Central Banks Have Already Used a Better Tool Than Helicopter Money

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Former Federal Reserve Chair Ben Bernanke has worked to disabuse investors and economists of the notion that the Fed is nearly out of ammunition, pointing to a number of other tools at the central bank's disposal.

One problem? Some of the world's largest economies might have already tried his most controversial idea.

The final edition of his three-part series on the more unconventional measures the Fed could pursue focused on an option Milton Friedman bandied about at the tail end of the 1960s: helicopter money. This entails central banks coordinating with the fiscal authority to finance the mailing out of a check to every citizen, or perhaps a slew of new infrastructure projects.

Toby Nangle, head of multi-asset allocation at Columbia Threadneedle Investments, contends that major central banks and governments have already done something that differs from helicopter money in form, but not in function. He claims that if a central bank is engaging in quantitative easing — buying sovereign bonds — at the same time the government is embarking upon a more expansionary fiscal policy, this constitutes de facto helicopter money.

"Given that debt is effectively canceled from the moment it is bought by the central bank from a monetary and fiscal perspective, the debt service and monetary effects of QE and helicopter money appear the same," he writes. "The implementation of quantitative easing during periods of fiscal expansion in the UK, US and Japan have effectively already delivered ex post helicopter money."

Source: Columbia Threadneedle

The rough mechanics of helicopter money: A central bank conjures up money to purchase and then write off a government bond, presumably in the primary market. The cost of servicing this debt is nothing, except for the rate paid on reserves.

In quantitative easing, the cost of meeting obligations remains the same, as the interest a central bank receives from the government on its bond holdings is remitted back to the treasury. The acquisition of the sovereign debt takes place in the secondary market, but as long as the program is in place, but for all intents and purposes, the practical effects are identical.

But what helicopter money would do, because of the permanent increase in the monetary base associated with the purchase and cancellation of a government bond, is make it more difficult for a central bank to normalize policy. In fact, just as helicopter money requires coordination between the monetary and fiscal authorities, some cooperation may also be needed in the tightening phase.

A central bank that has pursued helicopter money "is left with the option of either raising short-term rates by more than they would otherwise need to rise under the QE scenario, or persuading the government to gift the central bank with large amounts of government debt that it can then sell to the market (which may be tricky politically)," explains Nangle.

In addition, the radical step of central banks directly financing government expenditures could roil markets by conjuring up images of Zimbabwe or the Weimar Republic.

That's not to say such a reaction would be justified, given the similarities between QE and helicopter money in practice, but does serve as a strike against this unfamiliar policy relative to the unconventional policy that the developed world's four most important central banks have already dabbled with.

"With the unknown market impact of helicopter money, with prospective policy tools in the hands of central banks narrowed through debt cancellation, and with the economic benefits associated with helicopter money rather than straight fiscal expansion de minimis, it is not clear why policymakers will choose the path of helicopter money," concludes Nangle. "Perhaps the real lesson is that monetary policy has its limits and that in the event of an economic slowdown, aggregate demand is best supported by fiscal rather than monetary policy."

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