Economists from both left and centre have recently proposed we use 'helicopter money' – the direct injection of cash into the hands of consumers, or the permanent monetisation of government debt. They argue that central banks can prompt output and price growth without requiring higher debt financing by issuing money. It is, apparently, a free lunch.
Is that really the case?
Turner (2015) concludes that the stimulative impact of helicopter money is never inferior to that of a debt financed deficit, but he assumes HM is a costless way to increase agents’ nominal purchasing power through permanent additions of (fiat) money into the economy. The same consideration underpins Buiter’s (2014) formal demonstration that HM always succeeds in boosting aggregate demand, even in a liquidity trap.
If we want to understand how effective helicopter money would be as a policy instrument relative to other ways to help economies out of persistent stagnation and lowflation, we also need to appreciate its costs (Bossone 2013a, 2013b). If there are costs associated with the permanent injection of cash into the economy, they would diminish its effectiveness.
Is it really a free lunch?
Kocherlakota (2016) comments that, in a situation in which the money issued by the central bank pays interest, helicopter money would not provide much extra lift than financing the deficit with government debt – because, like a government debt, money is a costly liability. Similarly, Borio et al. (2016) argued that the central bank may give a permanent injection of non-interest bearing money liability (reserves) and accept a zero interest rate forever. The cost to this would be that the central bank gives up completely on monetary policy. To avoid this outcome:
- The central bank could pay interest on reserves at the policy rate, transforming its issuance into a source of perpetual financial obligation equivalent to debt financing.
- The central bank could impose a non-interest bearing compulsory reserve requirement on the reserves issued as helicopter money – which makes the operation equivalent to tax-financed deficit spending, since someone in the private sector must bear the cost (Borio et al. 2016).
- The central bank pays interest on reserves. It recovers the interest cost on the portion of reserves issued under the HM by applying a separate levy on banks (Bernanke 2016).
These policies mean that lunch would not be free. The key issue here is the relationship between the interest rate on central bank reserves and debt versus tax financing. Unlike the interest rate paid on debt obligations is a price mechanism that signals the value of central bank reserves, the positive remuneration of the excess reserves that commercial banks hold with the central bank does not (and is not designed to) reflect their value. Those reserves are a perfectly liquid asset and do not bear credit risk. Remunerating them does not reward their holders for sacrificing liquidity or for taking risk.
The remuneration adds to the reserves’ intrinsic liquidity premium and introduces a price incentive under a deliberate central bank policy decision. This incentive is a form of subsidy, through which the central bank alters liquidity preferences in the economy. As a subsidy, it eliminates the opportunity cost that banks would otherwise have to factor in when determining at the margin how many reserves to hold optimally compared to other, less liquid, assets. It breaks the link between interest rate formation and the amount of reserves in the system (Goodfriend 2002). Its use as a tax, on the other hand, is evident when the central bank applies negative rates as a way to discourage commercial banks from hoarding reserves.
Therefore, while a positive remuneration on excess reserves transforms them into fiscal liabilities (analogous to debt financing) in the consolidated public sector balance sheet, its suppression (or recovery through a separate levy, as proposed by Bernanke) does not imply an increased opportunity cost for banks – it removes the subsidy and re-establishes the true opportunity cost of money. (In equilibrium, this opportunity cost equals the implicit own rate of return on money.) Suppressing or recovering the interest rate paid on the reserves issued under HM re-introduces a constraint on the exercise of monetary policy. But it is not, and should not be considered as, a form of tax financing.
What is the impact of helicopter money on the conduct of monetary policy?
Helicopter money may also impose a constraint on future monetary policy decisions. It becomes more expansionary than a debt-financed programme only if the central bank credibly commits never to raise rates in the future and never to withdraw the increase in reserves (Borio et al. 2016). This is monetary policy surrender. It is also not what a HM policy would require.
Muellbauer (2016) observes that a future rise in interest rates would be state-dependent – it would depend on an economic recovery, and the escape from deflation. If helicopter money has achieved its objective of improving the economy, it would only be appropriate for interest rates, and the future cost of government finance, to rise.
The underlying argument for making the injection of reserves permanent rests on an incorrect concept of 'permanence'. The addition to the economy’s stock of nominal wealth should be permanent under helicopter money, not the stock of newly created money – the latter may well change over time as a result of future monetary policy decisions. To see this, consider that helicopter money injections can be effected by:
- Financing the government budget: A central bank issues reserves to purchase government debt on the primary or the secondary market;
- Financing the private sector directly: A central bank crediting the accounts of selected categories of individual economic agents with newly created reserves, which resembles the original concept of helicopter money as created by Friedman (1969).
If helicopter money is conducted through the government budget, the 'permanence' would be the central bank’s commitment to purchase the debt and to hold it perpetually (Turner 2013). In this situation purchases of government debt via helicopter money operations can take place in the primary market, whereby the government would get the money and finance the extra deficit deriving from larger expenses or tax cuts, or in the secondary market, whereby an equivalent amount of public debt obligations would be cancelled and the government would use the related budgetary savings to finance new spending or tax cuts.
