The (Impossible) Economics of Helicopter Money

Interest rates were first slashed to zero, then came successive rounds of QE, and most recently the ECB has led the world’s central banks into the netherworld of negative interest rates. Neither of these tools, however, have worked completely according to central banks’ and governments’ wishes. Unless you have been living under a rock, you will have noticed that “helicopter money” has been touted as the next policy tool which central banks will deploy in their attempt to reach their “targets.” 

But what is helicopter money exactly and could it work? 

Bruegel’s primer from January last year does a good job explaining the concept. That piece partly is based on this overview by Simon-Wren Lewis, a professor at Oxford University, which provides just about the right amount of information you need as a market participant to understand the topic. Wren-Lewis describes the policy as follows.

What makes helicopter money different from a conventional tax cut is that helicopter money is paid for by the central bank printing money, rather than the government issuing debt.

(…)

helicopter money is actually the combination of two very familiar policies: QE coupled with a tax cut. Another way of thinking about it: instead of using money to buy assets (QE alone), the central bank gives it away to people. If you think intuitively that this would be a better use of the money as a means of stimulating the economy, I think you are right.

Using a simplified concept, economic eggheads probably would liken helicopter money to permanent QE. The notion of “permanence” is the key and also, incidentally, the battleground upon which economists of different stripes argue whether this policy is a good idea or not. But it is very difficult to this question without first to trying explain the spectrum of its practical variations.

It’s useful to start with the halfway point between QE and outright pecuniary gifts to individuals or firms [1]; direct fiscal monetisation by the central bank or fiscal dominance. Proponents of taking monetary policy stimulus one step further would argue that this doesn’t qualify as helicopter money. But I think it does, or at least that it comes very close. Conventional QE takes place in the secondary market, and most central banks are prohibited from buying in the primary market. This is because of the need to safeguard central banks’ independence. But their independence can be bend by the governments which can “instruct” them to directly monetise fiscal deficits.

In all institutional setups across the OECD, this is not deemed legitimate or advisable [2]. But the government could, for example, oblige the central bank to print a certain amount of money every year to fund a pre-set deficit determined by the treasury. Assuming the government decided to hand out the money to its citizens, it would come close to helicopter money. In practice, however, the government probably wouldn’t and herein lies the rub. 

True helicopter money is when the central bank prints or creates money and gives it directly to the citizens [3], but even that seemingly simple process has countless permutations, all with different consequences. As a base case, suppose the central bank announced a policy in which it would provide $1.2t in helicopter money every year starting 2017. 

The central bank broadly speaking has three choices in terms of getting the money to the citizens.

It can create reserves in the conventional banking system, and instruct banks that the funds be credited to current accounts. Specific reserve requirements would have to apply for reserves created this way, and it is tricky to envision how this process would be efficient [4]. It can create its own “retail bank” with the sole purpose of furnishing money to the public. Each individual would have an account with this new bank, which would have reserves at the central bank. Finally, it could literally buy a few thousands drones and dump freshly printed money on pre-set physical locations every month.

Each of these methods has different drawbacks, but fungibility and control are key issues. Using the conventional banking system would be the easiest way to quickly implement helicopter money in our current economy. But it also gives the central bank least control. If John Doe suddenly saw that his account had $2000 more in it, there is no guarantee that he would spend it. He might save it or convert it to cash and hoard. In addition, these funds would still—in the current environment—earn a positive interest which is probably not what the central bank wants if it really wanted to use this policy. 

Creating millions of new individual accounts in a new central retail bank is a monumental task, but it would give policy makers larger degrees of control. Assuming the central bank want consumers to spend the new money on goods and services, it could make the funds completely digital—i.e. prevent individuals from converting into cash—and apply a highly negative rate. It could also make sure that the funds couldn’t be saved or invested in any way. It would do this by limiting the fungibility of the created funds, which could neither be transferred to other accounts, or be used to invest in shares or bonds. Each citizens would get a debit card for their central bank account, to be spent only on goods and services. We could think of this as a very advanced store credit.

It could also make the deposits time variant, for example via a system that erased the funds within 30 days if not spent. This would obviously simply be a case of a very negative interest rate or in other words: “Spend it or lose it!” Wilhelm Buiter, an economist at Citigroup, was essentially musing on a variation of this issue when he talked about how to abolish the zero bound through the use of virtual currency. 

Finally, the central bank could dump cash on the streets, but this would be impractical for a number of reasons. Firstly, controlling this process would be difficult and likely lead to violence, robberies and an overall security nightmare. Secondly, individuals might still choose to hoard the cash contrary to the central bank’s objective.

