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Economy in Brief

Helicopter Money + Negative Supply Shock = Higher Inflation
by Paul L. Kasriel  October 25, 2021

Although the Covid-19 pandemic has been horrible for mankind in general, it has shed some light on two economic concepts – the effectiveness of so-called helicopter money and the limits of Modern Monetary Theory (MMT). Helicopter money refers to a thought experiment used in University of Chicago money and banking classes. Specifically, what would happen to aggregate nominal spending if money were figuratively dropped from a helicopter? Modern Monetary Theory, as I understand it, is the idea that a government can increase its spending without concern about funding this increased spending by raising taxes or increasing debt sold to the public. So, long as the government has its own currency, it can fund its spending by issuing debt to its central bank. MMTers acknowledge that at some point this central bank-financed government spending will result in higher inflation. During the Covid-19 pandemic in the US, the data suggest that the figurative dropping of money from a helicopter has been very effective in stimulating nominal household spending. The Covid-19 experience has also demonstrated the limits of central bank-financed government spending with regard to the onset of higher inflation.

Early on in the Covid outbreak in the US, the federal government engaged in various income-transfer programs to households such as regular/enhanced unemployment benefits and outright payments to households regardless of their employment status. These Covid-related income-transfer programs began in April 2020. Plotted in Chart 1 are a rough estimate of the 17-month cumulative totals of these Covid-related federal government income-transfer payments to households (the blue bars in Chart 1). In the 17 months starting with April 2020 and running through August 2021, roughly $2.7 trillion in Covid-related income transfers were paid to households by the federal government. In this same 17-month period, the Federal Reserve and the commercial banking system, combined, increased their holdings of US Treasury securities by about $2.8 trillion (the red line in Chart 1). So, all of the Covid-related federal government income-transfer payments, and then some, were funded by the Federal Reserve and the commercial banking system. As regular readers of my commentaries understand (I hope), the Fed and the banking system have the unique ability to create credit figuratively out of thin air. In effect, the federal government deposited funds in households' bank accounts, funds created out of thin air, much akin to dropping money from a helicopter.

Chart 1

Did the helicopter drop work? Did it stimulate household nominal spending? In terms of nominal retail sales of consumer goods, it sure did. Plotted in Chart 2 are monthly observations of the year-over-year percent changes in nominal retail sales of consumer goods (the blue line in Chart 2). In the 12 months ended September 2021, nominal retail sales were up 12.2%. This compares with 3.2% in the 12 months ended September 2019, pre-Covid. But while retail sales growth was soaring after the helicopter drop of money, growth in the production of consumer goods was not keeping pace (the red line in Chart 2). In the 12 months ended September 2021, the year-over-year change in industrial production of consumer goods was only 1.4%. Industrial production growth was constrained by a lack of parts and workers to assemble the parts. Covid was partially responsible for this negative supply shock. In September 2021, the gap between year-over-year growth in retail sales of goods vs. industrial production of consumer goods was 10.76 percentage points (the green bars in Chart 2). The median of this differential from January 2014 through September 2021 is 3.51 percentage points.

Chart 2

What happens when demand is growing faster than supply? Prices go up. And that's what is shown in Chart 3. The blue line in Chart 3 represents monthly observations of the year-over-year percent change in the Consumer Price Index (CPI) for consumer goods (not services). As the gap between growth in nominal retail sales of goods and the domestic production of consumer goods widened after Covid took hold, consumer price inflation soared. In the 12 months ended September 2021, the CPI for consumer goods had risen 9.03%. This compares with minus 0.01% change in the CPI for consumer goods in the 12 months ended 2019, pre-Covid.

Chart 3

So, class, what have we learned? Funding increased government spending by credit created out of thin air by the Fed and the banking system, or dropping money from a helicopter, does, indeed, stimulate aggregate nominal spending. This might be a good idea when there has been a negative shock to demand, but not such a good idea when there has been a negative shock to supply. Similarly, the prescription of Modern(?) Monetary Theorists(?) to fund increased government spending via the central bank's creation of credit might not be a good idea when the economy has experienced a negative supply shock. In the 52 weeks ended October 13, 2021, money dropped from a helicopter increased by 12.81%. From 1974 through October 13, 2021, the median 52-week growth in helicopter money has been 7.25%. The constraints on US production and getting foreign-produced goods on the shelves of US retailers are likely to ease in 2022. But if the Fed and the banking system keep dropping money from a helicopter at a rate faster than the long-run median rate, consumer price inflation is likely to settle in at a rate higher than the Fed's 2% target.

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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