… A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices. Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers. A money-financed tax cut is essentially equivalent to Milton Friedman’s famous “helicopter drop” of money
– Ben Bernanke, Deflation: Making Sure “It” Doesn’t Happen Here, November 21, 2002
Previously we showed that despite an unprecedented surge in developed world debt over the past decade, and especially in the last five years since the onset of the Great Financial Crisis (currently at 450% debt/GDP), there has been only a nominal increase in economic growth as measured by G7 GDP as well as CPI-measured inflation. This has happened despite (or rather due to) a historic expansion in G7 central bank balance sheets, whose bankers first launched a policy of ZIRP, and subsequently replaced it with Quantitative Easing whereby trillions in reserves were injected in the banking system offset by the purchases of Treasurys, MBS and other “high quality collateral” (which has been soaked up to such an extent, the TBAC, led by Citi’s Matt King, takes every opportunity to warn and complain about it in the quarterly refunding presentations).
One direct result of such intervention has been the reflation of capital markets asset bubbles across the world, and especially in the US, where the S&P500 is trading just shy of all time highs, and yet as highlighted previously, the “wealth effect” generated by this monetary pathway has led solely to the enrichment of the wealthiest decile of the population, and to a income gap in the US that is now at record wides, and worse even than during the “roaring 20s.”
While in other times it would be safe to say such a monetary framework would and could continue indefinitely, or at least until this particular bubble burst once more (or the social fabric tears with other more severe consequences), recent developments and especially a key phrase from none other than Barack Obama uttered a month ago, namely that “we have to turn the page on the bubble-and-bust mentality that created this mess“ is why some believe an Obama-appointed Larry Summers could pull the punchbowl earlier than expected. After all, it is becoming increasingly more accepted even in the corridors of the status quo, that QE has failed completely at anything besides stabilizing the financial system in 2009 and then ramping equities to new highs. This fits in with the recent realization that over the next year, the Fed will “taper” its open-ended QE and ultimately bring its injection of “flow” into the capital markets to a stop.
But while QE may be ending, it certainly does not mean that the Fed is halting its effort to “boost” the economy. In fact, as Deutsche Bank’s Jim Reid suggests, the end of QE may well be simply a redirection, whereby the broken monetary pathway, one which uses banks as intermediaries to stimulate inflation (supposedly a failure according to the economist mainstream), i.e., “second-round effects”, is bypassed entirely and replaced with Plan Z, aka “Helicopter Money” mentioned previously as an all too real monetary policy option by none other than Milton Friedman and one Ben Bernanke. This is also known as the nuclear option.
Reid’s summation on why contrary to prevailing sentiment, the Fed may proceed with Helicopter Money, in order to achieve one simple target: target Nominal GDP, inflation be damned, is as follows: “Throughout the modern history of monetary economics one policy has been put forward as a monetary “super drug” (or deadly poison depending on your view). That is “helicopter money”. It has long been seen as being too powerful to control and thus beyond the scope of contemplation. However in the past decade such policy has slowly emerged from the shadow of heterodoxy.”
If dropping interest rates to zero was Unorthodox Policy #1 and QE was Unorthodox Policy #2 then it seems very possible Helicopter Money will be Unorthodox Policy #3. Whether this new level of expansionism, with all the hopes and theoretic power it is supposed to hold, can generate growth of the red-hot rather than lukewarm kind remains to be seen.
However in so much as it could potentially raise nominal GDP, it may become an increasingly more attractive policy option around a global economy (especially DM) economy that faces many natural and structural growth concerns in the year ahead.
From these charts it seems fair to argue that much of the impact of QE has indeed been lost in the financial and banking system, distorted as it is by postcrisis balance sheet rebuilding, adaptation to new regulations and rates at the zero lower bound and so never making it to the actual economy.
For helicopter money on the other hand, as we’ve already highlighted via Ben Bernanke’s own words, “the health of the banking sector is irrelevant to this means of transmitting the expansionary effect of monetary policy.” The reason is simple – helicopter money bypasses the banking system and puts money straight into consumers’ and businesses’ pockets. Where the first round effects of quantitative easing hit the financial system and then through the financial system the second round effects reach consumers and businesses, helicopter money first hits consumers/businesses and then through them the financial system.
Helicopter money achieves this direct impact by directly increasing the cash of consumers and businesses through (say) a money-financed tax cut.
