“Helicopter money”: A practical guide for markets

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If current non-conventional monetary policies fail to contain deflation risk, some form of debt monetization or “helicopter money” will become a policy option. The barriers are high but not insurmountable in the G3. Policies could range from a simple combination of QE and fiscal expansion to outright central bank funding or debt restructuring. If and when monetization of government debt becomes apparent the consequences for financial markets would be profound: the policy response to deflation risk would no longer drive bond yields lower but higher.

This post ties in with the systemic risks arising from non-conventional monetary policy (view summary page here).
The below are excerpts from range of relevant research papers and official comments. The links are provided at the end of the post.

What is helicopter money?

“Briefly, this means that the central bank, in various ways, more or less directly transfers money to the actors in the economy. One way is to increase public expenditure or lower taxes and fund this by increasing the money supply.”
[Cecilia Skingsley, May 2016]

“A ‘helicopter drop’ of money is an expansionary fiscal policy—an increase in public spending or a tax cut—financed by a permanent increase in the money stock.”
[Ben Bernanke, 2016]

“Functionally, this is equivalent to an increase in the government deficit financed by a corresponding permanent increase in non-interest bearing central bank liabilities. Thus, on the financing side, the main difference with central bank asset purchases financed by issuing non-interest bearing bank reserves practised in the past…is that it is intended and perceived to be a permanent rather than a reversible operation. The central bank credibly commits never to withdraw the increase in reserves.”
[Borio, Disyatat and Zabai, 2016]

What are the benefits of helicopter money?

“In theory at least, helicopter money could prove a valuable tool. In particular, it has the attractive feature that it should work even when more conventional monetary policies are ineffective and the initial level of government debt is high…the appealing aspect…is that it should influence the economy through a number of channels, making it extremely likely to be effective—even if existing government debt is already high and/or interest rates are zero or negative.”
[Ben Bernanke, 2016]

“The new money would bypass the financial and corporate sectors and go straight to the thirstiest horses: middle- and lower-income consumers. The money could go to them directly, and through investment in job-creating, productivity-increasing infrastructure. By placing purchasing power in the hands of those who need it most, direct monetary financing of public spending would also help to improve inclusiveness in economies where inequality is rising fast.”
[Kemal Dervis, 2016]

“In a liquidity trap, the risk-averse public hoards cash, perhaps because they anticipate consumer goods deflation, recession and/or a debt-deflation spiral. At certain low levels of output the public is willing to hold any amount of money the central bank is willing to supply regardless of the real interest rate. The nominal interest rate reaches the so-called zero lower bound in a liquidity trap, and as it turns out, can even sustain negative levels…Only fiscal policy raises GDP in a liquidity trap. Monetary expansions (such as quantitative easing or swapping of bonds for cash) increase neither output nor real interest rates, because the public simply hoards the money. By contrast, fiscal expansion increases GDP 1-for-1 with government spending…Monetary financing is super-charged fiscal policy because…the government would not need to raise revenues to service and roll future debt obligations. Consumers would not reduce current consumption to save for future taxes.”
[Brehon, Saravelos and Winkler, 2016]

“Three conditions must be satisfied for helicopter money always to boost aggregate demand. First, there must be benefits from holding fiat base money [currency issued by the central bank without asset backing] other than its pecuniary rate of return. Second, fiat base money is irredeemable – viewed as an asset by the holder but not as a liability by the issuer. Third, the price of money is positive. Given these three conditions, there always exists…a combined monetary and fiscal policy action that boosts private demand…Deflation, ‘lowflation’ and secular stagnation are therefore unnecessary. They are policy choices.”
[Willem Buiter, 2014]

Both quantitative easing (QE) and negative rates face significant technical constraints. QE requires assets that the central bank can buy. If, because of high debt levels, governments are not willing to spend and thus issue more debt, then central banks will effectively run out of government bonds to purchase. Moving into the purchase of risk assets is complicated. Not only does it take risk on to the government’s balance sheet, it might have adverse effects on the management of companies which could in turn damage productivity. Similarly, central banks are constrained in their ability to take rates deeply negative due to potential damage to the profitability of the banking sector. Knowledge of these technical constraints reduces the signalling power of central banks since markets are aware that even if central banks have the willingness to act, they might not have the ability…Helicopter money, since it overcomes many of the shortcomings of other monetary policy measures. No debt is created, so you overcome the issue of governments, households or corporates not spending now because of worries about…Central banks can create as much money as is required so the signalling is much more powerful.”
[Major and Ward, 2016]

What are the drawbacks of helicopter money?

