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The Unavoidable Costs of Helicopter Money

MUNICH – The long-running debate about the advisability of so-called helicopter money has changed shape, as new ideas emerge about the form it could take – and questions arise about whether it is already being dropped on some economies. What hasn’t changed is that embracing helicopter money would be a very bad idea.

According to the conventional view, helicopter money is newly printed cash that the central bank doles out, without booking corresponding assets or claims on its balance sheet. It can come in the form of cash transfers to the public or as the monetization of government debt; in both cases, it is a permanent loss for the central bank.

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In practice, helicopter money can look a lot like quantitative easing – purchases by central banks of government securities on secondary markets to inject liquidity into the banking system. The helicopter-money version would be the purchase of zero-interest-rate government bonds that will not be repaid, either because they are perpetual bonds or because they are rolled over every time they mature.

That is arguably what the Bank of Japan is now doing. BOJ Governor Haruhiko Kuroda has said that directly underwriting the budget deficit is not an option. Nonetheless, he has initiated a policy of replacing the government bonds on the BOJ’s balance sheet once they mature, while constantly increasing the volume of government debt on the central bank’s books.

This comes after years of declarations by prominent economists, including Berkeley’s Brad DeLong and former US Federal Reserve Chair Ben Bernanke, that helicopter money offers a way to overcome deflation (with which Japan has struggled for decades). The idea is that, by monetizing the fiscal deficit, the central bank helps the government to finance growth-enhancing investments in, say, infrastructure, while providing the liquidity needed to counter deflationary forces.

If it sounds too good to be true, that’s because it is. As Milton Friedman often said, in economics, there is no such thing as a free lunch.

In fact, there are major downsides to helicopter money. Most important, by enabling the monetization of unlimited amounts of government debt, the policy would undermine the credibility of the authorities’ targets for price stability and a stable financial system. This is not a risk, but a certainty, as historical experience with war finance – including, incidentally, in Japan – demonstrates only too clearly.

In the early 1930s, under Finance Minister Takahashi Korekiyo, Japan implemented money-financed deficit spending, in order to lift the economy out of deflation. But it worked a little too well, generating a powerful wave of inflation. Korekiyo’s subsequent attempts to rein in public deficits by slashing military spending failed. The military rebelled, and Korekiyo was assassinated in 1936.

Germany’s monetary breakdown after World War I also stemmed from the issuance of war bonds to the German public. In the United States, the excessive printing of dollars to finance the Civil War contributed to high inflation. The list goes on.

Some proponents of helicopter money, such as Adair Turner, former head of the United Kingdom’s Financial Services Authority, argue that this danger can be neutralized with clear rules to limit the use of monetary and fiscal stimulus. And, theoretically, they are right. But are such limitations politically realistic?

The truth is that the central bank would struggle to defend its independence once the taboo of monetary financing of government debt was violated. Policymakers would pressure it to continue serving up growth for free, particularly in the run-up to elections.

Even if central banks did retain their independence, it is doubtful that they would be able to steer inflation gradually to, say, 2%, and then keep it there. Dispensing liquidity to spur inflation is much easier than draining it to prevent price growth from spinning out of control.

The problem, which Friedman identified in 1969, is that while helicopter money generates more demand in an economy, it does not create more supply. So the continued provision of helicopter money after an economy has returned to normal capacity utilization – the point at which demand and supply are in equilibrium – will cause inflation to take off.

Developed economies have not reached that point today, because the consequences of the 2008 global financial crisis are still dampening demand. But once deleveraging is complete and the credit cycle turns, inflationary pressure is likely to reappear. And central banks’ efforts to suppress it will carry large costs, in terms of employment and growth, as occurred in the 1980s and 1990s.

But even if supply-side growth were maintained, say, by China, thereby holding down prices of tradable goods, helicopter money would carry major costs, because debt would still be growing faster than nominal GDP. In the long run, that would jeopardize confidence in the central bank, saddled with claims against an over-indebted government, and put the fiat money system at risk. Once investors began to move their assets into more stable currencies, the local currency would depreciate and bond prices would collapse.

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All forms of monetary stimulus – from quantitative easing to negative interest rates – carry risks. But helicopter money is particularly dangerous; indeed, there is no realistic scenario in which such a policy would not go awry.

It is time to recognize, once and for all, that governments, not central banks, are responsible for generating long-term employment and growth, by ensuring favorable investment conditions, a high-quality education system, and open, competitive markets. Monetary policymakers should defend this red line – which means keeping the helicopters on the ground.