Under this commitment, the government debt that is purchased is monetised forever. The government’s related future financial obligations are irreversibly suppressed, and the government budget constraint is relieved permanently as a result. This option is therefore fully equivalent to Friedman’s original conception of helicopter money – unlike what Cecchetti and Schoenholtz (2016) observe – and makes helicopter money especially useful for highly indebted countries with limited fiscal space.
On the other hand, if helicopter money is conducted directly with the private sector, the increase in central bank money permanently adds to the agents’ money balances, and permanently increases the nominal wealth of the private sector as a result.
This newly created nominal wealth could be destroyed only through taxation or spending cuts. As helicopter money transfers nominal resources from the state to the economy, taxation or spending cuts withdraw resources from the economy and transfer them back to the state. In this case taxation should be understood as including 'reverse helicopter money’ operations, whereby the central bank would debit the bank accounts credited under the helicopter money injection. The monetary financing of helicopter money and de-financing of helicopter money reversals, with a the central bank acting as executing agency, does not alter the essentially fiscal nature of helicopter money policy (Grenville 2013).
If the central bank sought to offset helicopter money injections through indirect instruments, say, open market operations (OMO), it would not alter the nominal wealth created by helicopter money, but only its composition via price changes. To execute OMO the central bank would have to mobilise debt instruments other than those purchased under helicopter money, because those have been permanently monetised and are no longer available for use. (Alternatively, the central bank could issue its own non-money debt liabilities in the form, for instance, of debt certificates.) Following an helicopter money operation and its expansionary effect through nominal wealth creation, the central bank would retain full flexibility in the use of monetary policy and steer interest rates consistently with its policy objectives, given the current and anticipated future state of the economy, including to affect wealth.
(Even under changed economic circumstances the central bank would not have the objective of reversing the helicopter money operation. Instead it would change interest rates to affect asset prices, and influence aggregate demand consistent with its objective function.)
As a result, helicopter money does not prejudge any future monetary policy decisions. At any time the central bank can tighten monetary conditions as needed.
In terms of effectiveness the real issue is how helicopter money and future anticipated policy decisions affect agent expectations (Rowe 2016 and Glasner 2016 discuss this in more depth). If there is large resource unemployment and lowflation, helicopter money effectiveness would require the central bank to commit to keep dropping helicopter money until NGDP reaches a desired target of employment and inflation. Helicopter money would then be part of a (monetary-fiscal) policy strategy specifically designed:
- To affect permanent incomes and expectations;
- To remain in place until these permanent incomes and expectations change.
Sooner or later, people will start to spend their excess cash and, as output and prices grow, the aggregate excess supply of cash in the economy would eventually be absorbed. Future seigniorage could take care of eventual central bank capital issues (Pâris and Wyplosz 2014).
Ricardian equivalence and the effectiveness of helicopter money
In this case, how would the future changes in monetary or fiscal policies affect expectations today?
We know that liquidity-constrained agents facing individual uninsurable income risk have a much shorter time horizon that the one implied by Ricardian equivalence (Deaton 1981, Carroll 1992, 1997, 2001, Johnson et al. 2006, and Kaplan et al. 2016 all make this point). In this case, Ricardian equivalence unrealistically assumes agents can see fully the government’s long-run budget constraint, but let’s argue it anyway. Helicopter money policy and its eventual future reversal depend on state-contingent decisions which take place under different economic conditions. Helicopter money would be enacted in situations of persistent economic stagnation and lowflation and would be highly valued by agents suffering from current unemployment and uncertain income prospects. But a future helicopter money reversal policy would take place at a time of better employment and economic perspectives, and in a situation where agents would be better placed to absorb that policy reversal. Different expectations and market sentiments would affect the utility calculation and net welfare effects of the two symmetric policies, Current welfare losses due to unemployment that would be compensated for by helicopter money would be larger than the discounted future welfare costs due to full helicopter money reversals at restored full employment. The present value of helicopter money net of equal future reversals would be positive.
The true costs of helicopter money
Helicopter money effectiveness does not require the central bank to credibly commit never to withdraw the associated increase in reserves. There is no intrinsic rationale for excess reserves issued under helicopter money to pay interest. The elimination of such interest does not represent taxation on the private sector. Therefore, the fiscal cost of helicopter money is nil.
Fiat money can then be used at no cost to the consolidated public sector balance sheet as a way to mobilise unemployed real resources and to accelerate prices and wages in economies hit by large, persistent output gaps and lowflation.
As a last-resort monetary and fiscal instrument for economies in severe crisis, the effectiveness of helicopter money critically depends on it being integrated in a credible monetary and fiscal policy strategy aimed at restoring full employment and price stability, which is capable to guide agent expectations accordingly. Such a strategy would obviously change with changes in underlying economic circumstances. Helicopter money does not preclude strategy change, and its effectiveness would not depend on it.
Author’s note: I am very much grateful to Claudio Borio for discussing the issue of helicopter money at quite some length. Most likely my arguments will not persuade him and his colleagues, but might nonetheless invite their further reactions. I also wish to thank Charles Wyplosz for exchanging views with me a while ago on the 'permanence' issue, discussed below, and Larry Summers for sharing with me his doubts on the relevance of permanent commitment in real-world circumstances. Of course, the opinions here expressed are my own and I am the only responsible for any error in the arguments exposed in the text.
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