“The most difficult practical issues…involve their governance—who decides, and how? Unlike orthodox fiscal and monetary policies, money-financed fiscal programs would seem to require close coordination of the legislature and the central bank, which may be difficult to manage in practice. To the extent that that coordination is successful, some worry, it might put at risk the longer-term independence of the central bank.”
[Ben Bernanke, 2016]

“Helicopter money…would tear gaping holes in central bank balance sheets. Ultimately, it would be down to…the taxpayer, to shoulder the costs because central banks would be unprofitable for quite some time. The question of whether and how money is given away to the general public is a highly political one that would need to be addressed by governments and parliaments. Central banks don’t have a mandate to do so, not least because it would mean redistributing assets on a huge scale.”
[Jens Weidmann, 2016]

“[If the central bank pays interest in excess reserves, as in the U.S.] the apparent attractiveness of the helicopter approach ignores something important: Money has a cost, too. When the Treasury spends USD100 billion, it will appear in bank accounts. Banks, in turn, will deposit the money at the Fed — a liability on which the central bank pays interest…The impact is the same whether the government finances the spending with debt or new money.”
[Narayana Kocherlakota, 2016]

“The central bank can of course implement a permanent injection of non-interest bearing reserves and accept a zero interest rate forever .This produces the envisaged budgetary savings but at the cost of giving up completely on monetary policy. If the central bank wishes to avoid that outcome, it has only two options. It can pay interest on reserves at the policy rate , but then this is equivalent to debt-financing from the perspective of the consolidated public sector balance sheet – there are no interest savings. Or else the central bank can impose a non-interest bearing compulsory reserve requirement equivalent to the amount of the monetary expansion, but then this is equivalent to tax-financing.”
[Borio, Disyatat and Zabai, 2016]

“Distributing largesse financed by the central bank would have dangerous systemic consequences in the long run, because it would create perverse incentives for everyone involved. Policymakers would be tempted to resort to helicopter money whenever growth was not as strong as they would like, instead of implementing difficult structural reforms.”
[Michael Heise, 2016]

Is helicopter money a realistic option?

“One idea that has seen lively discussion recently, albeit perhaps more among academics and economic debaters than among central bank representatives, is what is known as helicopter money…Of course, there are a number of practical and legal challenges inherent in this, such as integrating such measures into an operational monetary policy framework and ensuring an appropriate division of responsibilities between the central bank and the government or parliament. It is also probably something that should not be tried until other possibilities have been exhausted. However, considering the difficulties that are still weighing many of the world’s economies down, I think that it is wise to discuss the different possibilities, without closing any doors.”
[Cecilia Skingsley, May 2016]

While helicopter money is considered to be at the frontier of the ‘unconventional’, historical perspective shows it has been far more prevalent than recent central bank innovations such as negative rates…The constraints are lower than is commonly assumed, even for the ECB.

  • U.S.: Historical precedent, as well as the absence of constitutional restrictions, means that the bar for monetary financing in the US is quite low…The…Treasury-Fed Accord of 1951 cemented the separation between central bank and the executive branch. Yet despite the Accord plenty of flexibility remains. For one, the Accord is merely a statement of understanding between the Treasury and Federal Reserve rather than a legally binding text. The text itself is vague…More importantly, and unlike Europe, there is no explicit prohibition of Federal Reserve monetary financing in congressional legislation or the US Constitution.
  • Japan: Central bank financing of fiscal stimulus has been forbidden since the war and is legally prohibited under Article 5 of Japan’s Public Finance Law. The…legislation offers more leeway than meets the eye…First, there is an explicit allowance for exceptions, where ‘[if] there exists some special reason therefor, an exception shall be made …within the limits of the amount sanctioned as the result of a decision reached in the Diet’…Second, the monetary financing prohibition is not enshrined in the constitution providing additional leeway for change… Abe’s reflationists have never categorically ruled out monetary policy innovation under dire circumstances.
  • Euro area: Article 123 of the Lisbon Treaty prohibits the ECB from funding national governments. These restrictions notwithstanding, the Treaties leave considerable more leeway than first meets the eye…First…a view can be taken that the monetary policy prohibition does not cover pure monetary stimulus taking the form of ‘helicopter drops’ directly to households and corporates bypassing governments…Second, the European Court of Justice… decision makes clear that ECB policy action potentially has a wide scope of action provided it is proportional and serves its statutory objectives…there exists little case law on how a proportionate Euro-area wide restructuring of ECB-held government debt for monetary policy purposes would be treated…Third, the ECB monetary financing prohibition does not apply to ‘publicly owned credit institutions’ such as the European Investment Bank. In theory the ECB could buy ultra-long-dated bonds issued by the AAA-rated European Investment Bank at close to 0%. The proceeds could be used to finance public infrastructure spending.”
    [Brehon, Saravelos and Winkler, 2016]

“Canada used monetary financing for 40 years until 1975 under a free-floating exchange rate regime without calamitous macroeconomic effects, and India operated a policy of debt monetisation until 2006. Further examples abound. Indeed, of the 152 central bank legal frameworks analysed by the IMF, 101 permitted monetary financing in 2012.”
[Toby Nangle, 2016]

“Yes, all central banks can do it. You can issue currency and you distribute it to people. That’s helicopter money. Helicopter money is giving to the people part of the net present value of your future seigniorage, the profit you make on the future banknotes. The question is, if and when is it opportune to make recourse to that sort of instrument which is really an extreme sort of instrument.”
[Peter Praet, 2016]

What form could helicopter money take?

