ZURICH – The world has been on pins and needles since Donald Trump’s upset victory over Hillary Clinton in the United States’ presidential election last week. No one – including, perhaps, the president-elect himself – quite knows what shape the next US administration will take, or what its policy priorities will be.
Compounding this uncertainty is the fact that, around the world, geopolitical tensions are rising, with developed economies continuing to experience tepid growth, even after years of record-low interest rates. For Trump to stimulate enough activity in the US economy to satisfy his zealous base, he will have to find the right balance between fiscal measures and monetary-policy tools.
Whether Trump continues the post-1945 US tradition of international leadership, or instead chooses an “America first” approach, he will not be alone in his quest for growth: Japan and eurozone countries are also struggling to bring about sustainable recoveries and meet central banks’ inflation targets. Project Syndicate commentators have been at the forefront of the ongoing debate about what policymakers can do to achieve these goals. In particular, while Trump and policymakers elsewhere are embracing fiscal activism, how far they are willing or able to go remains uncertain, raising the question of what more central banks could do to stimulate demand and boost growth.
Spinning in Circles
The recent shift toward fiscal expansion reflects widespread agreement that policymakers are running out of stimulus options. Central banks can no longer rely on “forward guidance,” such as half-promises that interest rates will remain low indefinitely. And quantitative easing (QE) is quickly losing its potency, perhaps because it is inherently more effective as a crisis-response mechanism than as a long-term fix.
Moreover, QE seems to be far less effective in some economies than in others. “American-style QE,” argues the University of Oxford’s John Muellbauer, promises “little impact on the eurozone’s core countries,” because the US Federal Reserve’s “mechanisms [to] stimulate consumer spending – low mortgage rates, widely available home refinancing, high housing prices, and home-equity withdrawal – function differently in the eurozone.” According to Muellbauer, eurozone countries’ “high house prices spur non-owners to save more for the down payment,” and once they are owners, scarce home-equity loans prevent them from financing additional expenditures.
The same is true of ultra-low interest rates. As Muellbauer points out, in countries such as Germany, where households own more than they owe, “lower interest rates reduce total household spending.” Not surprisingly, then, negative interest rates have also failed to stimulate the level of demand that central banks anticipated. As Institute for New Economic Thinking Chairman Adair Turner explains, commercial banks do not want to “impose negative rates on depositors,” so they must instead impose “higher lending rates” to make up for “[losses] on their central bank reserves.” Lee Jong-Wha, the director of Korea University’s Asiatic Research Institute, agrees. “Lowering interest rates below zero,” he laments, “has hurt banks’ balance sheets, reducing their lending capacity. As a result, it has failed to increase business investment.”
To the Choppers
Lee reflects a broad consensus in calling on central banks to restore “credibility” by returning to conventional monetary policies, and he admonishes governments to step in and implement “effective fiscal policies and structural reforms.” But the prospect that governments will reject fiscal expansion, or refuse to go far enough, has turned the conversation in monetary-policy circles to “helicopter money,” a concept popularized by the economist Milton Friedman in 1969, and given new life by then-Fed Governor Ben Bernanke in 2002.
Turner defines helicopter money as “the direct injection of cash into the hands of consumers, or the permanent monetization of government debt.” Project Syndicate’s commentators agree about the potential costs and benefits of a central-bank-financed direct stimulus to the economy, but they differ over many central questions with respect to what, following QE and negative interest rates, certainly would be the most unconventional policy intervention of all.
Is today’s economic situation sufficiently dire to warrant using a tool that is so controversial and poorly understood? The University of California, Berkeley’s J. Bradford DeLong insists that it is, and he calls on central banks in countries with interest rates near zero to put “cash directly into the hands of people who will spend it.” Turner, for his part, argues that there is a “strong global consensus nowadays” that something must be done to stoke demand.
Allianz SE Chief Economist Michael Heise, however, provides a healthy dose of skepticism. “While helicopter drops are a viable policy option if deflation is spiraling downward,” he argues, “that is not the case today.” In fact, the Fed is poised to raise the interest rate in December. “Banks, firms, and households are still cleaning up their balance sheets and working off the heaps of debt they amassed during the credit boom that preceded the bust” in 2008, Heise argues. “But they have already made significant progress, meaning that the drag on growth is set to diminish.” Similarly, it is not obvious that a massive demand boost is necessary in the eurozone, given that the headline inflation rate there is rising.
