The next leap
Helicopter money sounds radical. It may not be that much of a departure
WOULD “helicopter money” (the use of newly created money to finance government spending or tax cuts) be a revolutionary break from existing monetary policy? Its advocates argue that the tactic would give the global economy a much-needed boost; its detractors see it as a further step on the path towards fiscal irresponsibility and hyperinflation.
A paper from Toby Nangle of Columbia Threadneedle, a fund-management group, argues that helicopter money is not as radical a leap as you might think. Money is created in two ways. By far the largest proportion is generated by the banking sector when it lends to consumers or businesses. The bank creates a deposit in the name of the borrower which can then be spent.
Mr Nangle refers to this as “inside money”. The other type, which he calls “outside money”, is that created by the government and central bank, including the notes and coins that everyone carries around.
Mr Nangle’s insight involves looking at outside money in a different way. In the conventional view, the government collects taxes from the private sector and uses the proceeds to finance its spending, covering any shortfall by borrowing in the bond markets. Instead, he suggests, look at the process through a monetary lens. The government creates money to pay its bills—public-sector wages, defence equipment and so on. Doing this without limit would quickly undermine confidence in its currency. So governments offset this monetary expansion by “sterilisation”—taking money out of the system through taxes or debt issuance.
Now think about quantitative easing (QE), the creation of new money to buy government bonds. In effect, this is undoing, or reversing, the sterilisation process. The aim was to prevent excessive monetary tightening. In Britain, the chart shows that bank credit (inside money) was shrinking after the financial crisis but, thanks to QE, the Bank of England partially offset this by creating outside money.
In addition, QE in effect reduces government debt held by the private sector, at least for as long as central banks hold on to their respective governments’ bonds and remit the interest payments back to the treasury in question. In accounting terms, one bit of the government owes money to another bit.
On a net basis, the ratio of government debt to GDP in Japan has been falling, not rising.
The only difference between the current situation and the use of helicopter money is that, in theory, central banks plan to unwind their bond purchases in the long term. Government bonds will eventually end up back in the private sector. (Either the central bank will sell the bonds in the market, or it will fail to reinvest when the bonds mature.)
However, it is almost eight years since the failure of Lehman Brothers and no central bank has started to unwind QE. In the circumstances, would the use of helicopter money be that much of a policy shift?
Mr Nangle’s argument is ingenious but raises questions. If helicopter money is so similar to QE, then would it really be effective? After all, despite several rounds of QE, developed economies have not reattained their pre-crisis growth rates. The essential difference, enthusiasts argue, is that the expansion of the money supply would be avowedly permanent, and thus would have a more stimulatory effect.
That difference might well cause helicopter money to be seen in a different light by the markets.
The idea of financing government spending by printing money is regarded with horror by many bond investors because it is a drug to which governments would quickly become addicted. Why bother with the unpopularity of raising taxes or the need to placate bond markets when a friendly central bank can fund all your spending promises? The first government to try it might see considerable downward pressure on its currency. Mild depreciation would be welcome; a rapid plunge would not.
In the end, Mr Nangle comes out against helicopter money because it would be harder to reverse than QE. Instead of selling government bonds to the market, the central bank would have to push up short-term interest rates, perhaps by a lot, since this would probably be its main tool. The impact on small firms and mortgage-holders might be crippling.
But the debate isn’t going to go away. With short- and long-term rates close to historic lows, there isn’t a lot central banks can do on the rates front if more monetary stimulus is needed.
Expect to see lots of sophisticated arguments in favour of helicopter money in order to quell the doubts of the markets.