Helicopter money: no such thing as a free lunch?

By Ed Sinclair, CA Today

21 June 2017

Economist Milton Friedman's concept of 'helicopter money' is back in the headlines – but does it really work?

The concept of 'helicopter money' was first proposed by American economist Milton Friedman, who also coined the famous saying: 'There's no such thing as a free lunch'.

A modernised version of his theoretical approach is increasingly being proposed as an alternative to quantitative easing (QE).

Helicopter money puts funds at the disposal of the public, and short-circuits the 'trickle down' approach of QE. But is it any more effective? To quote another of Friedman's sayings, 'The government solution to a problem is usually as bad as the problem.'

How does helicopter money work?

If an economy is seen to be performing below expectations and experiencing severe deflation, a central bank could implement a helicopter money policy by giving direct money transfers to consumers.

People would then start to spend more, increasing economic activity across the board, and pushing inflation back up – or so the theory goes.

In 2002, former Chair of the US Federal Reserve, Ben Bernanke suggested the possibility for monetary-financed tax cuts, channelling Friedman's theory.

His idea was that the government could cut taxes, securing an agreement with the central bank to purchase equivalent government debt and stabilise interest rates.

Coordinating the response of the government and the independent central bank proved challenging. In the US the two are often at odds, making Bernanke's plan close to unworkable.

Even co-ordinating this kind of approach across partisan political divides proved a challenge – arguments between Democrats and Republicans about the ideal level of the US debt ceiling were eventually settled with government spending cuts, which contradicted the efforts of the Federal Reserve to balance the country’s books.

Generating consumer demand

Despite Bernanke’s experiences, helicopter money policies are still being considered by central banks looking to spark economic growth and stabilise inflation in the long term.

Negative interest rates and QE tactics have failed to deliver the desired results. Both the Bank of Japan and the European Central Bank have cut interest rates past zero in attempts to stimulate growth, while The International Monetary Fund (IMF) has been warning of slow growth and a gathering storm in the global financial markets for some time.

Questions remain about how effectively helicopter money could be distributed, and with little control or ability to predict whether individuals will save it or spend it, some argue it could have undesired consequences for inflation in the short term.

Many governments and banks are part of larger economic zones like the EU, and the policy becomes even more complicated to implement.

Damaging deflation

Deflation can be deeply damaging, a self-fulfilling prophecy leading to spiralling growth and stagnant spending. Consumers and businesses are always going to be reluctant to spend in a deflated economy – the sensible approach is to wait, and spend when prices come down. But can helicopter money offer an effective stimulus?

Transferring funds to households is usually the job of politicians, via tax cuts and other means, and not the role of central bankers. As Stephen Cecchetti and Kim Schoenholtz wrote in their article for the Centre For Economic Policy Research “... the monetary base is determined by the demand of individuals to hold currency and of banks to hold reserves at the central bank’s interest rate target.

In practical terms, this means that the central bank cannot credibly promise to permanently increase the monetary base.”

Central banks in the modern era must pay interest on their reserves. And as Cecchetti and Schoenholtz point out, “they do so precisely to control the level of interest rates in the economy.”

These factors make helicopter money attractive only as a last resort.

Last chopper out of the war zone

Helicopter money must be contingent on the failure of QE policies and plummeting interest rates. At that stage, a bank's demand for additional reserves become much more flexible, meaning fluctuations in their overall holdings will have less consequence.

If these conditions occur, finding a way to give consumers a 'free lunch' could well spark a fully-fledged recovery.


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