A Monetary No-Fly Zone?
Turner has repeatedly argued that Japan should embrace helicopter drops; and, indeed, Japan may be the one developed-country exception. But, supposing that helicopter money is an appropriate intervention in any currency area, is it even legal? Jean Pisani-Ferry, an adviser to French Prime Minister Manuel Valls, acknowledges that, “Helicopter money raises both legal and technical difficulties.” And, as British economic historian Robert Skidelsky observes, “such monetary financing of public deficits is for the moment taboo” in Europe, as it runs “contrary to European Union regulations.”
In fact, the legality of helicopter money is dubious across developed countries. For example, Japan’s Public Finance Law (Article 5) seems to bar the Bank of Japan from extending credit directly to the government. On the other hand, there is usually room for legal finagling: while BOJ Governor Haruhiko Kuroda has dismissed helicopter money as unconstitutional, Heise points out that it “is arguably what the [BOJ] is doing now,” by “replacing the government bonds on [its] balance sheet once they mature,” and “increasing the volume of government debt on the central bank’s books.”
German economist Hans-Werner Sinn is similarly skeptical of helicopter money’s legality in the eurozone. As he emphasized in June 2013, “the eurozone is not a federal country, and the Treaty on the Functioning of the European Union (article 123 in particular) explicitly forbids monetary financing of the member states.” Likewise, the Statute of the European Central Bank (Article 21) seems to prohibit the ECB from extending credit to national governments or other EU institutions, or from directly donating or gifting to private individuals.
But, as with the BOJ, the ECB could find some room to maneuver. Since Sinn’s commentary appeared, the European Court of Justice has ruled in favor of the ECB’s Outright Monetary Transactions program, thus granting it considerable leeway in defining the scope of monetary policy. Still, I suspect that, ultimately, helicopter money would not be technically legal in the EU – including in the United Kingdom, so long as it is a member.
In the US, Congress has, since 1981, prohibited the Fed from purchasing securities directly from the US Treasury, and the Federal Reserve Act permits only purchases of government securities in the open market. It is unclear whether the Fed would be allowed to furnish private citizens with cash, checks, or vouchers, and Congress could of course amend the law to clarify such questions. But, as of now, policymakers pursuing helicopter-money policies in any developed country will probably have to clear considerable legal hurdles, or find a way around them.
Indeed, DeLong admits that actually implementing helicopter drops “will depend on the legal structure of a given central bank, and on the extent to which its administrators are willing to take actions that go beyond their traditional authority (with the implicit or explicit promise that the rest of the government will turn a blind eye).” Of course, in an age of rising populism, it is questionable whether central banks – which, with their closed-door proceedings and attenuated political accountability, are a natural target for populist leaders everywhere – will be afforded such leeway, especially under the coming Trump administration. And yet, as New York University’s Nouriel Roubini points out, “Trump is a real-estate mogul, so we cannot immediately assume that he is a true monetary hawk, and not a closet dove.”
The Sky Is the Limit
If we assume that helicopter money can clear existing legal hurdles, or that laws can be changed, how should it be administered? Surprisingly, many commentators seem inclined to take Friedman almost literally. As former Turkish Minister of Economic Affairs Kemal Derviş proposes, policymakers can “directly finance government spending by printing money.” But helicopter drops in the form of direct transfers would impose an enormous logistical burden on governments, as they grapple with such questions as determining who the beneficiaries will be and which agency should oversee such a massive, complex process. Helicopter-money advocates disregard these crucial questions at their peril. This is yet another reason for Heise’s blunt warning: “If it sounds too good to be true, that’s because it is.”
For Derviş, if helicopter money is to be delivered as a direct transfer to households, it should be designed to reach “those who need it most,” thereby helping “to improve inclusiveness in economies where inequality is rising fast.” However, former Reserve Bank of India Governor Raghuram Rajan cautions that even this well-meaning approach could be ineffective or have unintended consequences. If “an aggressive policy convinces the public that calamity is around the corner, households may save rather than spend,” he points out. Alternatively, “if people were convinced that policies would never change, they might splurge again on assets and take on excessive debt,” implying “enormous dislocation” from “shifts in asset prices” when “policy inevitably changes.”
