Central banks are already facilitating fiscal packages in various ways. But with the fiscal costs of the coronavirus likely to rise much further, policymakers might consider explicitly financing them with a permanent expansion of central bank money – the infamous “helicopter drop”. These are not the failsafe cure they are sometimes made out to be; indeed, in some circumstances, they offer little more than a QE-financed fiscal expansion. Nonetheless, in the current environment, it makes sense to try everything.
- Central banks are already facilitating fiscal packages in various ways. But with the fiscal costs of the coronavirus likely to rise much further, policymakers might consider explicitly financing them with a permanent expansion of central bank money – the infamous “helicopter drop”. These are not the failsafe cure they are sometimes made out to be; indeed, in some circumstances, they offer little more than a QE-financed fiscal expansion. Nonetheless, in the current environment, it makes sense to try everything.
- It may seem as though we are already at the point of such central bank-funded fiscal expansions. Governments are going to be issuing a lot of bonds and central banks are going to be buying them via big (in some cases unlimited) quantitative easing (QE) programmes. In addition, some central banks have put a cap on bond yields, essentially giving governments free rein to issue as much debt as they want.
- However, QE is temporary; the government debt still exists. In contrast, a helicopter drop is a fiscal expansion financed by a permanent rise in central bank money, with no rise in government debt. Of course, QE has been going on so long – two decades in the case of Japan – that it is pushing the definition of temporary. Even so, the debt is supposed to be sold to the private sector eventually; indeed, last year the US began reversing QE – so-called “quantitative tightening”.
- Be aware that specific policies (most notably direct one-off payments to households) might look and feel like helicopter money, but whether they are or not depends on how they are financed. So far in recent weeks, any direct transfers to households have been normal debt-financed fiscal measures.
- So what might a permanent helicopter drop achieve that QE doesn’t? The fact that government debt would not rise might help in three ways. First, it might make governments more willing to spend. Second, it might raise the chances of keeping bond markets calm. And third, it might make households more likely to spend their giveaway if they don’t have to fear taxes rising further ahead (although we have always been sceptical about how much this idea of “Ricardian equivalence” applies in reality).
- Admittedly, it is questionable whether a truly permanent helicopter drop and write-off of public debt is possible, as it can make a central bank insolvent (as rising reserves boost its liabilities but its assets do not rise). Insolvency for a central bank does not matter in the short term as it does for a company. But further ahead, governments might recapitalise it by issuing more bonds, in effect reversing the helicopter drop.
- This is where expectations are key. If people realised that it might not be permanent, then they would not behave any differently under a helicopter drop compared to a debt-financed fiscal expansion with QE. But would the person on the street – if they are given £1,000 and told that government debt is not rising to pay for it – really squirrel it away in case the government eventually has to recapitalise the central bank?
- One final obstacle is the risk that it would encourage governments to run looser policies in the future. And if markets feared that this would eventually result in inflation or even hyperinflation, bond yields could rise, making this recession even worse. But we think that this concern can be swiftly dismissed. If ever there were a time when helicopter money could be presented as part of a credible one-off macroeconomic policy to deal with an exogenous shock, surely this is it.
- Overall, although a helicopter drop is not a panacea, policymakers should not let inflationary worries stop them from adding it to their depleted toolbox. Stepping back, though, what is most important is that central banks make a clear commitment to finance whatever it takes on the fiscal side and stand fully behind government bond markets – whether that is with unlimited QE or a helicopter drop.
Is now the time for a helicopter drop?
Government deficits are set to soar as a result of the coronavirus-related support that governments are having to give the economy. In the euro-zone, for example, we think that the fiscal costs could easily top 10-15% of GDP, and if the lockdown lasted for a very long time, the costs would rise far above that. At the same time, central banks are largely out of ammunition and the global economy is nosediving. Is now the time for a helicopter drop?
Overlap between fiscal and monetary policy grows
As a reminder, a helicopter drop of money is typically used to mean a one-off fiscal stimulus directly financed by printing money. The expression originates from a 1969 article by arch-monetarist Milton Friedman in which he imagined dollar bills being dropped on people by a helicopter. In fact, this echoed the suggestion made by Keynes in the 1930s of burying bottles filled with banknotes and leaving them for people to dig up. These days, the term is often used to describe a one-off payment to households, but note that it could involve any spending rise or tax cut.