The examples described above show that rationing and distribution are critical elements in terms of implementing helicopter money. In practice, it would be impossible and inefficient to give every single individual the same amount of money, and some form of rationing would be necessary. The easiest way [5] would be through a monthly lottery based on personal ID numbers. In the example above, the central bank would be printing $120B a month, which would equal $10,000 to 12M individuals every month. Other solutions are possible, though, and economic theory provides some guidance to the considerations of channelling helicopter money into the real economy.

Broadly speaking, Keynes’ theory of consumption and Friedman’s permanent income hypothesis both point to the same potential problems and solutions. In Keynes’ theory, consumers spend out of current income determined by their marginal propensity to consume. This denotes a leakage in the system, when adopting helicopter money as a policy tool, via the propensity to save. In addition, empirical evidence suggest that wealthy people have a lower propensity to consume than poorer people. This implies that a randomly selected sample would inevitably be inefficient from the point of view of maximizing the multiplier effect of helicopter money. Friedman’s PIH puts it in a slightly more elegant way I think. A forward looking individual who suddenly gets a windfall of $10,000 will not drastically change her current consumption because the one-off [6] addition to her income is a relatively smaller addition to her permanent income. Whatsmore, and similar to the Keynesian outcome, a wealthy person who gets a check of $10,000 will experience only a trivial increase in her permanent income, and likely will spend only very little of it today.

This suggests a huge distributional aspect of helicopter money, which in many ways takes us full circle in terms of the government’s involvement. If the main objective with helicopter money is to increase consumers’ spending today, economic theory offers plenty of support for policy makers to design such a policy as a tax cut for low-income groups. The political implications of such a design, however, are substantial.

The Eurozone is a good example. The logical way for the ECB to distribute helicopter money would be to use the capital key to determine how many of each countries’ citizens to include in a monthly lottery. But similar with the paradox inherent in its current QE purchases, this would mean that German consumers would get the lion’s share of the newly printed money. But with German unemployment at record lows, surging consumers’ spending, a more clever designer of a helicopter money policy would quickly come to the conclusion that it would be better to give the money to consumers in the periphery. Output in these economies, allegedly at least, is further away from its pre-crisis and “normal” level. But even if helicopter money was politically feasible in the Eurozone, such a distributional outcome, however, almost certainly would not be.

The main macroeconomic challenge with helicopter money, however, arises in the context of its duration. The literature on the zero bound famously states that central banks can augment the power of ZIRP by “committing to being irresponsible,” or in other words; to maintain a very aggressive forward guidance. Yet, central banks have found this a mixed blessing, and QE has so far been deployed under the implicit assumption that it is temporary. In the ECB’s case, the policy’s duration has even become an explicit part of the bank’s communication. A similar strategy in the context of helicopter money creates obvious problems.

If we analyse helicopter money under the guise of a tax cut, Ricardian Equivalence states that forward looking consumers will not adjust their spending patterns today based on a tax cut they know will have to be paid back tomorrow. If helicopter money is temporary the very nature of the windfall also becomes temporary. Any households who are lucky enough to receive money in our lottery example above would see it as exactly that; winning the lottery. Again, the central bank would find itself fighting the tenets of Friedman’s PIH.

Strict Ricardian Equivalence, though, does not hold in the real world. A tax cut today does have a stimulus effect, even if it must be paid back by higher taxes tomorrow and that we can show in a representative agent model with perfect foresight that it shouldn’t be effective. Moreover, if the economy is deemed to be stuck in a liquidity trap, the New Keynesian literature is unanimous that fiscal policy is very effective in reviving growth and inflation. Or in other words; the fiscal multiplier is high and even above 1—implying non-linearily positive growth effects—when the economy is at the zero bound.

Simon Wren-Lewis gets around the problem with Ricardian Equivalence by drawing a distinction between a tax cut financed by issuing debt or printing money.

“Now suppose the tax cut is financed by printing money. There is now no interest to pay. So if the central bank never wanted to undo its money creation, there is no reason why private agents who hold this money should not regard it as wealth and at some point spend it. This is what is meant by money being irredeemable.”

This argument takes us into the dark and muddied waters of the short-term versus the long-term, and whether we have a vertical supply curve or not. In an economy close to “potential output,” printing money to finance consumption or investment runs into the exact same problems as cutting taxes via the issuance of debt. Money illusion might give consumers the temporary belief that wealth has gone up. But in the end growth and employment stays the same, while inflation simply increases permanently. If you do it enough times, the end result is hyperinflation. Standard undergraduate macroeconomics will show this if you follow the textbook sequence from a short-term IS-LM model to an AD-AS model with a vertical supply curve. 

Keynes famous statement about the long-run and longevity comes into play here, though. If the economy is in a liquidity trap, the argument by the likes of Paul Krugman, a U.S nobel laureate, and Wren-Lewis is that we are fine analysing the economy without a supply side constraint. We can stick with the traditional non-inflationary IS-LM analysis to show why helicopter money is a good idea. It unequivocally stimulates aggregated demand, and shifts growth permanently higher.

