For All Its Allure, Helicopter Money Won't Fly
Central banks have already gone in for zero lower bound and negative interest rates. Increasingly there is talk of a new frontier: helicopter money. If the first two have been, at best, ineffective, the third could be more damaging than everything that's been tried to this point.
It's now widely accepted that neither conventional nor unconventional monetary policy has helped spur inflation, much less growth or employment. QE hasn't worked, certainly not in Europe. It has resulted in national central bank purchases of more government debt, effectively financing government policy and increased financial asset volatility and triggered talks of a currency war. As Bank of England Governor Mark Carney noted Thursday in Shanghai, "For monetary easing to work at a global level if cannot rely on simply moving scarce demand from one country to another."
To some economists and writers, helicopter money is an old idea whose time may have come, a last-chance saloon for the global economy in the absence of government action.
The notion was first mooted by the late economist Milton Friedman in 1969:
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.
The idea is that through direct money transfers, a central bank could force money to circulate more freely, spurring economic activity. Former Fed Chairman Ben Bernanke refined the concept by suggesting it could come in the form of a tax rebate financed through central bank purchases of government debt.
A more recent advocate is British economist Adair Turner, who has argued that it may "in some circumstances be the only certain way to stimulate nominal demand, and may carry with it less risk to future financial stability than the unconventional monetary policies currently being deployed."
The notion that direct transfers would spur aggregate demand seems broadly accepted. Where current QE relies on the banks transmitting to the real economy their lowered borrowing costs -- something that hasn't really happened -- helicopter funding would result in instant, real demand-creation, according to the theory. In practice, it may not work out that way.
First, as Willem Buiter has explained, it's difficult to get a central bank and treasury to coordinate an effective helicopter drop. Second, as Friedman himself noted, rational consumers are likely to save their windfall gains. If you do not believe your future income is changed, you will not consume the helicopter money, or perhaps you will consume only a small fraction of it. Little real demand will have been created.
Indeed, this is what the evidence is already telling us. Central banks have inflated assets prices through QE purchases, itself a form of helicopter money, although the move benefited mainly the owners of financial assets, thereby increasing inequality without spurring demand. The created money, as these financial assets were "monetized," led to a doubling of base money from 2009 to today. The bank notes were stored, reducing the velocity of money in circulation, the key factor that measures how a currency is being used, and thus its impact on prices and growth. Inflation did not rise; we remain in an unsettled economic situation, but with more money in our hands -- often literally in the form of cash holdings.
Perhaps the bigger argument is social. While Friedman's concept anticipated a one-off money drop, it's hard to imagine governments exercising such discipline. And what then? If consumers perceive that an endless supply of money will be given for free, it will no longer have any value. Consumers will switch to new currency forms, whether foreign currency, bitcoin or old-fashioned commodities. Confidence will collapse leading to further reduced consumption. Money would no longer serve its role as an essential price signaling mechanism; its role in the social contract would be fatally undermined.
In the meantime, nothing will have been done to address the core problem that has given rise to increasingly exotic forms of monetary policy. There are many theories to account for the global slowdown, but falling prices tell us that global overcapacity can only be absorbed at a lower cost, where it will find renewed demand. Trying to tamper with this important process is sure to lead to a misallocation of resources. As Carney noted to G-20 ministers, supply-side initiatives are required here.
What is there to do? Nobel laureate and Yale University economist Robert Shiller told a conference in South Korea this week:
Negative interest rates failed already in Europe and can't be a fundamental way to respond to recession. Rather than throw money from the helicopter, it is much better for policy makers to create an environment for business people to increase investment based on animal spirits.
Shiller is right. Helicopter money is a nifty concept and an interesting intellectual exercise. Central bankers should leave it there and push governments to focus on investment. There are many ways to do this, but here's one: Banks could subscribe to shares in new funds for infrastructure and human capital investment. Doing so would increase demand over time and produce long-term growth without adding to national debt. Eventually, these funds could be privatized.
Such an idea, of course, is not without risks. But it offers a more targeted solution to today's problems than some of the alternatives being suggested and shifts the onus for creating demand from central banks, whose toolkit is limited, back to government policy.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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Jean-Michel Paul at JPaul@acheroncapital.com
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