It may seem as though we are already at the point of such central bank funded fiscal expansions. Given the big fiscal packages being announced, governments will be selling large amounts of bonds to pay for them. Even though some measures (such as loan guarantees) don’t have upfront costs, many (such as grants to firms) do and will require immediate financing. At the same time, central banks worldwide have announced big quantitative easing (QE) programmes in which they will effectively buy those bonds. (See Chart 1.)
Chart 1: Discretionary Fiscal Stimulus & QE Announced Since Coronavirus (% of GDP)
Sources: Various. France and Italy QE figures are ECB QE as % of euro-zone GDP. QE figure for US includes government bonds only; other countries include some small amounts of corporate bond purchases.
Some central banks have introduced caps on bond yields – implying open-ended commitments to buy government bonds – which should facilitate fiscal expansions too. And the US Fed has committed to unlimited purchases of government bonds.
Note that this is another step further towards the overlap of fiscal and monetary policy. When QE was widely adopted following the financial crisis, it was very much about lowering the long end of the yield curve in order to boost the economy and stave off deflation. While this is still an aim, it is surely now the case that the freshly announced rounds of QE are designed in part to support governments’ issuance of so many bonds in such a short time – as evidenced by the fact that the fiscal and monetary measures have in some countries been announced jointly by the central bank and finance ministry. Indeed, there is little point fretting about the blurring of the line between monetary and fiscal policy; that ship has sailed.
Given all this, the way seems clear for government debt to rise much further. Indeed, remember that public sector debt got to much higher levels (around 250% of GDP in the US and UK) than at present during the Second World War, during which time central banks significantly increased their holdings of government debt.
Not quite at a helicopter drop yet
We are not yet at the point of true helicopter money, though. QE programmes are only supposed to be temporary. Sure, they make it easier and cheaper for governments to issue debt. But that government debt still exists; it is just temporarily held by the central bank up until the time that the bonds get returned to the private sector. In contrast, a helicopter drop consists of a fiscal expansion financed by a permanent increase in central bank money, meaning that government debt does not rise.
Be aware that specific policies might look and feel a bit like helicopter money, even if they are not. In particular, because a helicopter drop is often assumed to involve a direct payment to households, it is often assumed that all one-off payments to households must be helicopter money. Indeed, Hong Kong’s recent HKD10,000 payment to every household – has been characterised as such. But that is not necessarily the case; whether it is a helicopter drop depends on how it is financed. So far in this downturn, any direct transfers to households – including Hong Kong’s – are just normal fiscal measures funded by taxes or borrowing, even if such broad and direct fiscal giveaways are unusual.
Admittedly, the line between temporary and permanent QE has been blurred significantly in recent years. After all, the QE programmes that were started after the financial crisis are still going, ten years on. Japan’s QE programme has been going on for almost two decades. This is stretching the definition of temporary. Similarly, what looks like temporary QE now may also end up effectively being semi-permanent; we will only find out ex post.
Moreover, even assuming that QE is reversed at some point, financial markets might believe that central banks will only sell their bonds when they can do so without pushing government bond yields up significantly. In other words, markets could rest assured that the government will only take back “ownership” of its debt at a point that the central bank effectively judges it able to. That might reassure them about the fact that QE is only temporary.
Nonetheless, as things stand, QE is still supposed to be temporary; even if it has been going for decades, at some point that debt is supposed to be returned to the private sector. Indeed, the US Fed actually began such “quantitative tightening” (i.e. reversing QE) last year.
Does a helicopter drop offer any benefits over QE?
So what might be gained from instead doing an explicit helicopter drop and making it clear that it was a permanent expansion of the money supply with no increase in government debt?
Some would say that not much would be gained, given that a helicopter drop would not actually reduce the debt-servicing costs of the overall public sector. Although the government would not have any extra debt on which to pay interest, the central bank would pay interest on the extra reserves it issued to fund the fiscal expansion. Admittedly, this would still generate a net saving for the consolidated public sector if the interest rate paid on central bank reserves was less than the interest rate that the government would have paid on new government bonds. But currently there is little difference between the two. So from the point of view of the consolidated public sector, financing costs would be no lower under a helicopter drop than a normal debt-financed fiscal expansion.
