Greg Ip is overstating the effectiveness of helicopter money as a tool for jump-starting the economy.
With world economies still sluggish, more and more people are claiming that central banks are out of ammo in their fight against recessions. This has lead to an increase in calls for adopting less conventional monetary policy; something the Fed did when it used quantitative easing in response to the Great Recession. In a recent article in the Wall Street Journal Greg Ip explains how one of these policies, helicopter money, could be a viable solution for countries struggling with slow growth and looming deflation. However, Mr. Ip completely ignores the presence of the zero lower bound and overstates the effectiveness of helicopter money as a practical tool for jump-starting an economy.
Renowned economist Milton Friedman first coined the term “helicopter money” and simply put, it is a way of giving money directly to citizens. It works by the government issuing bonds to the central bank, which buy them using newly printed money. The central bank then promises never to sell the bonds or withdraw the newly created money from circulation. The government gives that money to its citizens and the central bank returns the interest earned on the bonds to the government.
As Miles clarified in “Helicopter Drops of Money Are Not the Answer,”
Printing money and sending it to people is equivalent to printing money to buy Treasury bills and then selling those Treasury bills to raise funds to send to people. Written as an equation:
printing money and sending it to people =
printing money to buy Treasury bills
+ selling Treasury bills to get funds that are sent to people
Here is the same equation, with the usual policy names attached:
helicopter drop = standard open market operation + tax rebate
Understanding helicopter money as a tax rebate financed by a standard open market operation makes it easier to see the limitations of this tool. Near the effective lower bound–the interest rate at which paper currency is a very close substitute for Treasury bills, even after accounting for storage costs , standard open market operations are not effective because they cannot push the interest rate any lower to stimulate spending. This means that a helicopter drop is now essentially just a tax rebate, and while tax rebates do impart some stimulus they are not nearly as effective as desired because not everyone spends the windfall.
Only one-fifth of respondents to a rider on the University of Michigan Survey Research Center’s Monthly Survey said that the 2008 tax rebates would lead them to mostly increase spending. Almost half said the rebate would mostly lead them to pay off debt, while about a third saying it would lead them mostly to save more. The survey responses imply that the aggregate propensity to spend from the rebate was about one-third, and that there would not be substantially more spending as a lagged effect of the rebates. Because of the low spending propensity, the rebates in 2008 provided low “bang for the buck” as economic stimulus.
What’s troubling is that despite the limitations of helicopter money, limitations that even Mr. Ip acknowledges, it seems to be gaining traction as a potential policy. European Central Bank chief Mario Draghi has said
… helicopter money is an interesting idea currently being explored by various economists. While this is certainly not an endorsement, he is not dismissing the possibility of helicopter money due to the perception that their latest attempt, negative interest rates, is already failing.
Rather than explore this radical and less efficient option, the ECB should work to strengthen their negative interest rate policy by, as our Miles suggests, establishing the electronic euro as the unit of account and introducing an exchange rate between paper and electronic currency. That way the negative rates can affect paper money as well and there will be no place to hide from the negative interest rates other than through physical investment or abroad–which would increase net capital outflows and in turn increase aggregate demand as desired.
Luckily there seems to be some growing consensus that negative interest rates can be a very powerful and effective instrument for monetary stimulus. Just last week International Monetary Fund Chief Christine Lagrande said that while we should closely monitor the potential side effects of negative interest rates these subzero rates are in fact a net positive for the global economy. This means that with negative rates it is possible to have an overall boost in world aggregate consumption as opposed to the very small bump given by helicopter drops.
In theory, helicopter money would work, but it is not the most efficient option central banks have for battling recessions. Once people realize that powerful tools necessary to stabilize the economy are there, in the form of negative interest rates, helicopter drops will no longer get so much attention.