that the bank then keeps 10% of this deposit in reserve, $100,000.00, and then loans out the remainder -- $900,000.00. This is not what happens. Instead, the bank will use the entire $1,000,000.00 amount as its reserve, which allows it to loan out $9,000,000.00. This is one reason why banks are a weak point in the economy, as they can cause a positive feedback loop when the economy is doing well, by literally increasing the money supply on their own and adding to the increased boom.

Sorry, my friend, the government is 100% responsible for inflation. In fact, the Federal Reserve has a goal of approximately 4% inflation per year, in other words stealing 4% of everybody's money regardless of where they live! And please, don't say the Federal Reserve is not the government, since it answers to the government!

[Science Fan]

You are wrong. Banks have been granted the legal authority to create money, and they do so. They are also responsible for inflation. Not just general inflation, but also specific market asset bubbles, which is the equivalent of inflation, except more confined, which is what the central bank in the USA now realizes it needs to confront as opposed to simply thinking without broad-based inflation that there is no "inflation" to worry about at all.

The government in England, more than a century ago, started modern banking by granting authority to its banks to create money. This has simply been carried over into modern times, with the vast majority of people failing to understand what is taking place. Before 1913, when the USA adopted its fourth central bank, we used to have central banks at the level of the individual states. People then understood that state banks created money, because the money that a bank, in let's say, the state of Texas created, would not be honored at 100% of its value, by let's say a bank in California. That's one of the reasons the FED was established in 1913 --- to give all states the same currency. The FED continued to allow each state bank to create money, but now, the money they created would involve a single currency backing it up, so individuals would not have to worry about bank notes from a bank in Texas being discounted by a bank in California over currency exchange rates between the states.

[bobevenson]

Any time the money supply exceeds the intrinsic value of property, you have inflation or the dilution in the value of money, and that, my friend, is criminal grand larceny, regardless of who commits it, but it is ultimately the responsibility of government, whose officials should be indicted, tried, convicted and thrown in jail!

[Arising_uk]

...
Helicopter money might be the solution to that problem. The idea is that instead of using the complex interactions between banks and the multiple markets they serve (bonds, equities, forex), just print a bunch of fucking cheques and hand one to everybody. The money printed for QE in the UK amounted to several thousand quid for every man woman and child. But every stage along the line dissipated and slowed it down. If you give a butt load of money to poor people instead of fat cats, they will get out there and spend it right now. So you can get the same price increases with half the amount of fake cash. Extra benefit - there's no worry about what future politicians and bank governors will do because they can't undo helicopter money, so they will have to raise interest rates to punishing levels one day and thus nobody gets an unpleasant surprise (it may be unpleasant, but it isn't a surprise).

The exact mechanism of how to do helicopter money is almost certainly a huge problem. If you give a big lump sum to people they will tend to squirrel it away long term (great for them, disaster for you). If you send everyone a hundred pounds a month for two years, too many of them will save up for something big when you want them to spend right away. If somebody works out a formula for efficiently pumping money into the economy this way (where minimum new currency equals maximum spending), I guarantee it will be highly sensible but morally revolting to all (my guess is it would use random sums of cash equivalent to lottery cards).

Ah! That's interesting FDP as at the time of the crash I was talking to City boys and girls and my proposal was to nationalise the failing banks, fire all their investment arms with no redundancy packages(given they say they are such a valuable resource they would surely be able to find employment), guarantee the savings of those with them in the bank and write-off all the debts. Start re-lending to those who need it, businesses etc but at slightly higher interest rates than the other banks who haven't gone bust, restart the investment arms but at a much smaller and more prudent pace and sell the bank as soon as possible. What stuck in their craw the most was the debt write-off, they were horrified but my point was that this in effect would be a big pay-off for many and odds-on that they would soon re-borrow or remortgage, etc again as they would suddenly feel much richer and spend. This way the 'cash' would get to those who want to spend it. I also added that it would be the christian thing to do as does not the Lord's Prayer say forgive us our debts as we forgive our debtors, they hated that even more. I'm pretty sure we'd still have had to have some QE but think it might have been less this way and it would have had consequences for those who were primarily to blame for the mess(not ignoring that all were greedy at this time) and not hit those poor saps who had just saved with the bank. Oh! And would have kept the part of the banking system open that we all use.

[bobevenson]

You are wrong. Banks have been granted the legal authority to create money, and they do so. They are also responsible for inflation. Not just general inflation, but also specific market asset bubbles, which is the equivalent of inflation, except more confined, which is what the central bank in the USA now realizes it needs to confront as opposed to simply thinking without broad-based inflation that there is no "inflation" to worry about at all.

Please, you don't have the slightest understanding of economics or inflation.

[Science Fan]

Bob, you have no understanding of the most basic economics. Ideology is not a substitute for economic understanding. You don't even know how the government in England first granted money-making abilities to banks, which is an idea that has been adopted throughout the western world, including the USA. In fact, that's when modern-day capitalism took off -- when England allowed banks to make money on their own. You don't understand basic economic history, which is why you cannot grasp the fallacies that you cling to. This is not too surprising because economic history is a subject most people who claim an interest in economics ignore. The problem is that economics is not a science capable of repeated experiments at the macro level, and at the macro-level, economics is merely a branch of history.