However, there are ways around this. One is for the central bank just to stop paying interest on the excess reserves created. In that case, the expansion in the quantity of reserves will push interest rates to zero. Admittedly, as we come back to later, that could cause problems further down the road. But former US Fed chair Ben Bernanke has suggested another option, namely a new levy on banks, sufficient to reclaim the extra interest payments associated with the rise in reserves. Banks’ net income would be unchanged (as the levy would cancel out the extra income they would have received on their higher reserves). And the central bank (and therefore overall public sector) would not face any rise in financing costs associated with the fiscal expansion.
Government debt would not rise
In any case, even if we do accept that debt servicing costs are not lowered by a helicopter drop, this is all a bit academic given that these costs – whether measured by government bond yields or the rate central banks pay on reserves – are extremely low at the moment. Of course, this situation will not last forever. Nonetheless, in the current circumstances, the main point of a helicopter drop is be that there would be no principal of the debt for the government to repay. This could have four advantages.
First, the fact that government debt does not rise should make governments feel more comfortable about pulling out all the stops to support the economy, especially as it would be fully sanctioned by the central bank which, in most countries, has more credibility in financial markets than the government.
Second, with no increase in government debt, bond markets might remain relaxed, rather than worrying about how governments were ever going to pay back this debt (although more on this later). As it happens, we think that most countries have scope to tolerate a significant rise in their ratio of government debt to GDP. But financial markets might not agree. Indeed, there are already some signs of market nervousness. Although in most cases the rise in government bond yields reflects the liquidation of assets to pay for losses, risk premia on government debt have generally risen a bit, especially in Italy. (See Chart 2.)
Chart 2: Government CDS premia (bps)
Third, the lack of any rise in government debt might make it more likely that firms and households spend the extra money they get. Remember that the theory of Ricardian equivalence suggests that when a government tries to stimulate demand by increasing debt-financed spending, demand remains unchanged as the public saves more in order to pay for the future tax rises that will be needed to pay off the debt. Admittedly, we are sceptical about how much this applies in reality; it seems unlikely that people would save a QE-financed £1,000 payout per household because they anticipate that at some point taxes will have to rise to pay for it. Furthermore, in the current circumstances, there is a limit to what people can spend their money on when much of the services sector is shut down and the manufacturing sector is disrupted. But perhaps the reassurance that they would not face higher taxes in the future could at least shore up households’ confidence.
And fourth, to the extent that the boost to the money supply was perceived as permanent, it would boost inflation expectations and prevent a deflationary spiral from taking hold.
Can a helicopter drop really be permanent?
But would there really never be a rise in government debt? Just as QE is not as temporary as it might seem, a helicopter drop might not be as permanent as it might seem.
This relates to the impact of a helicopter drop on central bank balance sheets. Chart 3 shows that, under normal QE, the liabilities side of the central bank balance sheets is boosted by the newly created reserves. Offsetting this on the asset side of the balance sheet are the government bonds that the central bank has acquired.
Chart 3: Central Bank Balance Sheet Under QE
Source: Capital Economics
Under a helicopter drop, though, these assets don’t exist, as government debt has not risen. This means that the central bank effectively becomes insolvent, as its liabilities become greater than its assets and its capital (which typically makes up only a very small share of its balance sheet) gets eroded. (See Chart 4.) Ordinarily, a government would recapitalise a central bank by giving it government securities. But this would require issuing new government debt, which of course would offset the entire point of the helicopter drop.
Chart 4: Central Bank Balance Sheet Under a Helicopter Drop
Source: Capital Economics
Of course, a central bank is not like an ordinary company; being insolvent would not stop it from continuing to conduct monetary policy in the near term. Indeed, there are examples of central banks which have operated with negative equity for a long time, including the Czech National Bank between 1998 and 2013.
