Money Falling From the Sky: A Utopia?
Since 2014 the European Central Bank has launched a series of unconventional monetary policies aimed at stimulating its stagnant economy and bringing inflation back to the 2% target. As part of this unconventional response, on March 9th 2015 the ECB President Mario Draghi announced the beginning of his long-awaited program of Quantitative Easing, six years after his collegues at the FED and the Bank of England embarked on theirs. Initially, Mr. Draghi, overcoming the German-led opposition in the Governing Council, committed to launch an “extended asset purchase program” worth about 1.1 trillion euros. The program provided for an injection of money in the economy equal to more than 60 billion euros per month.
In December 2015, faced with a disappointingly low inflation (far below the 2% threshold), the ECB decided to extend the length of the program by six months, at least until March 2017, while keeping the monthly buying rate unchanged. Later on, recurrent warnings and concerns about the prolonged European economic fragility led the central bank to undertake a further extraordinary measure on March 10th 2016. While the Eurozone had entered the negative interest rate territory already since January 2014, the ECB March meeting provided for a cut in the deposit rate of 10 basis points. The interest rate was thus brought to minus 0.40 percent, the lowest level ever reached since the beginning of the measures. Moreover, in the face of an economic growth “weaker than expected”, Mr. Draghi announced that the central bank would increase the monthly bond buying from 60 to 80 billions euros, also expanding the range of buyable assets to include high-quality corporate bonds.
Despite their aggressive and radical nature, these far-reaching measures, have not proven to be effective as expected and the Eurozone economy does not seem to respond as it should. Indeed, during the March meeting both ECB inflation and growth forecasts were downgraded relative to the levels predicted in December (inflation forecasts went down from 1% to 0.1%). As a consequence, there is widespread concern among economists about the future effectiveness and sustainability of Mr. Draghi’s efforts. It is commonly held that there exists a theoretical limit to which interest rates can become negative and to the amount and range of bonds that the ECB can bring into its balance sheet; however, whether and when this limit will be reached in practice is not yet understood. Nevertheless, in the face of amounting pessimistic data about the European economic prospects, economists are exploring possible alternatives to Quantitative Easing. One of the most appealing and advocated by several experts is undoubtedly the idea of money falling from the sky, namely helicopter money.
The notion of helicopter money goes back to the founding father of Monetarism, Milton Friedman (1912-2006). In this famous paper “The Optimum Quantity of Money and the Essays”, Friedman wrote: “Let us suppose, then, that one day a helicopter flies over our hypothetical long-stationary community and drops additional money from the sky equal to the amount already in circulation” [..] “People’s attempts to spend more than they receive will be frustrated, but in the process these attempts will bid up the nominal value of goods and services”. Thus, according to the author the end result of the extended money supply would be a nominal income that has increased by the amount of money dropped by the “helicopter” but no effect would result on the supply of goods and services.
The idea was later developed and slightly revised by numerous economists, including Ben Bernanke. The former Federal Reserve Chair referred to this idea as a solution to the U.S deflationary pressures of the early 2000s. Indeed, the passing reference to the helicopter drop idea in his popular November 2002 speech earned Bernanke the nickname of “Helicopter Ben”, making him one of the strong supporters of this policy.
Today, the term helicopter money refers to an unconventional monetary policy tool that involves two different sets of policies. The first set refers to financing budget deficits through the creation of newly printed money. In this regard, Willem Buiter, current Chief Economist at Citigroup, sees the implementation of helicopter money as a close cooperation between the central bank and the State. According to his interpretation, the policy would materialize in a temporary fiscal stimulus (i.e. a one-off monetary transfer to households), financed permanently through an increase in the stock of fiat base money. In these terms, helicopter money can be seen as a slight variation of quantitative easing: they both imply the monetization of budget deficit. One importance dissimilarity, however, rests on the different temporal nature of the two policies. On the one hand, QE is a reversible policy, because newly created money can be taken out of the system, whenever it is needed, by selling the assets that quantitative easing buys; on the other hand, helicopter money is an irreversible policy and its effectiveness strongly depends on this particular temporal feature.
The second set of policies, instead, brings the concept of helicopter money back to Friedman’s idea of “bills from the sky, […] hastily collected by members of the community.” It implies, in fact, a system of money transfers targeted to the citizens, financed by fiat base money and coming directly from the central bank, with no intervention of intermediary fiscal authorities. If we consider this second variation of helicopter money, the differences with QE are evident, especially in terms of its impact on central banks’ balance sheets. Under QE central banks create reserves by purchasing government bonds or other financial assets.
