The possibility that central banks might resort to extreme monetary measures, including helicopter money, is much debated in monetary policy circles. But what is “helicopter money”?
In normal times, central banks in developed countries try to control inflation and the level of economic activity by controlling the short term interest rate. But since the financial crisis, the central banks in the US, Eurozone, Japan and UK have tried to meet their inflation targets by resorting to unconventional measures, because interest rates have reached close to zero or even slightly below zero. The main policy has been quantitative easing, which means central banks buying government bonds in the market, in an attempt to raise their price (which automatically cuts the long term interest rate). But now that long term interest rates are also very low, this policy has run out of steam. What remains to be tried is a policy that is known as helicopter money.
This name goes back to a 1969 thought experiment by the famous American economist Milton Friedman. Friedman, a leading member of the Chicago school of economists, is widely associated with a strong belief in the power of free markets. But he made his name originally in the analysis of monetary economics. Friedman was convinced that monetary policy was a necessary and sufficient means of achieving macroeconomic stability (i.e. that there was no role for active fiscal policy – the deliberate variation of government taxing and spending, usually known as Keynesian policy). He argued that even in a depression, when demand was persistently too low to create full employment, and even if interest rates had been cut to the minimum, central banks had one more weapon available.
Let’s assume that inflation is too low and the economy is depressed. Friedman imagined a helicopter dropping $1,000 bills over the nation. People below would pick up the bills and would almost certainly spend them. Why? They would rationally assume that the bills would potentially lose their value so the best thing to do was spend them quickly before that happened. This is exactly what the policy is intended to achieve: a sudden, pronounced increase in spending power. The effect of adding demand which is backed by artificially created money would be to push up inflation – which is in this case what the central bank wants.
Helicopter money requires the government to work with the central bank
In reality it’s not necessary to drop cash like confetti. Any policy which increases spending, financed by an expansion of the central bank’s balance sheet, is equivalent to helicopter money. Central banks have no direct interaction with the general public and could not put money into the hands of ordinary citizens on their own. Some economists argue that central banks should take over the payments function from central banks, by offering every citizen a bank account. This would take away the risk of bank runs and leave central banks as pure lending institutions. In that case the central bank could actually give everyone extra money by crediting their acccounts.
An equivalent policy could be achieved by the government sending everybody a tax rebate cheque, funded by borrowing from the central bank. Everybody gets a free increase in spending power, created out of nothing by artificial central bank policy. Or the government could increase spending on say infrastructure or healthcare, whatever seemed most valuable, funded by borrowing from the central bank. So helicopter money in practice means a form of fiscal policy but instead of the government borrowing from the private sector by issuing bonds, it borrows from the central bank.
The “free” money comes from the central bank’s ability to create reserves at zero cost. This is the near-magical power of a central bank. It can issue new currency or reserves, which are held by commercial banks, at little or no cost, precisely because it is the monopoly provider of such assets(*). Normally we say that any financial asset must have a counterpart liability. So it might seem that creating new assets is precisely offset by the new counterpart liability – that would mean no net increase in wealth or spending power. But although central bank reserves and currency are theoretically liabilities of the central bank, they are irredeemable – there is no practical liability to the central bank. You can take your $1,000 bill to the Fed but all you’ll get is another one, produced at close-to-zero cost.
Note that quantitative easing (QE) is driven by the same mechanism. In QE the central bank buys existing financial assets such as government bonds, paid for by newly created reserves credited to the commercial banks, which then credit the accounts of their customers who sell the bonds to the central bank. The difference is that with QE the central bank is acquiring one financial asset with another. This doesn’t change total private sector wealth but the structure of it (ideally encouraging private sector agents to buy riskier assets and drive down the cost of risk capital, which should encourage companies to invest more than they would otherwise have done). In helicopter money, the private sector is better off as a result of the new purchasing power it has received from the central bank.
The road to ruin?
This apparent free lunch gives a clue to why a lot of people are deeply uneasy about the policy. It has long been etched into the memories of central bankers that the path to ruinous inflation is for central banks to print money to fund reckless government spending. This is indeed what has happened behind some of the famous hyperinflations of history, such as the Weimar inflation in Germany in 1922-23, when Germany was trying to pay reparations for World War One. Central bankers would normally sooner sell their grandmother than do this. The European Central Bank is actually prohibited from directly funding government borrowing, though it is allowed to buy existing government bonds in the market (this is quantitative easing).
But hyperinflation is rare in history and almost always happens when the state has broken down, following a war or major political crisis (Argentina, Zimbabwe). Helicopter money is there to solve the problem of too little inflation (and too high a level of unemployment). The weak recovery in the US and Eurozone since the financial crisis, and the continuing deflation in Japan, despite exceptionally low interest rates and a raft of other central bank stimulus measures, makes policy makers think, what can we do if or when the next recession inevitably comes? Normally a recession is fought by cutting interest rates but if they’re already very low, central banks lack any means of stimulating the economy. So they may have to resort to helicopter money.
Some people accept the need for helicopter money but worry that it blurs the line between monetary and fiscal policy. It would be better, perhaps, to use fiscal policy directly, meaning tax cuts or increased government spending or both. There is close to a global consensus at present that the US and UK governments should spend more on infrastructure, which directly adds to the productive capacity of the economy and so yields a positive return. When government borrowing costs are low (and currently negative in several countries) it is a perfect time to borrow to invest in productive assets. The fact that despite this consensus very little is happening (infrastructure spending in the UK is actually falling) is extraordinary and a testimony to the failure of the political system in many developed countries.
(*) Currently the Federal Reserve pays 0.5% on the reserves held by commercial banks, but it used to be zero.