The main concern is that, if the central bank continued to pay interest on all its reserves, these payments could outweigh its asset income, leaving it with a financial deficit. Of course, the central bank being the central bank, it could just print more money to pay for this. Or it could stop paying interest on reserves. But either of these would have inflationary consequences further ahead. Printing more money to pay for financial deficits would keep pushing reserves upwards and could lead to the quantity of money in the economy spiralling out of control (so-called “policy bankruptcy”). Alternatively, if the central bank stopped paying interest on reserves, it could be left unable to raise interest rates when inflation started to pick up. Control of interest rates would only return once the nominal economy – and therefore reserves demand – had grown sufficiently to bring reserve demand and supply back into balance at a non-zero interest rate.
Admittedly, there are still other ways in which policymakers could at a later date withdraw the stimulus from the economy in order to quell any inflationary pressures – for example, the government could issue more government bonds than are needed to finance borrowing in order to draw money out of the private sector or the central bank could contract the amount of reserves in the system by other means, such as selling sterilisation bills or raising reserves requirements. Or further ahead, once the crisis had passed, the government could recapitalise the central bank. But any of these options would mean that it would never have been a permanent expansion of the money supply. Indeed, for these reasons, is it questionably whether a truly permanent helicopter drop is ever really possible.
Does that mean it is not worth doing in the first place? It all depends on expectations. If people and markets realised that the helicopter drop might not actually be permanent, then they would not behave any differently under a helicopter drop compared to a debt-financed fiscal expansion. People would be no more likely to spend the extra money they were given. And financial markets would be as worried about the eventual rise in government debt. But do we really think that the man on the street, who is given £1,000 and told that government debt is not rising to pay for it, will squirrel it away in case the government eventually has to recapitalise the central bank?
What about moral hazard?
Accordingly, it is possible – but not guaranteed – that a helicopter drop would have some advantages over just financing the fiscal expansion with QE. But there is one final obstacle to get past – namely concerns about moral hazard. In particular, future governments might be more inclined to run looser policies on the assumption that the central bank would bail them out if necessary. Remember that governments’ inability to keep inflation in check is the reason why independent central banks were established in the first place. Knowing that helicopter money was available as a fall-back might also remove the incentive for governments to undertake structural reforms, as well as encourage the private sector to take excessive risks.
Indeed, once governments come to rely on money printing, they have historically found it incredibly hard to stop. Just think of all the past times that helicopter money has been used – Weimar Germany, Japan in the 1930s, and more recently Argentina, Venezuela and Zimbabwe. Indeed, these experiences explain why Japan and the euro-zone, despite having the most limited policy options, might be most reticent to try a central bank financed fiscal expansion.
If markets worried that the experiment would end up in high inflation, or even hyperinflation, bond yields would rise, providing an offsetting drag on the economy. Meanwhile, people might begin to lose faith in the central bank and question the value of their money, prompting their inflation expectations to rise too.
However, we think in the current circumstances, such concerns would be overridden. If ever there were a time when helicopter money could be presented as part of a credible one-off macroeconomic policy to deal with an exogenous shock, surely this is it. And it could be done without compromising the central bank’s independence. So there is no reason to assume that it would inevitably be the first step on the path to hyperinflation.
Overall, then, helicopter drops are not some failsafe cure, on which central banks can reliably fall back when they have tried everything else. Indeed, in some circumstances, they offer little more than a QE-financed fiscal expansion. Moreover, policymakers might well be too timid to adopt the policy on a large enough scale to make much difference, as many initially were with QE, for fear of the inflationary consequences.
But if ever there were a time to consider them, now is it. Even if the benefits are marginal, in the current environment and with conventional monetary policy operating at its limits, we should try everything. Worries about the inflationary consequences should not be an obstacle.
Stepping back, though, what is most important is that central banks make a clear commitment to finance whatever it takes on the fiscal side and stand fully behind government bond markets – whether that is with unlimited QE or a helicopter drop.
That said, a helicopter drop would be easier to undertake in some countries than in others. For example, countries where policymakers have less credibility are at greater risk of a rise in inflation expectations and bond yields as a result. Accordingly, this is more likely to be used by developed, than emerging, economies. Meanwhile, euro-zone countries obviously cannot do it on a unilateral basis. So they are reliant on the ECB being prepared to set aside its usual caution about the monetary financing of governments, and willing to undertake any constitutional changes required, to do it on a euro-zone-wide basis.
Vicky Redwood, Senior Economic Adviser, +44 20 7808 4989, email@example.com