Helicopter Money. A way out of Recession?

Dossier / Travail , 2018 , 8 Pages , Note: 1.0

Economie politique - Macroéconomie, en général

The so-called "helicopter money" is discussed as a direct alternative to monetary policy instruments like QE with which a Central Bank (CB) purchases government securities. This flooding [of] financial institutions with capital lowers interest rates and increases the money supply without printing new money. However, the effects of QE on the real economy were described as indirect and underwhelming.

Introduction

“Let us suppose that one day a helicopter flies over this community and drops additional $1,000 in bills from the sky” (Friedman, 1969). This metaphor used by the economist Milton Friedman (1969) describes the effects of an “once-and-for-all change in the nominal quantity of money”. What was originally intended to describe the effects of monetary expansion is now discussed as a “nuclear option” (Borio, Disyatat & Zabai, 2016; Dowd, 2018) for an economy in recession facing a liquidity trap (LT), where the interest rate is equal to zero. People become indifferent between holding money or bonds making the demand for money horizontal (Figure 1).

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Figure 1: The Liquidity Trap. Helicopter Money (HM)

Alternative to Quantitative Easing (QE)

The so-called ‘helicopter money’ is discussed as a direct alternative to monetary policy instruments like QE with which a Central Bank (CB) purchases government securities. This “flooding [of] financial institutions with capital” (Investopedia, n.d.) lowers interest rates and increases the money supply without printing new money.

However, the effects of QE on the real economy were described as indirect and “underwhelming” (Belke, 2018).

The Three Approaches Towards HM

In general, one can differentiate between three general approaches towards HM. In contrast to QE, HM implies that CBs creates money and distributes it directly to the public through fiscal transfer payments (LaROSE, 2016).

Concerning the first approach, the CB prints money and gives it directly to the government which spends it immediately (Belke, 2018). Countries issue hypothetical assets, e.g. perpetual bonds, in exchange for freshly printed money with no interest payment and, therefore, no market value (Dowd, 2018).

Secondly, a “broad-based tax cut combined with money creation by the central bank to finance the cut” would be a monetary-financed tax cut in which the CB cooperates with government authorities (Belke, 2018).

In the third approach, the CB could open accounts for each citizen directly giving them fixed amounts with expiration dates to encourage spending (Belke, 2018).

Desired Effects of HM

According to Friedman (1969), HM leads to a boost in demand through a perceived wealth gain since consumers would want to raise consumption and reduce their cash balances to their former level.

One of the most appealing aspect of HM is that it uses multiple channels increasing its chance to succeed (Belke, 2018). First of all, the tax cut increases the economic agents’ nominal purchasing power and, therefore, induces increased total spending without increasing future tax burden or government debt (Borio, Disyatat & Zabai, 2016).

Additionally, HM leads to an increased money supply (M) which leads to a temporary increase in expected inflation implying lower real interest rates (i) which incentivize capital investments (Figure 2).

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Figure 2: The Effects of an Increased M on i.

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Figure 3: The Effects of Aggregate Demand on P.

Getting out of the LT

All in all, HM boosts demand to get the economy out of the LT although interest rates are low. Since the net present value of the terminal stock of base money can be made anything the monetary authority wants it to be, monetary injections loose none of their potency (Buiter, 2016). As Buiter (2016) points out, in an economy where the State controls the issuance of money, “a liquidity trap is a choice, not a necessity “(p. 25). When HM boosts real demand by a sufficient magnitude, the LT vanishes (Buiter, 2016).

Challenges of HM

Firstly, according to the economist Scott Sumner, HM might be obsolete since the CB already has sufficient tools at hand, for example, nominal GDP targeting (Borio, Disyatat & Zabai, 2016).

Apart from this, it is crucial that the monetary base growth permanent. Otherwise, the ECB would have to reduce the distributed profits abolishing the flow of interest income emerging under traditional money creation (Belke, 2018). But even if it is permanent, HM is not ‘free’ since it implies the opportunity cost of lost seigniorage (Dowd, 2018).

In addition, distributing money directly would weaken the balance sheet of the CB. HM would increase the value of liabilities although the value of assets does not change since it ‘buys’ bonds with no market value (Dowd, 2018). According to Belke (2018), the money transactions would increase the claims on the commercial banks. Therefore, the minimum reserves at the CB must be adjusted accordingly forcing it to pay interest without receiving interest on its own debts. According to Dowd (2018), the leverage of a CB is operationally irrelevant. However, a negative capital could have an adverse impact on the trust in the CB and erode the international confidence in the respective currency.

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• Université: Jacobs University Bremen gGmbH
• Note: 1.0
• Auteur: Julia Kaiser (Auteur)
• Année de publication: 2018
• Pages: 8
• N° de catalogue: V1030659
• ISBN (ebook): 9783346462398
• Langue: anglais
• mots-clé: Macroeconomics, Helicopter, money, recession, Friedman, liquidity, trap