Helicopter Money: Nothing New Under the Sun

May 23 2016

“Helicopter money” once started as a scientific aid. It was part of a thought experiment, for monetary economists to understand the consequences of changes in the supply of money. Assume, as the experiment would say, that central banks instead of buying bonds (with which they increase the monetary base), would throw money out of helicopters, giving every citizen instantly an x amount of additional money? What would that do to prices? In contrast, today we are discussing helicopter money as a practical policy tool, instead of an abstract, analytical aid.

From Thought Experiment to Policy Instrument

Today, helicopter money is seen as a practical (and according to some, highly necessary) policy instrument. Perhaps we Dutchmen just recently started to debate the pros and cons of this unorthodox monetary “tool.” Yet for someone that is more familiar with the important public debates beyond its own country’s borders, the debate is nothing new.

Because not only in the Netherlands the idea of helicopter money is under public scrutiny, but also in Japan.

And in Japan, it is the second time in history that this rather unorthodox policy is being debated.

The debate on helicopter money gained importance and took center stage exactly 19 years ago for the very first time.

Something with a Horse and Water …

In recent years, the same truism has been repeated over and over again: “You can lead a horse to the water, but you cannot make it drink.” If we would have to count the number of times that this catch phrase has been used by financial commentators, then two hands would definitely not suffice.

The idea is the following: central banks lower interest rates, expand their balance sheets by buying bonds, increase the monetary base (the money supply) and loosen monetary policy.

Under normal circumstances this would stimulate credit expansion by the banks. But not this time. This time (commercial) banks fail to do what they normally would do: extend more credit and stimulate aggregate demand in the economy. The monetary transmission mechanism is broken, some economists say (yes, throwing around complex words scores points at the Federal Reserve). The interventions of the European Central Bank, the Federal Reserve, and the Bank of Japan in the financial economy do not find their way to the real economy. A “liquidity gap”, some would call it. The current monetary policy is, akin to Japan over the past few decades or the US during the Great Depression of the 1930’s, like “pushing on a string.”

In other words: you can lead a horse to the water (central banks can “loosen” their monetary policy and lower interest rates), but you cannot force it to drink (but you cannot force banks to lend money and “loosen” their lending standards).

Now monetary policy is reaching its limits, many policy makers are considering the most extreme monetary tool ever used: waterboarding the horse.

By giving newly printed money directly to citizens, the money will without any doubt reach the “real” economy. And when they finally succeed, despite their broken “transmission mechanism”, all our worries will disappear like snow in the sun.

On Negative Interest Rates

The first solution is, of course, charging a negative interest rates on (excess) bank reserves. This tax in disguise has at least one beneficiary: central banks will earn more money and distribute their profits to the government. And what now is deemed necessary because of an “emergency,” might endure longer than many think.

But even if that doesn’t work, central banks could simply hand out money directly to their citizens. Being completely independent from credit markets, they could simply choose to spend money on whatever goods and services they wish.

Helicopter Money in Practice

In the 90’s, the following proposal was made in Japan: the Bank of Japan would announce that they would start paying 5000 Japanese yen a month (in that time about $50 dollar) to every Japanese citizen, until consumption spending picks up, which would help Japan out of its deflationary crisis and bring it to an end.

Given Japan’s total population, the monthly payout would increase Japan’s monetary base with about 10% a year. A substantial increase, but not as large as more recent annual increases.

Moreover, they would say, just announcing the policy would be enough to encourage consumption spending in the short run, which would assure that the policy would probably be of shorter duration than one might think beforehand.

Increasing Probability That Japan Will Be the First Country to Try Helicopter Money

It appears to be some sort of a competition: which country will be the first to implement helicopter money? Given the political consequences of such a policy in the euro zone, it seems the European Central Bank (ECB) prefers to wait for Japan’s lead.

While in Japan this policy has been under debate for quite some time, for Europeans it remains a large unknown.

But the moment Japan decides to give its citizens “free money,” it will signal the European Central Bank to embark upon the same policy. The Bank of Japan, after all, was also the first to buy up Japanese shares and ETF’s. Unorthodox monetary policy is a key characteristic of Japan.

Investors would do wise to follow any new developments in Japan closely. And as soon helicopter money becomes reality, no doubt that hard assets will profit most. With gold as front runner.

 

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