Perspectives on ‘helicopter money’
When Friedman introduced his idea, he intended to optimise monetary policy and support economic growth by raising demand. He actually had two proposals, one deflationary (known as the Friedman Rule) and one inflationary (helicopter money). In this article, I will focus on the latter.
Types of helicopter money
Three main variations of helicopter money have been discussed in recent times:
- The Bernanke helicopter: Discussed by former chairman of the US Federal Reserve, Ben Bernanke, it involves transfers to households and businesses through a tax cut or rebate, coupled with incremental purchases of government debt. It is effectively a tax cut financed by money creation. He recently re-visited this topic in his blog and concluded that under “certain extreme circumstances” it may be the “best available alternative”.
- The Woodford helicopter: Discussed by leading monetary economist Michael Woodford, it centres on a version of flexible inflation-targeting, in which the central bank commits future monetary policy to a permanently higher nominal target (such as the path of nominal GDP). This involves various tools within that framework, including permanent increases in the monetary base using fiscal transfers.
- The Turner helicopter: Discussed by former FCA chairman Lord Adair Turner, ‘Overt Monetary Financing’ means the Treasury issues interest-bearing debt, which the central bank purchases, holds and perpetually rolls-over (buying new government debt whenever the government repays old debt). The central bank also returns the interest income it receives as profit to the Treasury. Importantly, the central bank must credibly communicate and commit to this perpetual rollover in advance.
|“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 Optimum Quantity of Money, 1969
A key shared element among the various types of helicopter is a consolidated view of the balance sheets of both the central bank and the Treasury. Clearly, this arrangement can jeopardise the independence of a central bank. In terms of destinations for the money, helicopter drops can involve financing one or more of:
- Tax cuts or rebates
- Increased public expenditure e.g. on infrastructure
- Public debt write-offs
- Bank recapitalisations.
Lessons from history
There have been – often notorious – examples of helicopter money, such as in the Weimar republic, Hungary and Zimbabwe. In these cases, these experiments led to hyperinflation. But even the Bank of England has a rich history of directly funding the government. For example, until 2000, it regularly used money creation to finance part of the government’s spending by way of an overdraft facility, called ‘The Ways and Means Advance’.
There are a couple of more recent examples that are closer in spirit to helicopter drops, particularly of the ‘Bernanke’ type, albeit without the explicit direct funding via central banks.
The first is from the Netherlands where, in January 1998, the then finance minister Gerrit Zalm introduced his ‘Zalmsnip’. This consisted of a tax cut of 100 guilders (today’s equivalent: €45.38) per household per year to compensate for a general increase in local (municipal) taxes. Due to a budget surplus, the government had some fiscal leeway and increased its contribution to the municipalities, which were responsible for the implementation of this measure. Most municipalities chose to deduct the Zalmsnip from the property tax assessment, while others implemented it through a reduction in charges for waste collection or sewerage. As this measure was more a compensation for higher charges than a real boost to income its effect remains unclear. It was abolished in early 2005.
In the US, both Presidents Clinton (2001) and Bush (2008) issued tax rebate cheques, amounting to a maximum of $600 and $1,200 respectively. In the first instance, households reportedly spent 50-70% of their ‘Clinton cash’, while this decreased to one-third of the ‘Bush cash’, with the remainder instead saved or used to reduce debt. This suggests that the timing of the drop relative to economic developments matters in terms of how the money is spent.
Again, although these recent examples are not pure helicopter drops, they provide an operational template whereby these measures are extended via direct funding via the respective central banks.
Conditions for success
In terms of its impact, Buiter (2014) argued that there are three conditions that must be satisfied for helicopter money to be effective (i.e. to always boost aggregate demand):
- There must be benefits from holding fiat money (a currency not backed by any physical commodity, such as gold) other than its financial rate of return. For example, as a precautionary move, people keep some money in cash to pay bills, even though it earns a zero rate of return.
- Fiat money is not redeemable, and is perceived as an asset by the holder but not as a liability by the issuer. In other words, a transfer of this money is not ‘balance sheet neutral’ for the economy as a whole, but rather permanently increases the money base.
- The price of money is positive. This means that in order to buy something (e.g. a good) you need to hand over a positive amount of units of money. Stated differently, if the price of money were zero then for any (even very large) amounts of money one could buy nothing. Importantly, the price of money is not necessarily equivalent to the interest rate.
The question of whether the economy would remain stuck at the zero-lower bound without helicopter money becomes a moot point. In the view of its advocates, helicopter money, enacted in a collaborative way by a country’s central bank and treasury, could raise aggregate demand and thus lift the economy from levels associated with the zero-lower-bound. That’s all that counts.
Will the helicopters take-off?
The fact that flying them is actually being discussed suggests that this is no longer taboo. Friedman’s starting point for considering a helicopter drop is the situation where a central bank has already lowered its rate to the zero-lower bound and actually needs higher inflation. Although it varies across regions, deflationary forces remain prevalent within the global economy, while many interest rates are close to or even below zero. So the conditions for considering helicopter money are roughly present. Specifically, the combination of deflation and zero interest rates points to the risk of a liquidity trap, making monetary policy ineffective and thus in need of fiscal support.
However, the debt overhang means that government finances are still dominated by budget cuts and austerity. As Stanley Fisher recently remarked:
“Certainly, it is easier for a central bank to change its policies than for a Treasury or Finance Ministry to do so, but it remains a pity that the fiscal lever seems to have been disabled.”
What could change this, of course, is further serious deterioration in the economic outlook and/or another financial crisis.
A note of caution
So why are critics – including myself – afraid of helicopters? The answer lies in Friedman’s second sentence in our introductory quote.
“Let us suppose further that everyone is convinced that this is a unique event which will never be repeated.”
The danger is that governments become used to money drops. Critics also point out that certain policies, such as negative interest rates, erode depositors’ trust in banks, which is the broader issue in our fiat currency system.
Anecdotally, for example, the sale of safes have increased in Germany and Japan since negative interest rates were introduced. This goes beyond private individuals – the German insurer Munich Re announced that it has stored a seven-figure sum of cash in its vaults to test how it could avoid paying negative rates.
Moreover, critics point out that monetary policies have actually contributed to the predicament the global economy finds itself in, and that helicopter money is only the most extreme of a succession of bad medicines.
On a number of occasions I have previously highlighted that these policies, and the thinking behind them, are based on a flawed mechanical perspective on the economy and markets. On that note, although Friedman initially states that money is “an extraordinarily efficient machine”, his later comments suggest that fiat money doesn’t operate as such. Specifically, because:
“It is so pervasive, when it gets out of order, it throws a monkey wrench into the operation of all the other machines.”
Unfortunately, as expressed by Bernanke, for example, circumstances may dictate that policymakers start their engines and prepare for take-off.
Patrick Shotanus is an investment strategist at Kames Multi-Asset Investing