For further reading, the following recent articles explain the theoretical weaknesses of Helicopter Money. My discussions here overlap these arguments.
- "Of Voices in the Air and Never-Ending Dreams of Helicopter Drops," by Jörg Bibow.
- "Helicopter Money: Too Confused to be Helpful," Andrea Terzi.
Money Just Another Financial Instrument
Money is just another financial instrument. However, for historical reasons, economic theory has been warped by the concept of money. As a result, any debate involving money usually takes place behind a cloak of unreality.
As I will discuss below, the use of "helicopter money" offers no new policy space. At best, there is a reshuffling of central government liabilities amongst holders.
If someone presented us with a theory that by issuing Floating Rate Notes instead of fixed coupon bonds, all our economic ills would suddenly disappear, people would not take the theory seriously. But by replacing "Floating Rate Notes" with "money," we end up with an interminable debate.
The rest of this article explains why Helicopter Money offers us no new policy options, instead it is akin to fooling around with the mix of types of Treasury bonds and bills issued.
What Is Helicopter Money?"Helicopter money" consists of the central bank transferring money to lucky citizens (or all citizens). Although this is usually thought of to be the result of an interbank transfer, one particularly bad way to accomplish this would be to drop newly-printed money from helicopters. (I still think that the literal use of helicopters dropping currency to provoke riots for the amusement of
Since such an action is obviously outside the remit of central banks, one accepted variation is for the central bank to "finance" a handout of cash by the fiscal agency of the central government (the Treasury).
Yes, The Euro Area Is An ExceptionTo begin, I accept that a "helicopter drop" would be an improvement over the existing framework in the euro area. This partially reflects the utter failure of the design of the euro. It also reflects the fact the reality of ECB policy. This is a central bank that deliberately smashed the Greek economy for political reasons. Any policy framework is going to be more benign than that. However, this tells us nothing about policy in less dysfunctional regions.
No Operational ExpertiseThe central bank has no ability to make transfers to the population itself. It would be a massive waste of real resources to build an infrastructure to allow it, since it would be needed only extremely infrequently.
If all the central bank is doing is "financing" Treasury expenditure, we run into the obvious issue: developed Treasurys have been financing themselves for decades without incident.
Fiscal Policy Can Do The JobAlthough many economists dismiss the idea of using fiscal policy in a counter-cyclical fashion, the experience around the Financial Crisis showed that an active fiscal response is probably just as effective as that of the central bank in practice (other than the lender-of-last-resort operations).
Fiscal policy did exactly what it was expected to do. During the crisis, almost all countries had well-timed discretionary fiscal responses that help reduce the impact of the freezing of the financial system. (Of course, there was a considerable automatic response as well.) After the crisis, fiscal policy was tightened fairly quickly, and growth slowed rapidly, as one would have expected.
Of course, the people implementing the fiscal tightening expected the economy to expand, based on the theory of "expansionary austerity." All that proves is that many people are clueless. (Since the ECB was a major backer of "expansionary austerity," we can see that central bankers have no particular claim to the possession of clues.)
Hawkish central bankers have been screeching for tighter policy almost as soon as the dust settled after the Financial Crisis, and some central banks even raised rates despite the obvious signs of weakness. Therefore, there is no reason to believe that giving the central bank fiscal powers will mean that it will be deployed any more effectively than by politicians.
Involuntary Default Risk Unchanged
- Probability of a nation with currency sovereignty being forced into involuntary default without Helicopter Money: 0%.
- Probability of a nation with currency sovereignty being forced into involuntary default with Helicopter Money: 0%.
Financing Costs -- Small ChangesThe use of Helicopter Money would change the mix of liabilities issued by the consolidated central government. The new instruments may have a slightly lower interest cost. (Why this is just a mix change is detailed below.)
However, it is unclear whether this will reduce the aggregate interest costs. Since the purpose of interest payments by the central government is regulate economic growth (and inflation), if we lower the relative costs of some instruments, the interest rate across other instruments might need to rise to compensate. The net effect on interest expense is unclear
We would need an accurate and detailed model of the effect of interest rates on the economy to judge the effect, and that is precisely what decades of mainstream monetary research has not produced.
Cannot Force An Increase In Currency HoldingsMainstream economists have a strange tendency to lump currency holdings (notes and coins) with settlement balances at the central bank ("reserves"). These are very different economic animals.
In a positive interest rate environment, the level of currency holdings is largely voluntary. People only hold currency for small transactions, and for illicit activities. Unless the central bank decides to purchase a large amount of product from neighbourhood drug dealers, there is no way of forcing an increase in currency holdings. The central bank can only "control" the level of settlement balances, which I discuss next.
In a negative interest rate environment, the central bank could induce an increase in currency hoarding. But in a negative interest rate environment, zero interest money is the high cost source of government financing; "money financing" increases the interest burden.
Excess Settlement Balances -- Must Pay Same Interest Rate As T-BillsIf the central bank induces an excess of settlement balances at banks, those banks will wade into the Treasury bill market if the interest paid on those excess balances is less than the rate on Treasury bills.
In other words, the central bank has to keep the interest rate paid on excess settlement balances to be the same as the policy rate. There may be a gap of a dozen basis points, but that is not enough to have a visible effect on anything.
If the interest rate on excess balances is 0%, the Treasury will be able to issue Treasury bills near 0%, and there is essentially no reduction in the interest burden.
Who Pays The Interest Does Not MatterProponents of "helicopter money" often underline that the central bank will be paying the interest, not the Treasury. This does not matter (outside of the dysfunctional euro area). As long as rates are non-negative, the central bank will always have a positive net interest margin if there are no excess settlement balances (its liabilities pay 0% interest). All profits are paid to the Treasury at the end of the accounting period.
If the central bank pays interest on excess settlement balances, it will cut dollar-for-dollar into the dividends paid to the Treasury. Any competent credit analyst would therefore not distinguish between interest paid by the central and the interest paid by the Treasury when assessing interest cost trends (even if we do not consolidate the central bank).
Increasing The Reserve Ratio -- Can Always Be DoneThe only way of reducing interest costs for the central government is to raise the required reserve ratio for banks. This turns "excess" settlement balances into "required" settlement balances, which pay 0% interest. Since the banks cannot reduce their settlement balance below the required level, they cannot use those balances to buy Treasury bills. This allows the policy rate to be held above 0% (which is how the pre-2008 system worked in the United States).
Although such a step would reduce interest costs, it is a policy option that is always available to the government.
However, it is bad policy. Required reserves are just a tax arbitrarily hitting one segment of the financial sector. Although not too many shed tears about the fate of bankers, "shadow bankers" are even less popular. Increasing required reserves makes banks less competitive versus other financial firms, which face much less regulation. One of the reasons why countries like Canada abolished reserve requirements on the basis that it made no sense to favour unregulated lenders over regulated entities.
Why Are We Debating This?Even though "Helicopter Money" is a completely pointless exercise, do not expect the debate to go away any time soon. The only value of the discussion is that it provides a demonstration how economic theory cannot properly deal with money.
(c) Brian Romanchuk 2016