“The following menu of policy options [may be considered by central banks]:

  • Quantitative easing combined with fiscal policy expansion…is already happening, albeit with a lack of explicit co-ordination. Central banks purchase interest-bearing government debt with a temporary increase in the monetary base. This is accompanied by increased fiscal spending (or tax cuts), enacted by the Treasury in reaction to implicit central bank support for bond markets. The Treasury has more room to increase the deficit and the outstanding term of its maturing government bonds, because financing costs are made lower by central banks.
  • Cash transfers to governments…[are similar to the above except that] government debt is non-redeemable, and hence the increase in the monetary base is permanent. Money can be credited directly to the Treasury account at the central bank, which would keep government debt/GDP ratios stable. The central bank can purchase 0% coupon perpetuities from the Treasury.
  • The central bank can unilaterally restructure or forgive its government debt holdings, improving government debt sustainability and allowing the Treasury room for future deficit spending. This can happen in a one-off fashion, or according to some graduated rule…The Greek OSI and PSI experience offers a precedent for distinguishing between privately and publicly held government bond holdings thus potentially avoiding CDS triggers. Note that central bank purchases of negative-yielding instruments are a form of notional haircuts as the government pays back to the central bank less than it issued.”
    [Brehon, Saravelos and Winkler, 2016]

“The prospective economic, monetary and fiscal effects of helicopter money (absent the shock of a new unfamiliar policy being implemented) look identical to a normal fiscal expansion supplemented with additional quantitative easing…Perhaps the real lesson is that monetary policy has its limits and that in the event of an economic slowdown, aggregate demand is best supported by fiscal rather than monetary policy. In the event that new fiscal expansion requires supplemental monetary support in the form of additional quantitative easing, that is a decision that could be made at some point in the future.”
[Toby Nangle, 2016]

What would be the likely market impact?

“We know that previous unconventional monetary policies helped to pull yields lower and we have the benefit of historical analysis which shows how central bank policies reduce term premium through QE… Helicopter money steps into the realms of fiscal policy and unless managed appropriately would likely result in higher yields…The lack of term premium, evident in the longer maturities of G4 government bond curves, would point to the risk of steeper yield curves.”
[Major and Ward, 2016]

“We assume an aggressive form of stimulus large enough to generate an increase in inflation and growth expectations – for instance, a one-off write-down of debt owned by the central bank as well as large-scale fiscal stimulus financed by the issuance of zero-coupon perpetual bonds bought by the central bank…Under this scenario, we would expect [that]…bond yields should rise and the curve should bear-steepen…If the policy is perceived as a loss of monetary discipline, inflation expectations would spike, leading to an aggressive re-pricing of yields higher.”
[Brehon, Saravelos and Winkler, 2016]

Sources

Bernanke, Ben (2016), “What tools does the Fed have left? Part 3: Helicopter money”, April 11, 2016.
http://www.brookings.edu/blogs/ben-bernanke/posts/2016/04/11-helicopter-money

Borio, Claudio, Piti Disyatat and Anna Zabai (2016), “Helicopter money: The illusion of a free lunch”, 24 May 2016
http://voxeu.org/article/helicopter-money-illusion-free-lunch.

Brehon, Daniel, George Saravelos and Robin Winkler, “Helicopters 101: your guide to monetary financing”, Deutsche Bank Research, April 14, 2016.
http://pg.jrj.com.cn/acc/Res/CN_RES/INVEST/2016/4/14/4fc0be66-222c-4477-97df-7e61e341c2c4.pdf

Buiter, Willem .(2016), “The Simple Analytics of Helicopter Money: Why it Works – Always,  August 21, 2014.
http://ssrn.com/abstract=2484853http://papers.ssrn.com/sol3/Papers.cfm?abstract_id=2484853

Dervis, Kemal (2016), “Time for Helicopter Money?”,  March, 3, 2016.
https://www.project-syndicate.org/commentary/coordinated-monetary-policy-revive-growth-by-kemal-dervis-2016-03

Heise, Michael (2016), “The Case Against Helicopter Money”, April 20, 2016.
https://www.project-syndicate.org/commentary/case-against-monetary-helicopter-drops-by-michael-heise-2016-04

Kocherlakota, Narayana (2016), “Helicopter Money Won’t Provide Much Extra Lift”, Bloomberg View Article, March 24, 2016.
http://www.bloomberg.com/view/articles/2016-03-24/-helicopter-money-won-t-provide-much-extra-lift

Major, Steven and Karen Ward (2016), “The real elephant in the room – Why helicopter money could be a game changer”, HSBC Global Research, 25 May 2016.
No public link, please contact HSBC for a copy.

Nagle, Toby (2016), “How Helicopter Money Works”, Columbia Threadneedle Investments, May 2016.
http://www.columbiathreadneedle.co.uk/media/10023117/en_viewpoint_the_impact_of_helicopter_money.pdf

Praet Peter (2016), “Interview with La Repubblica”, March 18, 2016.
http://www.ecb.europa.eu/press/inter/date/2016/html/sp160318.en.html

Weidmann, Jens (2016), Interview published in the newspapers of the Funke Mediengruppe on 21 March 2016:
http://www.bundesbank.de/Redaktion/EN/Interviews/2016_01_29_weidmann_funke_mediengruppe.html