Around the world, the most conventional way of conducting monetary policy is by targeting the short-term nominal interest rates. The assumption is that monetary policy changes real short-term rates to influence economic decisions through their effect on other asset prices.
However, people can always hold currency instead of depositing it in banks. This implies that nominal interest rates can not go below zero which limits the effectiveness of conventional monetary policy. This is precisely what happened in the early 2000s in Japan and then, after the 2008 crisis, in the US, UK and the EU.
This led the Federal Reserve, the Bank of Japan, the Bank of England and the European Central Bank to resort to unconventional monetary policies such as Quantitative Easing (QE) to stimulate economic growth. QE refers to the purchase of long-term assets by the central bank from the commercial banks and other financial institutions. QE, thus, lowers the yield of these assets and simultaneously increases the monetary base. This incentivises banks to make more loans rather than invest in long-term assets. QE, thus, attempts to spur economic growth by encouraging the banks to lend more and the increased money supply is expected to lead to higher investment.
After successive rounds of QE by the Fed, ECB, BoJ and the Bank of England, their respective economies have been unable to achieve their respective inflation targets. The global economy still continues to be plagued by inadequate demand and the rising risk of deflation. The International Monetary Fund (IMF) has slashed this year’s global growth expectations from 3.4% to 3.2%. So, why did QE fail to boost GDP? Remember that success of QE crucially depends on whether banks use the additional reserves to lend or not. However, the money created through QE was used to buy long-term bonds from the financial market.
In a desperate attempt to boost demand, the world is contemplating the implementation of yet another unconventional policy—’helicopter drops’, i.e., the financing of private consumption by printing money. The idea of ‘helicopter money’ was first mooted by Milton Friedman in 1969 in his famous paper, The Optimum Quantity of Money, where he talked about newly-printed money dropped from helicopters to kick start the economy. Of course, he used it as a metaphor to bring home the point that the government could always create inflation by printing enough money and distributing it. As people spent this money on buying goods and services, nominal GDP would rise.
In more realistic terms, helicopter money is an expansionary fiscal policy; say an increase in public spending or a tax cut, which is not financed by the issue of interest-bearing debt, but by an increase in the monetary base. In the words of Ben Bernanke, helicopter money is nothing but money financed fiscal program (MFFP), one that is financed by a permanent increase in money stock without increasing the debt burden of the government.
Adair Turner, in his IMF paper, discussed a number of ways in which money could be created to finance the expansionary fiscal policy. The central bank directly credits the government current account and records as an asset a non-interest bearing non-redeemable “due from government” receivable. The government issues interest-bearing debt which the central bank purchases and which is then converted to a non-interest-bearing non-redeemable “due from government” asset. The government issues interest-bearing debt, which the central bank purchases, holds and perpetually rolls, returning to the government as profit the interest income it receives from the government.
Thus, in the case of MFFP, the increase in monetary base is permanent whereas QE leads to only a temporary increase in monetary base as the bonds bought by the central bank will at some point of time be sold back to commercial banks and private sector.
Bernanke, monikered ‘helicopter Ben’, highlights possible channels through which MFFP could influence the economy: (a) the direct effects of the public works spending on GDP, jobs, and income, (b) the increase in household income from tax rebate, which should induce greater consumer spending, (c) lower real interest rate as a consequence of temporary increase in expected inflation, the result of the increase in the money supply This, in turn, should incentivise capital investment.
But the talk on helicopter money has produced a strong counterattack, from RBI Governor
Raghuram Rajan, chief economist of Allianz Michael Heise and chief economic adviser to Japanese prime minister Shinzo Abe, Koichi Hamada, one of architects of the ‘Abenomics’ economic-recovery programme. The effectiveness of “helicopter money” depends on how much consumers decide to spend versus save.
Rajan highlighted the fact that if people decide to save the newly-created money rather than spend, then most of it would end up in bank accounts, and its creation wouldn’t have had much impact on the broader economy. Heise and Hamada assert that it is susceptible to the political risk of overuse. If monetary finance is not prohibited, governments might use it repeatedly to bolster their electoral prospects. Some also fear that such a policy may threaten the independence of the central bank.
However, both Turner and Bernanke have argued that there is no reason why we cannot ‘construct rules and responsibilities to mitigate the political risk of excessive use’.
Bernanke proposes to give independent central banks the authority to approve a maximum quantity of monetary finance if they believe doing so is necessary to achieve their clearly-defined inflation target. This will not only retain the independence of the bank, but also limit the ability of the fiscal authority to spend frivolously. At the same time, the fiscal authority can determine their course of action.
Helicopter money, which was considered unimaginable till recently, has currently become hot topic of debate in academic and central bank circles. It is a concept that has never been tried out in real life by any major central bank. But with growing concern that QE has failed to revitalise economy, we shall not be surprised if the discussions about helicopter money move to the next level.
Anand is an officer of the Indian Economic Service, serving as research officer, ministry of finance, and Agarwal is an intern at the National Institute of Public Finance and Policy.
Views are personal