Commentary |
24 April 2020

Helicopter money is not what you think

Originally published in the Australian Financial Review.

Stephen Grenville
Stephen Grenville

Overseas, there are increasing calls for ‘helicopter money’ to be implemented. As the enormity of the epidemic’s economic response sinks in, the term is beginning to enter the conversation here. We need to sort out some current confusions.

Some think of helicopter money as governments handing out cash or cheques to the public on a wide scale. Such a policy is hardly novel or exceptional. Social security has done this routinely for many decades. In the current fiscal package, a variant of the famous 2009 "cash-splash" has already been adopted, with the two $750 payments to social security recipients.

But this is not the kind of ‘helicopter money’ that Milton Friedman had in mind when he initiated the idea in 1969. Nor what Ben Bernanke, Janet Yellen and a host of other central bankers have discussed over the past decade. These expenditures, including the ‘cash splash’, are examples of fiscal policy, funded in the usual way by taxes or the issue of government bonds.

The distinguishing characteristic of helicopter money, as envisaged by Milton Friedman, is not in the nature of the fiscal spending, but about the method of financing this expenditure. Friedman’s helicopter money applied to expenditure finance by the central bank rather than bond-issue – by ‘money printing’ in his lexicon.

Why is this distinction so important? History provides case-studies where central banks have funded profligate expenditures which have bankrupted countries or led to rampant inflation. The Weimar Republic is usually cited. To guard against a repeat, most countries developed institutional independence for their central banks, the ‘money printers’, separating them from the budget, administered by the parliament.

Since the 2008 crisis, this neat division-of-labour has been fuzzed by quantitative easing (QE). The first US QE, in 2008, involved the traditional and legitimate role of the central bank in supporting the essential core of the financial sector. But QE soon took on the task of keeping bond interest rates low. The US Federal Reserve has now begun ‘QE infinity’ -- a broader commitment to buy as many government bonds as are needed to keep interest rates around the current historically low rates, negative in inflation-adjusted terms.

In principle, this policy can still be differentiated from the unrestrained money-printing of the Weimar Republic. The US Fed board and its chairman, Jerome Powell, understand the importance of central bank independence. In this, they have widespread public support. The Fed makes its own decisions about QE. It does not have a specific commitment to fund the budget deficit and is not doing so by direct purchase of government bonds. And of course in practice the difference is huge: there is no inflation, either current or in prospect. Wheelbarrows brimming with banknotes aren’t seen in the streets.

Nevertheless, the Fed is negotiating a tenuous line with unrestricted QE. What "exceptional circumstances" (to use Ben Bernanke’s phrase) would justify taking the further step to money-financed deficits, aka "helicopter money"?

The attraction is that it seems to provide costless funding of the huge budget deficits which seem to be an inevitable outcome of the response to the Covid-19 emergency.

Helicopter money is not, however, zero-interest funding, as many believe. Whether the central bank buys unlimited bonds in the market or directly funds the deficit, the outcome is more bonds in the central bank balance sheet and more cash in the hands of the public as a result of the budget deficit. The public doesn’t want more cash, so when the rounds of fiscal stimulus are done, the excess cash is deposited with the banks. With no unmet demand for loans by bankable customers, the cash flows back to the central bank in the form of banks’ reserves.

The central bank pays interest on these reserves, so it is not free money. To the extent that this interest rate is below-market, it is a hidden tax on banks. Moreover, this is a type of "financial repression": banks hold more reserves than they would normally want. And the reserves are a liability of the official sector, so should be counted as part of public debt. In short, there is no free lunch here.

Let’s exclude the confusing term ‘helicopter money’ from the debate, and accept that there is no free lunch in money-financed deficits. While-ever the bond market is still ready to take up government debt at low, even negative, inflation-adjusted interest rates, this kind of unconventional financing makes no sense.

Why do "QE infinity" and money-financed deficits represent a perilous slippery slope? An undertaking to keep bond rates low creates vested interests who will resist attempts to wind this policy back. The finance sector never sees a good time to normalise interest rates.

The central bank itself might share this reluctance to record capital losses on its bond holdings as interest rates rise.

Governments like low interest rates to keep their debt funding costs down, and like the convenience of assured funding. As we move into the post-crisis world of huge public debt, policymakers might be tempted by the historical precedents of inflating away the debt burden through negative real interest rates.

Stephen Grenville is a non-resident fellow at the Lowy Institute and former deputy governor at the Reserve Bank