Central Bank Watch – 09 May 2016

09 May 2016

Everything you ever wanted to know about helicopter drops (but were afraid to ask)

► The textbook helicopter drop involves a permanent injection of money into the economy. From a monetary perspective, more money now and in the future means more inflation and from a fiscal perspective the fact that the spending today is not financed by taxes tomorrow means the stimulus can be highly effective.

► Many central banks have already begun to head along the flight path of a helicopter drop. In what we call Persistent quantitative easing (QE), past, current and future asset purchases are unlikely to be unwound for years, if not decades.

► We identify other variants of helicopter drops, depending on the degree of permanence of the cash injection and the level of coordination between the central bank and government. In one variant, Permanent QE is paired with fiscal stimulus, such that fiscal expansion is fully monetized by the central bank.

► If permanent expansion of the monetary base proves legally or politically challenging, the central bank may engage in QE alongside fiscal stimulus without communicating how long the bonds will be held on its balance sheet. But this strategy could be perceived as “more of the same” as opposed to a change in central bank strategy, and would prove less effective in boosting growth and inflation.

► Even when implemented through asset purchases, a helicopter drop will eventually deplete the capital of the central bank. The central bank can recapitalize itself by printing money, but it may have to print a lot to raise the necessary seigniorage income, and that can lead to monetary and financial instability: a lot of inflation and significant losses for leveraged institutions holding fixed income assets.

The economic malaise that followed the financial crash of 2008 has prompted numerous innovations in the monetary policy toolkit. The scale of the initial hit to demand and the stubborn refusal of inflation to return to target has forced central banks to turn to unconventional tools to inject additional stimulus into economies, from large-scale asset purchase programmes to negative deposit rates to multi-year fixed rate loans to banks. However, inflation has yet to achieve escape velocity so the period of innovation may not yet be over. Attention is increasingly turning towards more extreme options like so-called ‘helicopter drops’, in which the central bank makes a permanent injection of money into the economy. In this note we describe a range of policy interventions which fit under the broad umbrella of a helicopter drop of money, assess their likely impact and highlight some of the constraints on implementation.

Decoding Milton’s metaphor

The term helicopter drop belongs to Milton Friedman, who famously posed the following thought experiment way back in 1969:

“Let us suppose now that one day a helicopter flies over this community and drops an additional $1,000 in bills from the sky, which is, of course, hastily collected by members of the community. Let us suppose further that everyone is convinced that this is a unique event which will never be repeated”

The idea of distributing hard currency to the general public as a means of stimulating the economy seemed far-fetched during the tranquil times of the so-called Great Stability before the crash. Indeed, when then Federal Reserve Governor Ben Bernanke had the temerity to reference Friedman’s idea in a November 2002 speech about how US policymakers would deal with a deflationary episode, he was given the nick-name ‘Helicopter Ben’. However, helicopter drops have become much more fashionable in the post-crash era, with some high profile commentators, academics and market participants arguing that helicopter drops would be a more effective way of reflating the economy than more QE or more negative rates. But what exactly is a helicopter drop?

The basic case for a helicopter drop is typically articulated as follows: policymakers can better stimulate the economy by putting cash directly in the hands of the general public, rather than relying on the transmission mechanism of unconventional monetary policy through financial markets reaching those agents in the real economy. However, as we shall go on to discuss, unconventional monetary policy still plays a pivotal role in the real-world implementation of a helicopter drop. Indeed, the technical details of helicopter drops are far less radical than you might think.

The many faces of the helicopter drop

There are a number of policy measures which superficially look quite different but conform to the basic template of the helicopter drop. We now briefly review some key operational judgements which distinguish the different forms of drops:

  • Is the drop intermediated? In Friedman’s original thought experiment the central bank prints currency and distributes it to the public. However, while central banks may be well-equipped to distribute cash to banks, finance ministers have the comparative advantage in raining cash on the real economy since the government has a ready-made distribution pipeline (the tax and benefit system) through which cash can be passed to households and companies. The central bank might finance the drop, but in practice the government would likely distribute it.
  • Is the drop ‘something for nothing’ or ‘something for something’? The currency that is distributed to the public is conventionally assumed to be a liability of the central bank. In one form of the drop the central bank gets nothing (no asset) in return for the cash. In another – and we believe more likely – variant the fiscal authority provides the central bank with an asset
    (to match the new liability) that derives its value from the future flow of tax receipts that the government expects to receive.
  • If the central bank is given an asset, does it receive a marketable security? The government may provide the central bank with a promissory note (essentially an IOU) or it may instead issue a bond that is traded in financial markets and can be readily converted into cash.
  • If the central bank gets nothing in return for the drop, does it print new money or convert old QE to a “drop”? The conventional ‘something for nothing’ helicopter drop involves the central bank passing new cash to the government and getting nothing in return. An alternative way to envisage this mechanism is for the central bank to announce that it will never sell assets purchased under QE. This variant converts past QE into a helicopter drop, though has the disadvantage of not being accompanied by any new expansion of the central bank balance sheet (it just eliminates the possibility of the balance sheet shrinking in the future).
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