Around the world, central bank leaders are warily peering into their toolboxes.
Unfortunately, most of the fiscal and monetary policy options have been exhausted. The pressures of stagflation and deflation are growing, and the search for new solutions has run its course.
So what happens next?
Well, way down at the very bottom of the toolbox, a last-resort option remains: so-called “helicopter money.”
The term conjures an image of a helicopter flying overhead, dropping wads of bills to the people below – which isn’t far from the truth.
We Have Lift-Off
In fact, helicopter money is a reference to an idea popularized in 1969 by the American economist Milton Friedman in his essay, “The Optimum Quantity of Money.”
Friedman wrote, “Let us suppose now that one day a helicopter flies over… and drops an additional $1,000 in bills from the sky, and let us suppose further that everyone is convinced that this is a unique event which will never be repeated.”
Basically, when a central bank wants to raise inflation and output in an economy running below potential, it might attempt to do so through an increase in government spending or a change in tax policy.
Proponents see this as an effective tool that directly transfers money to the public and private sectors.
The recipients are then expected to see these funds as a permanent and one-off expansion of the amount of money in circulation, which encourages them to spend more freely.
The result? Increased economic activity and a rise in inflation toward the central bank’s target.
The theory gained popularity in 2002, when Fed Chairman Ben Bernanke referenced it by proposing monetary-financed tax cuts.
Essentially, when the economy is in a slowdown, the government could cut taxes while the central bank commits to purchasing government debt, thus preventing interest rates from rising.
He was thus referred to as “Helicopter Ben” for much of his tenure.
And now fast forward to today. Helicopter money has re-entered the policy debate precisely because global economic expansion has run out of steam.
The result of runaway economic stimulus has been an unprecedented explosion of government debt. Meanwhile, global economies are still in a rut.
This year is looking to be the weakest growth year for the U.S. economy since 2013. Elsewhere, negative interest rates are doing little to spur growth in Europe and Japan, China is on track for mid-6% GDP, and the sustainability of the eurozone’s cyclical recovery is now highly questionable.
Isn’t This Just More Quantitative Easing?
You see, unlike Friedman’s vision, the many rounds of quantitative easing (QE) we’ve seen under the Fed, the European Central Bank (ECB), and the Bank of Japan (BOJ) post-financial crisis were structured as asset swaps – that is, exchanging government bonds for bank reserves.
More specifically, they involved large-scale asset purchases from financial markets (predominantly government bonds), along with a range of alternative assets, including commercial debt, mortgage-backed securities, and even stock market exchange-traded funds.
QE essentially worked by lowering bond yields.
But these large-scale asset purchase programs didn’t constitute helicopter drops, as central banks haven’t committed to keeping the assets acquired on their balance sheets forever.
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Additionally, central banks engaging in recent QE were determined to shrink their balance sheets at some point in time, whereas helicopter drops don’t include an elimination of debt.
With helicopter money, the central bank promises to never sell the bonds or withdraw the money it created from circulation. And it returns the interest earned on the bonds to the government.
So while QE alleviates reserve constraints in the banking sector and lowers government borrowing costs, its transmission to the real economy has been indirect and far less effective. Basically, a long run for a short slide.
Now, who decides who gets the money, and how much?
The most realistic ways to accomplish this include direct transfers into people’s accounts, monetary-financed tax breaks, or government spending, in which each or a combination thereof could more directly influence aggregate demand.
Unfortunately, it’s not always that simple. There are a number of preambles before the government just creates money out of thin air and hands it out.
First, the government and the independent central bank need to be coordinated, which isn’t always an easy task.
Then, there’s timing. In 2013, Bernanke pointed out that the problem was a long-term one, while government spending cuts were a short-term solution, and thus harmful to the recovery.
There’s also the fear that central banks might get too comfortable knowing they can turn to the printing press to fund tax breaks or investment projects.
This addiction could turn to inflation, currency appreciation and trade imbalances, rising solvency worries, and the destruction of household wealth.
And when households anticipate a tax hike, they’re likely to spend less. So the newly created money won’t work if people are so risk-averse they would rather hold Treasury bills or cash with close to no return than spend.
Buzz in the Air
So can and will helicopter money be deployed successfully to boost growth?
ECB Chief Economist Mario Draghi refuses to rule out the prospect, only saying that the bank hasn’t “discussed” such matters yet due to their legal and accounting complexity.
As for the Fed, it hasn’t openly discussed helicopter money yet, likely because the stock market is doing OK and the unemployment rate is low.
While it might sound idealistic and scary, a helicopter drop could work under certain circumstances.
The central bank must commit to holding debt it purchases to perpetuity, and articulate this very clearly and repeatedly so that citizens don’t expect future tax increases or more publicly held debt.
The debt should also finance spending that boosts economic growth in a direct fashion, rather than using the financial markets as a proxy.
And finally, the central bank should define what potential growth means in percentage terms, and commit to funding a fiscal deficit until growth meets this target and the output gap is fully closed.
Additional targets such as employment and inflation should also be set and met, dictating their exit strategy.
In a perfect world, helicopter money would deliver a substantial and immediate boost to economic growth, with an expected and modest rise in interest rates.
Of course, the theory isn’t perfectly transferable, as every economy is different. But we may just find out how effective it can be before long.