Suppose, a developed economy is experiencing a period of stagnation coupled with really low-interest rates and the government approaches the central bank to devise a way to spur spending and output in the economy. The central bank tries the conventional way of reducing interest rates to stimulate spending, inflation, growth and output but it falls flat as the interest rates were already very close to zero. Hence, the changes in the interest rates were not substantial enough to bring about a major change in output and spending. Worried, the central bank finds itself in a tough spot with limited monetary options to get out of this fix, none of which are effective. According to Friedman, the only solution would be to fly a helicopter above a community, literally dropping 100 dollar notes out of the sky for the general public to freely spend on commodities and services, therefore stimulating spending, output, and growth.
Initially developed as a classroom theory, ‘Helicopter Money’ refers to direct money transfers, virtual or cash, from the central bank to the general public with an aim of increasing spending, output, inflation and growth in an economy trapped in stagnation coupled with a liquidity crisis. The tool remained as a textbook chapter for most of the latter part of the 20th century. However, it was brought to light in 2002 by the then Fed governor Ben Bernanke who considered it as a suitable option to revive the US as well as Japan from the deflation which hit most developed countries at the beginning of the 21st century.
But, how does ‘Helicopter Money’ succeed when all other monetary methods fail to stimulate expenditure and output in the economy?
The problem is that quantitative easing, rate cuts and other monetary methods generally adopted by a central bank fail when the interest rates hover around zero. This is because when the interest rates are near zero, a further rate cut, buying up of government bonds or negative interest rates would not increase the money supply in the economy sufficiently to increase spending. Moreover, most of these traditional financial methods have already been used and proven inefficient in various developed economies at various points in time, such as Japan in the 1990’s and the US in the early 2000’s. Hence, the only method which still remains unused is the Helicopter Drop.
Helicopter Drop has been hypothetically proven to stimulate demand in the economy. As the measure requires a one-time direct cash transfer to the general public, it is sure to stimulate spending. This is because the money supply in the economy increases by the amount of cash transferred by the central bank to the public which then increases the purchasing power of the individual. Naturally, with a higher purchasing power, spending would increase by the MPC (Marginal Propensity to Consume) amount in the economy.
The prospect of a Helicopter Drop is rather fascinating and sounds too good to be true. Realistically, Helicopter Drops and similar stimulus pose many questions to the central bank, from accounting to distribution. In spite of logistical issues such as how to disperse the amount equitably among the general public, another question which comes up is how will the central bank account for these Helicopter Drops?
In the cases of traditional quantitative easing methods, such as open market operations, it is very easy for the central bank to account how much high-powered money has been circulated in the economy. As each accounting transaction has two sides, a debit and a credit, the central bank has to ensure that each accounting debit has its respective credit entry as well. In the case of open market operations, the amount of bonds bought from the market is an increase in the assets of the central bank, which is a debit entry. While the money circulated in the economy is a reduction in the assets of the central bank, hence a credit entry. However, in the case of Helicopter Drop, there is only a reduction in the assets of the central bank. This means that there is only a credit side to this entry, which violates the fundamental principle of accounting.
To counter this, the central bank assumes that it has bought perpetual bonds from the market which have zero interest coupons on it. Basically, this means that The Central Banks assumes that for the money circulated among the general public as helicopter drops, it has bought from the market bonds which are irredeemable for perpetuity and which do not pay interest at all. This ensures that there is a debit side to the accounting entry for Helicopter Drops and that the fundamental principles of accounting are not violated.
Although this solves the issue of accounting, it raises another important question. Nowadays, most economists are concerned with whether a monetary method is reversible or not. In the case of traditional monetary methods such as rate cuts, open market operations, and reserve ratios, all are reversible. Rates and reserve ratios can be increased or decreased as per the situation as the central bank can always buy or sell back government bonds in the market. However, Helicopter Drops are irreversible in nature. That is, once a drop is made, neither its effects on the economy nor the drop itself can be reversed. This limitation makes the economists weary and they argue as a normative proposition, that these drops, if used, should be at most used as a stimulus package to increase one-time spending, output, growth, and inflation in the economy.
Inconvertible fiat currency is unique in the fact that it has a positive exchange value against commodities as it can be produced at essentially zero cost. Therefore, there is always a potential temptation for central banks to undertake such action by the virtue of printing more and more currency. However, one needs to keep a check on the amount of currency circulated in the economy to ensure that hyperinflation does not occur and the intrinsic value of all commodities do not fall to zero.
Helicopter Drops are dangerous as they conjure up the illusion that monetary magic can whip up real goods and services out of nothing. If this notion holds among those who influence monetary policy, then rational policymaking would become literally impossible. This is because policymakers would become so addicted to Helicopter Money that the overissue of fiat currency would only be dealt with a larger issue of currency until the economy collapses. Therefore, there is a good reason why Helicopter Money has not been used as a monetary policy tool but kept as a classroom experiment. And if Milton Friedman would have been alive today, he would have been horrified at what the Keynesians, the Classicals and the world at large have done to his innocent classroom experiment.
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