LAST week Cardiff Garcia produced a lovely taxonomy of views on the proper composition of stimulus. The idea is that there is a large group of economists and economics writers who think most rich-world economies are suffering from a demand shortfall. But within that group there are big disagreements over how to address that shortfall, and in particular how much work fiscal policy—changes in taxes and spending—needs to do relative to monetary policy. Mr Garcia makes the useful point that there are lots of possible policy combinations that should in practice appeal to many of the people in the more-demand group, regardless of their position on the fiscalist-monetarist spectrum, and he's right. It's worth noting that Milton Friedman's helicopter drop—a money-financed tax cut—is kind of a monetary policy ideal which also happens to have at its heart a policy (a tax cut) that is clearly fiscal in nature.

David Beckworth responds to Mr Garcia with an idea to operationalise the fiscalist-monetarist synthesis:

First, the Fed adopts a NGDP level target. Doing so would better anchor nominal spending and income expectations and therefore minimize the chance of ever entering a liquidity-trap. In other words, if the public believes the Fed will do whatever it takes to maintain a stable growth path for NGDP, then they would have no need to panic and hoard liquid assets in the first place when an adverse economic shock hits. Second, the Fed and Treasury sign an agreement that should a liquidity trap emerge anyhow and knock NGDP off its targeted path, they would then quickly work together to implement a helicopter drop. The Fed would provide the funding and the Treasury Department would provide the logistical support to deliver the funds to households. Once NGDP returned to its targeted path the helicopter drop would end and the Fed would implement policy using normal open market operations. If the public understood this plan, it would further stabilize NGDP expectations and make it unlikely a helicopter drop would ever be needed. This two-tier approach to NGDP level targeting should create a foolproof way to avoid liquidity traps. It should also reduce asset boom-bust cycles since NGDP targets avoid destablizing responses to supply shocks that often fuel swings in asset prices. This approach is consistent with Milton Friedman’s vision of monetary policy, would impose a monetary policy rule, and provide a solid long-run nominal anchor. Finally, per Cardiff Garcia’s request it would satisfy both fiscalists and monetarists. What is there not to like about it?

There is a lot to like about it, and possibly good reason to go further. The Fed could move to an NGDP target, and the government could pass a law giving the Fed direct control over the payroll tax rate (as it applies to both the worker and the employer). The Fed could then use the payroll tax rate as an additional policy tool when interest rates fell to near zero. Or it could use the payroll tax rate as its primary policy measure, in place of the fed funds rate. To provide expansionary impetus to the economy when expectations for nominal output dipped below the desired level, the Fed would reduce the payroll tax rate, making it more attractive to hire and giving workers an immediate and direct lift to their paycheques. And when expectations began to run too hot, the Fed could raise the payroll tax rate, reining in spending.

The downside to this plan would be the loss of the payroll tax rate as an instrument of independent fiscal policy; the government could no longer rely on it as a mechanism to fund social programmes or use changes in the tax rate as its own stabilisation policy. Of course, the revenue from the tax would still ultimately flow to the Treasury (just as the Fed's profits do now). Funding Social Security (pensions) out of general revenue and handing control of the payroll tax to the Fed, with revenues to be returned to the Treasury at some regular interval, might not lead to any meaningful change in the government's budget.

There would be several key upsides. The first would be to make moot concerns about the effectiveness of monetary policy. The second, related advantage would be the elimination of the zero lower bound as an obstacle to monetary policy. The beauty of the payroll tax rate as policy instrument is that there are no headaches associated with negative tax rates (indeed they too come with the Milton Friedman stamp of approval).

And there might well be a significant third benefit to it: reducing the ability of the financial sector to "break" monetary policy. When the central bank is forced to operate through the banking system, there is the risk that the banking system will pursue a contraction of its own, privately created money and will hamstring the central bank's efforts to ply the economy with more central bank money. Handing payroll tax rates to the Fed would largely, though not entirely, eliminate this risk. (Since there tends to be at least one financial intermediary involved in employee payments, there would still be room for collapsing banks to mess things up.) As Nick Rowe recently wrote:

It is presumably not a coincidence that a global financial crisis coincided with the beginning of a global recession. There was a connection between money and finance. But does there have to be that connection? Or was it simply a contingent fact based on our particular monetary practices?

There are several large pipes involved in this particular policy dream, and even it would not banish recessions forever. But so long as we're trying to build consensus around demand management, let's see if we can create the best first-best framework possible.