Picture a helicopter flying overhead and dropping off $100 bills, which get evenly distributed to all the people on the ground. With no obligation to return it, it’s easy, smooth and free money! Welcome to the helicopter money, a concept making waves in recent times amid zero and negative interest rates prevailing in major economies like Japan and some of the European nations.
What is Helicopter Money?
Helicopter money implies free and irreversible distribution of money to the end consumers. It can be achieved by literally transferring money to individuals’ accounts for free or by reducing taxes universally to all households enabling more disposable money in their hands. Such measures are utilized when the economy is in slowdown or in recession and interest rates are hovering around zero or even turning negative. (For more, see: How Interest Rates Can Go Negative.)
The end aim of helicopter money is to boost consumer demand and spending, and increase inflation to optimum levels, thereby leading to economic recovery. It has emerged as a possible alternative to the widely followed Quantitative Easing (QE) methodology. It is also known by various other names which include Helicopter Drop, QE for the People, Strategic QE, Overt Money Financing, Green QE and Sovereign Money Creation.
How Helicopter Money Differs from QE
Quantitative easing is essentially an asset swap, where the central banks introduce more money in the market by purchasing government bonds, as well as other assets like commercial bonds, mortgage-backed securities (MBS) and even exchange-traded funds (ETF). QE allows for eliminating limitations on available reserves in the financial sector, and reduces the cost of borrowing as more money is made available in the financial system. However, its impact remains indirect and often not effective to expected levels as it takes time for the benefits to percolate down to different strata of economic systems and sectors. (For more, see: Quantitative Easing: Does it Work?)
Helicopter money has advantages, as money directly reaches the end consumers who would increase spending. The same can be achieved by reducing tax rates, where the end consumer gets the benefit of having more disposable money.
QE is a temporary and reversible measure as the central banks will sell off the purchased assets once economic recovery is achieved. Helicopter money distribution is permanent and irreversible, as it increases the base money available in the hands of end consumers.
The Helicopter Money Scenario
Drafted in 1969 by Milton Friedman, the underlying principle of helicopter money is that the central banks can theoretically introduce newly printed money to increase the supply of money in the constrained markets. Japan and many rich economies in Europe are battling economic slowdown with near zero interest rates and low inflation. The borrowing costs in these economies are close to zero even for durations up to 30 years. Enthusiastic supporters of helicopter money perceive it to be a foolproof method of getting out of such economic slump. (For more, see: How Negative Interest Rates Work.)
In his research paper “Recovery in the Eurozone,” economist Frank van Lerven concludes that “(QE) is an ineffective tool for growing GDP and reducing unemployment.” The newly printed money by central banks should get absorbed in the real economy through the hands of end consumers, rather than through slow and uncertain measures of purchasing financial assets.
Citing the economic scenarios of Japan, the U.K., the U.S. and the European Union, economist Adair Turner in his research report submitted to the IMF concludes that it is realistically feasible and desirable to implement helicopter money. It will “always stimulate aggregate nominal demand” and will be less risky compared to other alternatives measures. (For more, see: The Lost Decade: Lessons from Japan's Real Estate Crisis.)
Deutsche Bank analysts cite that helicopter money was widely used in the past and was effective with positive result. The case of Canada is cited by economist Josh Ryan-Collins, who claimed “that monetary financing was a standard part of the central bank toolkit until the 1970s monetarists revolution.”
Challenges with Helicopter Money
Political versus Regulatory: Coordination between stakeholders is one of the primary roadblocks for implementing helicopter money-based stimulus. While politicians may like to implement a cut in government spending for political gains, the central bank may find this short term cut in spending detrimental to the long term economic recovery it wants to achieve. Willem H. Buiter recommends in his published paper that “Cooperation and coordination between the central bank and the Treasury is required for the real-world implementation of helicopter money drops.” Additionally, there is always a risk that if proved successful in slumping times, the political class may overdo it even during stable economic periods.
Spending versus Saving: Once the money reaches end consumers, they may decide to save instead of spending it.
Effects on Currency: Economists also fear that printing more money may lead to currency devaluation in the international markets, which would hamper economic recovery.
Where is the Real Problem?
Helicopter money is being termed as “a technical solution to a political problem.” Irrespective of varying economic situations and theoretical solutions, the real problem persists around building a political consensus on whether and how to use helicopter money. While this option has been talked about in individual economies like Japan which have faced deflation and negative interest rates several times, the problem becomes gigantic in cases such as the European Union, where individual political interests hamper the implementation of the unified policies. If the European Central Bank was to implement helicopter money measures, it may need to change the fundamentals that formed the basis of EU creation. (For more, see: Understanding Negative Rates of Europe's Central Banks.)
The Bottom Line
While the concept seems right in theory, there are challenges with implementation. How effectively helicopter money is distributed, whether individuals will save it or spend it and if the supply will lead to inflationary pressures are some of the concerns in its implementation. Cases of combined economic zones, like the EU, complicate matters further. Historical instances around the periods of great recession (1930s) and around the world wars claim to have led to economic recovery for economies who implemented this methodology. With Japan being the best suited economy to try it in the present times, it will be interesting to observe how this concepts plays out. (For more, see: Forces Behind Interest Rates.)