Not as big of a deal as it may seem.

Photographer: Christof Stache/AFP/Getty Images

'Helicopter Money' Won't Provide Much Extra Lift

Narayana Kocherlakota is a Bloomberg View columnist. He is a professor of economics at the University of Rochester and was president of the Federal Reserve Bank of Minneapolis from 2009 to 2015.
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Global central bankers' quest for unconventional ways to stimulate weak economies has generated a lot of excitement about "helicopter money," a policy that entails creating money and giving it directly to people or the government to spend.

The excitement seems unwarranted to me and misses the important point: The government has all the borrowing and spending power it needs to boost the economy and get inflation up to the desired level, if only it had the will.

To understand helicopter money, consider two ways that the government can raise $100 billion to fund new spending (or a tax cut).

  • The Treasury can sell $100 billion in bonds to investors.
  • The Treasury can issue $100 billion in bonds to the Fed, which pays for them by creating new money.

The second form of financing looks like it should be cheaper and potentially more stimulative. After all, the government has raised $100 billion without increasing its debt burden, because payments on the bonds will simply go from one government pocket (the Treasury) to another (the Fed, which remits its profits to the Treasury). The term “helicopter money” reflects the idea that the government could drop the new $100 billion on people as if from a helicopter -- a windfall completely independent of whatever decisions those people make.

But the apparent attractiveness of the helicopter approach ignores something important: Money has a cost, too. When the Treasury spends the $100 billion, it will appear in bank accounts. Banks, in turn, will deposit the money at the Fed -- a liability on which the central bank pays interest. To see why this matters, imagine that the interest rate on the Treasury bonds moves in lockstep with the Fed's rate on deposits. For the finance geeks among you, imagine that the Treasury issues floating-rate consols, with coupons pegged to the Fed's deposit rate. (I’m an economist, so I get to make completely false assumptions just to make a point.)

In this hypothetical world, there is absolutely no economic difference between the two forms of financing. In the first case (where investors buy the bonds), the Treasury pays interest on an added $100 billion in debt. In the second case (where the Fed creates money), the Fed pays exactly the same interest on an added $100 billion in bank deposits -- which means that it can remit that much less money to the Treasury. (Fed liabilities grow only in the second case. That's because, in the first case, the increase in liabilities generated by government spending is exactly offset by investor withdrawals to buy the Treasury debt issue.) 

Note as well that both forms of financing count against the debt ceiling, which by law includes Treasury debt held by the Fed.

To be sure, the Treasury doesn’t issue floating-rate consols. By using floating-rate deposits to buy fixed-rate Treasury bonds, the Fed can push down longer-term interest rates and have an effect on the economy -- indeed, that was the purpose of the Fed’s bond-buying program known as quantitative easing. But the effect is likely to be much more modest than what people seem to expect from helicopter money. 

The crucial point here is that there's no need to employ helicopter money if the government is willing to use its powers to help central banks generate inflation.  Suppose the Treasury borrows $100 billion and spends it on new construction. The related hiring will put upward pressure on wages, which will increase businesses' costs and prompt them to raise prices. Of course, the Fed must remain passive. If the central bank responds to the Treasury’s new spending by raising interest rates, it can cancel out the effect of the added government spending.

Fiscal and monetary policy makers can cooperate to generate desired inflation. The government can provide stimulus, and the central bank can help by allowing that stimulus to push upward on prices. But the impact is the same whether the government finances the spending with debt or new money. Why confuse matters by talking about helicopters?

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Narayana Kocherlakota at nkocherlako1@bloomberg.net

To contact the editor responsible for this story:
Mark Whitehouse at mwhitehouse1@bloomberg.net