In contrast, under helicopter money, the money created by central banks are distributed right away, without any “asset swap” taking place. Moreover, the system of direct transfers differs also from the concept behind unconditional basic income. Although the two policies converge in their final result (increase in households’ nominal income), the two systems significantly differ in terms of objectives and targets. Basic income is a social policy aiming at improving households’ well-being, whereas helicopter money has a fully monetary aim: stimulating inflation. Moreover, while the amount of payments to individuals under basic income is meant to cover basic needs, the size of helicopter money only seeks to stimulate growth.
At this stage, it should be clear that a single implementation of helicopter drops does not exist and indeed numerous variations have been embraced by different economists. Notwithstanding this variety, all the models share a common set of channels through which helicopter money would in theory succeed in stimulating inflation. In this regard, an illustrative example recently posted by Ben Bernanke in his Brookings’ blog will help us clarify the nature and characteristics of those channels. Assume that, in response to deflationary pressures, “Congress approves a $100 billion one-time fiscal program, which consists of a $50 billion increase in public works spending and a $50 billion one-time tax rebate. In the first instance, this program raises the federal budget deficit by $100 billion.
However, unlike standard fiscal programs, the increase in the deficit is not paid for by issuance of new government debt to the public. Instead, the Fed credits the Treasury with $100 billion in the Treasury’s “checking account” at the central bank, and those funds are used to pay for the new spending and the tax rebate.” The channels through which money drops would then work can be summarized as follows: first of all, the stimulus to public works results in a net increase in GDP, jobs and income; in turn, higher households’ income translates in an increase in consumer spending; additionally, the creation of newly printed money is likely to have a positive effect on expected inflation. In this regard, the expectations channel becomes especially relevant for the economies that are still facing the consequences of a prolonged liquidity trap.
According to the Philipps’ curve, when nominal interest rates are set at zero, the higher expected inflation caused by the increased money supply implies lower real interest rates, which in turn incentivise capital investments and other spending. Furthermore, in Bernanke’s view, the monetary nature of helicopter money not only has the benefit of overcoming the zero lower bound but, unlike debt-financed fiscal programs, has no impact on future tax burdens. Standard (debt-financed) fiscal programs, in fact, run the risk of being ineffective due to the Barro-Ricardian equivalence. According to this relationship, when an increase in the government deficit is financed by debt issuance, future tax burdens rise. To the extent that households anticipate that they will have to pay higher taxes in the future, they will increase savings to pay the anticipated future tax increase. To do so they will reduce consumption, offsetting some of the policy’s expansionary effects. Being totally funded by money creation, helicopter money would not incur in this problem, providing a greater stimulus to consumer spending compared to debt-financed programs, all else equal.
Although we cannot rely on empirical evidence in order to confirm supporters’ view, the idea of helicopter money is becoming increasingly popular, deemed to be “very interesting” also by Mr. Draghi during his press conference on March 10th. Of course, critics are not lacking and they are indeed one of the reasons why the idea of “money falling from the sky” is likely to remain a utopia, at least in the near future. A recurring critique points to the potential risk of hyperinflation. While the latter does not seem worrisome for the European economy that is squeezed by deflationary pressures, the claim that helicopter money would not be effective requires a more detailed analysis. Some critics reasonably argue that, because helicopter money works through the citizens’ savings accounts, the beneficiaries of the program are likely to be individuals who prefer saving their money for the future, instead of spending it all today. For this reason, the rise in inflation via the consumption stimulus may fail to materialize.
Another range of concerns include the fact that helicopter money could potentially undermine investors’ trust in the currency. Other critics, including Bundesbank president Jens Weidmann, similarly fear that helicopter money would have devastating consequences on the balance sheets and the profitability of central banks, with negative spillovers to the whole economy. Even though these economics-related critics may certainly have some foundation, supporters and opponents of helicopter money mostly fight over the legal admissibility of the program. Whether the policy could be admissible or not by art. 123 of the TFEU in the end depends on how we consider helicopter money. Shall we consider it a fiscal or an exclusively monetary policy? Experts have very different views on the issue. And given the ECB’s ambiguous stance towards the matter, the question on whether helicopter money will become a legally integral part of the ECB toolbox remains open.
In conclusion, the concept of helicopter money can be interpreted and implemented in different ways. Under some circumstances, the policy could succeed in stimulating aggregate demand and inflation and, according to some, it could indeed represent a feasible solution to the agony afflicting the euro area. In the end, however, the final question relates to its democratic legitimacy. Are we, ready, as European citizens, to give “unelected central bankers the right to take such a decision, even if it may well be the right one”?
WRITTEN BY MARIA COSTANZA CAU FOR BESA
PLEASE DIRECT ANY INQUIRY TO AS.BESA@UNIBOCCONI.IT