A way to introduce inflation into the analysis here through the backdoor is to accept the argument that temporarily raising the central bank’s inflation target, or overshooting inflation is a small cost to pay for kick-starting the economy. This is essentially the argument for nominal GDP targeting. The financial crisis shocked the economy away from its long-run growth path, and we need an equally aggressive positive shock to bring us back in line with the pre-crisis trend. This argument is enticing, but also unconvincing for a number of reasons. If the theory allows for the economy to deviate from its trend to the downside, the flipside must also be possible. It isn’t completely crazy to argue that the global economy was running well above trend going into the 2008 crash. A more fundamental argument is  that trend growth in the global economy—mainly in the OECD and China—since the crisis is lower than before. The secular stagnationists seem to agree here, but what they don’t appear to have considered is that this could be used to argue for lower, not higher inflation targets, due to a structurally lower trend in nominal GDP growth.

I find the argument for the non-inflationary or “costless” dynamics of helicopter money risky. The commitment to a permanent increase in the money supply via helicopter money would eventually be self-defeating. If it works, consumers, firms and investors will start discounting that it isn’t permanent via higher inflation, and if it doesn’t work. Well then it doesn’t work! I find it difficult to see how you can avoid that loop even if you start in a liquidity trap.

I can hear the frown from Princeton all the way up here in the north east of England. But this is a key part of the problem. If the policy works as intended, inflation will increase, but it won’t stabilise, and if policy makers act to quell inflation—which is relatively easy for them—the whole policy would have to go in reverse anyway. The short-term gains would be lost in the long run.

Making something out of nothing? 

The conclusion of the discussion above has to be broken down into two questions. Will monetary policy makers launch helicopter money policies, and will they work. 

The ideological battleground has already been drawn up on the first question. Bloomberg reporter Simon Kennedy provides a good overview of the recent flurry, telling a story that we’re steadily moving towards a form of helicopter money by one or more central banks. Ray Dalio, a U.S. hedge fund manager, recently argued that the next logical step for the Fed would be a variation of helicopter money, given relative ineffectiveness of ZIRP and QE. Current Bundesbank Chief Jens Weidmann and former ECB chief economist, however, have warned against the policies. Mr. Weidmann’s comment that helicopter money is not “manna from heaven” is particularly poignant as it refers to the idea that freshly printed money cannot replace productivity as a source of growth [7]. 

I remain agnostic. I can certainly envision a scenario in which central banks like the ECB and the BOJ end up being cornered trying to reach unattainable inflation and growth targets. If that happens, helicopter money is certainly possible. As I have explained, the best way to interpret this in an international context is to see QE/helicopter money and population ageing as an externality to the global economy. 

But what about the implications; could helicopter money work? 

My discussion above indicate that I am sceptical. Politically, I can easily imagine situation where the government, in presiding over a slowing economy, gradually encroaches on the central bank’s domain. We are seeing this in Japan, and may even come to see it in the Eurozone too. But I doubt that helicopter money such as I have described it above will be the end result. I think it is much more likely that the government simply becomes the vehicle through which direct monetisation is used to finance deficit investment and spending. A very strict “spend it or lose it” digital currency account funded by the central bank might work, but over time our economies would adjust to the “permanent” boost of the freshly created money every month via higher inflation in key goods and services. The central question is whether the “short-run” constitutes a time-horizon long enough to merit the use of helicopter money. If employment and growth goes up over say a period normally understood as a business cycle—five-to-six years—then maybe Krugman et al are correct in their exclusive focus on aggregate demand. But it would be a risk throw of the dice. 

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[1] – A major distinction has to be made between individuals and firms here. Almost all discussion on helicopter money has been about money being distributed to households. But you could give firms’ free money in the form of working capital. In the standard representative agent model where the household owns the firm, it doesn’t matter. But in the real world it matters. Just think about the trend in dividends and share buybacks financed via debt issuance etc. In other words, what would firms do with helicopter money?

[2] – The situation in Japan following the Fukushima disaster and the BOJ’s active role in Abenomics comes very close to fiscal dominance, though, I think.

[3] – Presumably with the government’s blessing, but at this point the distinction between the central bank and the government is difficult to see anyway. 

[4] – Many economists would argue that this is impossible in a free market with private commercial banks, but given the right “incentives” by the central bank I reckon it is just about feasible. 

[5] – That I can come up with at least. 

[6] – The issue of permanency or duration of the policy is obviously a critical element here. 

[7] – Geek alert. In exogenous growth theory the steady state of the economy is often said to be determined by “unexplained” productivity gains which tend to fall like “manna from heaven” at a specified constant rate. In endogenous growth theory, though, productivity is part of the nuts and bolts of the model and can be manipulated.