The alternative to direct transfers, say Berkeley’s Laura Tyson and Chairman of the McKinsey Global Institute Eric Labaye, is to finance stimulus programs by “crediting national treasuries.” Under this approach, central banks would make transfers directly to national governments by purchasing government bonds and rolling them over in perpetuity when they mature, similar to the BOJ’s program. Although governments would need to pay the coupon rate on the bonds, they would essentially be paying it to themselves.
This kind of monetary financing is politically appealing to populists and non-populists alike, because it requires no increase in taxes, now or in the future. In fact, Turner suggests that central banks should permanently carry government debt to combat public-debt overhangs. In this scenario, central banks would directly finance government spending, but they would delegate the responsibility for executing stimulus programs to governments, which already have more experience overseeing safety-net programs, such as unemployment insurance, and infrastructure projects.
Project Syndicate commentators’ views also differ on how the proceeds from government bond sales should be allocated. While some favor direct transfers to consumers, Tyson and Labaye argue for increased investment in infrastructure projects, such as public transportation, which would generate more economic activity, raise productivity, and boost future tax revenues. Skidelsky, for his part, suggests that both forms of helicopter money “could (and should) be dropped together.”
Black Hawk Grounded
But, as Fitch Ratings Managing Director James McCormack cautions, helicopter drops are “troubling for many reasons.” Above all, monetization of fiscal policy “unambiguously weakens central bank’s balance sheets by adding assets that carry no real value (claims on government that will never be repaid), offset by liabilities (newly created money) generated to acquire them.”
McCormack issues a warning that all commentators broadly acknowledge: governments that resort to helicopter money could become addicted to it, if they come to regard monetary financing as “the proverbial ‘free lunch.’” Should this happen, high inflation in developed countries could become as common and severe in the future as it was in the 1980s. In fact, the threat of high, volatile inflation is precisely why many countries prohibited monetary financing in the first place.
Turner acknowledges this concern, but argues that “a failure to implement any policy … can be equally dangerous.” Just as central banks decide on what interest rate to set, they could also independently determine how much monetary financing they are willing to provide, and then transfer that amount to the government.
That argument is unlikely to persuade Heise, who argues that central banks will be pressured to furnish additional monetary financing, regardless of what safeguards are put in place. This is a credible concern: a central bank that finances government spending will necessarily have to work more closely with that government, especially when infrastructure projects or other programs span a number of years and encounter cost overruns and delays.
Furthermore, if monetary financing succeeded in raising inflation to meet central banks’ target rates, governments would inevitably come to regard close monetary-fiscal cooperation as desirable, jeopardizing central-bank independence. As McCormack puts it, “helicopter money would transfer risk from governments’ balance sheets to those of central banks, blurring the lines between policies, institutions, and their relative autonomy.” At some point, McCormack fears, “confidence in the financial integrity of central banks – and consequently the soundness of money – will be undermined.”
Learning to Fly
Helicopter money works in theory, and the historical record suggests that it could also work in practice. But, unlike fiscal expansion, it is a blunt and imprecise tool that central banks would probably do well to avoid, at least in the near term. As Koichi Hamada, a senior adviser to Japanese Prime Minister Shinzo Abe, cautions, “adverse global conditions, however troubling, should not lead central bankers to neglect the risks of untested policies.”
Indeed, helicopter-money enthusiasts have skirted many practical considerations, not least the effects policies in one currency area can have elsewhere. As Rajan reminds us, “Beyond the domestic impacts, all monetary policies have external ‘spillover’ effects.” For example, “unconventional monetary policies” can create “large capital outflows that provoke asset-price bubbles in emerging markets.”
Furthermore, all Project Syndicate commentators do acknowledge that helicopter money could threaten central-bank independence, and potentially lead to extremely costly hyperinflation. But, putting these misgivings aside, most would keep it in their monetary-policy toolkit, because it could prove effective as an emergency response to a large, deflationary recession. As Michael Biggs, a strategist at GAM, writes, helicopter money during deflationary periods really is “as close to a free lunch as economics has to offer.”
Barring a deflationary cycle, however, we should expect the helicopters to remain firmly grounded in all of the world’s major currency areas outside of Japan, where inflation is now the least of policymakers’ concerns.