By Krishna Koundinya Mothukuru
Things have changed. Post 2008, the financial landscape has never been the same. Even after 8 years, the world economy has not recovered despite the unconventional policies of central banks around the world. Fiscal and Monetary policies designed to spur the growth and consumption have arguably failed. European Central Bank is nearly out of ammunition; Japan’s ‘Abenomics’ has almost fizzled out. With various versions of Quantitative Easing (QE) across central banks, low to negative interest rates, concessions, infusion of trillions of dollars, a minor blip on the economic recovery radar was seen. The Bank of America calculated that 637-interest rate cuts, $12 trillion asset purchases by central banks since 2008 in various QE rounds have been unsuccessful, giving diminishing returns.
Economists backing the effectiveness of monetary policies are becoming endangered species and their effectiveness in stabilizing economies is reaching its limits.
When the conventional policies are invalid, not-so-conventional policies fail, economies get desperate and then the only way out is the adoption of ‘crazy’, ‘insane’ policies as a last resort. Helicopter Money is being touted as the ‘next thing’ for central bankers.
What is this ‘crazy’ alternative ?
Helicopter Money (or ‘dropping money out of helicopters) was first suggested by Economist Milton Friedman in his work Optimum Quantity of Money in 1969, in order to get around cash infusion indirectly. Ben Bernake used this term in 2002 (in the context of Japan’s economic issues in 1999) and was called “Helicopter Ben” as the Governor in 2006. The whole idea is that, suddenly one day, helicopters drop money from the skies to the citizens who grab the money and go on a spending spree.
Till now, as part of QEs, central banks tried to spur the economic growth by reducing the interest rates (ECB made them negative, i.e. penalty for holding onto money), buying toxic assets from banks so that banks in turn can lend the money to business and individuals so that investments and consumption can be kicked up. This has clearly failed to reach the objectives as policy transmission was not effective. It indirectly led to few asset bubbles, banks holding excess reserves (esp. to clean up their balance sheets, risk aversion etc.).
How does this ‘crazy’ Helicopter Money policy work?
One mechanism proposed is tax rebates, which is financed by the Government borrowing (Fiscal Deficit). Fiscal Deficits are a major problem especially for developing economies like India. Developed Economies like US, Japan also have huge sovereign debt but the confidence of financial markets in their currencies is still to a large extent intact (after all, it was deficit spending that got US out of the Great Depression). Financing the government’s borrowing, at least in developed economies is easier to predict. Short term debt by cash constrained governments will be purchased by the central bank and is directly infused into the economy. The central bank’s action of monetizing the government debt becomes the engine which powers the helicopter. In simple words, economies do this by printing more money. Banks are bypassed; the idea of influencing the bond yields, market sentiments, and policies becomes moot. However, for developing economies fiscal deficit may be dangerous. It erodes the currency strength, distorts balance of payment and increases the inflation to unsustainable levels (while inflation rates of developed economies like US, Japan, remained low since 2008, developing economies like India, Brazil till recently faced nearly double digit inflation rates). On the brighter side, governments can focus more on social sectors with this move. Economies like France and Italy faced plummeting investments in crucial sectors like infrastructure and increased government spending on pensions, healthcare etc.
For Helicopter Money to work, it has to satisfy certain conditions or assumptions. First, is that money which is given away has to be worth something. Too much money chasing few goods leads to worthless pieces of paper, further paving a path to the Weimar Era issues, during the inter war period. Secondly and most importantly, is that people should choose to spend the extra money on buying goods and services in the market, thereby spurring the economic engines and not save in banks instead (it can be especially problematic in the developing world with an inherent tendency to save than to splurge). This also assumes that the central banks keeps the interest rates sufficiently low to make saving unattractive (negative interest rates are best). Third is that the ‘kick’ to the monetary system received should seem to be irreversible (unlike QE), which requires the central bank to hold coupon free reserves and roll this over indefinitely.
The pros and cons of the Helicopter Money policy
Like any other policy tool, even Helicopter Money also has two sides to the coin. The real world rarely corresponds to econometric models, and consumers are not rational agents whose behaviour patterns strictly correspond to mathematical equations. Hence, successful infusion of Helicopter Money would be difficult to achieve in reality. This infusion mandates that people should believe that the Government and central banks would not control the inflation rates for the foreseeable future, which requires few commitments and measures that will most likely toy with the future price stability. It would be like a rudderless ship venturing into a stormy ocean with no compass, all for the sake a short term spur in economic growth. Also, designing & implementing irreversible policies is very difficult and if the initial rounds of commitments fail to get the confidence of the consumers, then the future stimulus rounds would require disproportionate efforts, tearing gaping holes in the balance sheets.
This is the 1st part of a 3 part series
Krishna Koundinya Mothukuru is an entrepreneur and writes on Foreign Policy, Economics and Law.