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Recently Mario Draghi, President of the European Central Bank, ECB, made some remarks that were interpreted as an endorsement for the idea of 'Helicopter money'. To many, it was deja vu - in 2002, US Fed Governor Ben Bernanke talked about a variant of this concept, which promptly earned him a nickname that stuck: "Helicopter Ben".
What is helicopter money?
The concept of 'helicopter money' originated with Nobel Laureate Milton Friedman, when in a 1969 paper, 'The Optimum Quantity of Money', he mooted this theory as a thought experiment. "Let us suppose now that one day a helicopter flies over this community and drops an additional $1,000 in bills from the sky, which is, of course, hastily collected by members of the community. Let us suppose further that everyone is convinced that this is a unique event which will never be repeated." (World Economic Forum, August 13, 2015, Tomas Hirst)
How will it work?
According to Friedman, such an action would touch off a wave of consumption that would energize a stagnating economy. People would start spending this windfall quickly, goods would fly off shelves and manufacturers would receive new orders, setting off a chain of economic expansion. The underlying principle is that when a central bank wants to advance output and inflation, direct transfers of money would be a very effective method. Since marketers would have enough demand to increase prices, deflationary pressures could be avoided. Where inflation is very low, such a move would also restore inflation back to a central bank's target rate.
A modern version
A modern version of this was mooted by Ben Bernanke in 2002, which quickly earned him a nickname that stuck: "Helicopter Ben". He said, "A broad-based tax cut, for example, accommodated by a programme of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices. Even if households decided not to increase consumption but instead rebalanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers. A money-financed tax cut is essentially equivalent to Milton Friedman's famous 'helicopter drop' of money."
In 2008-09, when US was battling the financial meltdown and consumption had sharply tapered off, the US Government announced the "cash for clunkers" incentive program. People had stopped buying new cars to replace old ones as fast as they used to. Postponing these purchases was hurting business growth. So, the US Government announced an incentive for a short period of time - it decided to give a handsome cash incentive to any person who traded in his old car (clunker) for a new one within a finite period of time. This was as direct an incentive as any, to goad consumers to go out and buy new cars, and spur growth.
Helicopter money versus Quantitative Easing
Helicopter money-which, in its more practical forms, is called monetary finance, or monetizing the debt-is used to purchase goods and services, writes Greg Ip in the Wall Street Journal. This is what Friedman proposed; that the money should go directly to the consumers, who will then start spending the money, thus boosting the economy directly.
Quantitative easing, QE, as practiced by central banks in the recent past has consisted of asset swaps. For example, the newly created money is utilized to purchase government bonds, the funds of which are used to finance banks. This has had the effect of reducing borrowing costs for governments, while allowing banks more money to lend. In theory, this should encourage consumers to borrow and spend more. Yet its impact on the economy has not been deep. People and firms may have grown so averse to taking risks that they seem to prefer holding the bonds, despite the low returns, rather than spend and invest the amounts.
Writes Tomas Hirst, editorial director of Pieria magazine, about QE; "As such, it does not provide much bang for your buck. Direct transfers into people's accounts, or monetary-financed tax breaks or government spending, would offer one way to increase the effectiveness of the policy by directly influencing aggregate demand rather than hoping for a trickle-down effect from financial markets."(World Economic Forum, August 13, 2015)
Pipedream
Another criticism of the idea is by the Austrian School of economists, called Libertarians. According to this school of thought, all such measures are likely to lead to inflation. All of us would love to have a million dollars credited to our bank accounts. What would be the immediate effect of such a move? Prices would go through the roof since the quantity of goods and services available in the economy would not change. All those millions of dollars would be chasing exactly the same quantity of goods and services as before. While early buyers might get some advantage, the vast majority would find themselves in the same place as before, if not worse off. On the face of it this idea sounds absurd. Yet, when someone says that we can give a far lower amount, like say 2,500 dollars per person, then this concept of free money suddenly becomes respectable. What is missed is that this $2,500 too would have the same inflationary impact as in the earlier case.
"If helicopter money is implemented, those who first gain the use of the new money may benefit by increasing consumption before prices rise, while others will see prices rise before they are able or willing to use the money. But the end result will be higher prices but no overall increase in welfare. The economy will not see any sort of burst in productivity from a one-shot injection. So what will be proposed next? How about multiple injections of helicopter money over extended periods of time? That would seem to follow," according to Paul-Martin Foss. (Mises Wire, April 5, 2016)
Central Bank - Finance Ministry tango
Finally, if it is to be at all implemented, then an unprecedented and perhaps unconstitutional co-ordination between the Central Banks and the respective Finance ministries will have to be developed. There are good reasons to fear the erosion of the separation of the Central Banks from Finance ministries. There is every chance that greedy politicians', intent on winning the next election, would resort to the printing press recklessly, provoking hyperinflation. As Ip writes, "helicopter money merges QE and fiscal policy while, in theory, getting around limitations on both. The government issues bonds to the central bank, which pays for them with newly created money. The government uses that money to invest, hire, and send people checks or cut taxes, virtually guaranteeing that total spending will go up. Because the Fed, not the public, is buying the bonds, private investment isn't crowded out."
For this to work, the Fed should never withdraw the money it has created from circulation or even the sell the bonds. Since the interest earned on the bonds will be returned to the government, the public can rest easy that tax monies won't be used to repay the bonds. Spending will increase, as will inflation and the GDP in nominal terms. Newly increased GDP would maintain the debt to GDP ratio.
If all this sounds fantastic, well it certainly is, according to Greg IP in WSJ. He writes that throughout history, governments that couldn't or wouldn't collect enough taxes to finance their spending resorted to the printing press, from the U.S. Confederacy in the 1860s to Zimbabwe in the 1990s. It's why so many central banks, including the ECB, are prohibited from financing government deficits. In the current context, he says that, between 1997 and 2007, before QE began, its holdings of government debt rose by $355 billion, and currency in circulation rose by a similar amount. In effect, the government borrowed and spent $355 billion and never has to repay it.
Mr. Clarida, an adviser to the Pacific Investment Management Co., says that, "to have the desired effect central banks and governments must coordinate at the outset. Rather than commit, as the Fed has done, to eventually get rid of its bonds, it must promise to hold them forever. If markets expect the new debt to be sold into the market in the future that would depress consumption as households and firms expect a future tax increase." Moreover, he notes, the Fed must not pay interest on the reserves it creates when it buys the debt, as that would negate the fiscal benefits. (Wall Street Journal, Mar 21, 2016, Greg Ip)
Presently both the ECB and the US Federal Reserve have a two percent inflation target, while actual inflation is well below this figure, and Europe is fighting deflationary pressures. 'Helicopter money', began life as a thought experiment. No central bank or country has implemented it so far, though more limited variants like "cash for clunkers" was executed in the US. No one knows how the public will react to a full blown cash incentive to blow as you please. No one knows for sure what the effects will be. But with growing concern that quantitative easing and zero or even negative interest rates have lost their power to kick start the economy, it is clear that Draghi, however terse his remarks were, is not dismissing the idea entirely out of hand.
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