Importantly this money has very high “economic power” as it is very likely it will be spent (on consumption or investment) because the central bank has purchased permanently the debt created to finance the tax cut meaning no current or future debt liability has been incurred and so higher taxes in the future shouldn’t be expected. As Bernanke stated in 2003, after a helicopter money policy, “essentially, monetary and fiscal policies together have increased the nominal wealth of the household sector, which will increase nominal spending and hence prices.” All of this is achieved without any involvement of the banking sector, which is “irrelevant”.
All the data we have points to the developed world’s financial and banking system unable and/or unwilling to put their grown central bank reserves to work in the real economy. All unconventional monetary policy to date has fallen foul of this fact. Helicopter money won’t.
Indeed to our eyes this debate gets to the heart of what central banks fundamentally can and cannot do, chiefly that they seem to have the ability to control only one economic variable at a time. During the 1970s central banks successfully supported high nominal growth at the cost of runaway inflation. In the 1980s they successfully strangled inflation at the cost of sharp falls in real economic activity. In the Great Moderation of the 1990s and early 2000s they kept a lid on inflation and inflation expectations at the expense of a series of asset bubbles. Post-2009 central banks have successfully avoided deflation and kept inflation around their targeted levels, but allowed continuing slack and unemployment in their economies. Maybe helicopter money and a combined nominal GDP target might allow for stable, slack eliminating, nominal GDP growth. Of course there is a question of what it might leave uncontrolled…
A double-edged sword?
In spite of the theoretical power of helicopter money it has and continues to face strong opposition. Indeed, fast-forward 9 years from 2002’s Professor Bernanke to 2011’s Chairman Bernanke and we see the quote, “monetary policy can be a powerful tool, but it is not a panacea for the problems currently faced by the US economy.” This reasoning can be seen as coming straight out of a 2003 Fed Policy Paper presented to the FOMC (which by then included Bernanke among its numbers) by Vincent Reinhart which concluded on money-financed tax cuts and other “extreme” policy measures that, “You can see why I put this list last. These options would change how we are viewed in financial markets, involve credit judgments of a form we are not used to, perhaps smack of desperation, and pulls us into a tighter relationship with other parts of the government.”
The message is simple – helicopter money is a step too far for central bank policy. It risks creating unintended consequences (“change how we are viewed in financial markets”) and asset market mispricing (“involve credit judgments of a form we are not used to”) as well as possibility abandoning the independence of the Fed (“a tighter relationship with other parts of the government”).
As with all economic decisions, there is a trade-off. And as with all trade-offs, priorities and preferences change. There is an argument that helicopter money could put the world’s economies back on a stronger nominal GDP growth track, boost spending, increase confidence and reduce debt burdens. But it could well do so at the risk of financial market mispricing (i.e. asset bubbles) and letting the inflation genie out of its bottle after three decades ensuring it stayed in it.
NGDPT and Helicopter Money pose Deeper Questions then Any Framework and Policy Yet Used
In a world which, to our eyes, continues to be weighed down by uneroded debt burdens; nominal GDP targeting and helicopter money could be the logical next step in today’s monetary-stimulus heavy economies. More than that, it could be successful in a way that its less radical predecessors have not been.
However the decision to go down the path of helicopter money would pose deeper questions and possibly far greater risks then any policy enacted so far. It is still our view that aggressive expansionary monetary policy post-2008 put “capitalism on hold”, saving the economy from undergoing the type of creative destruction debt liquidation and businesses failure Schumpeter pointed out as being at the very core of capitalism. In turn this has prevented the type of rejuvenation that might have been expected “post-crisis”. Maybe the scale of the GFC meant such activism was a necessary and unavoidable response as the alternative would likely have been a socially divisive depression.
With so much previously unforeseen unorthodox monetary policy conducted since 2008, it’s impossible to rule out NGDP targeting or even helicopter money. Perhaps the closest thing we have to this at the moment is in Japan. Perhaps this will be a test case for such policy that might herald its global adoption or consignment to the economic graveyard.
Monetary policy and growth
It is an open question whether pushing monetary policy aggression to a whole new stratosphere can generate sustainable real growth. The evidence from Japanese monetary policy in the 1990s and 2000s and US/UK/EA policy post-2008 certainly points to aggressive monetary policy putting capitalism on hold and embedding deep-set structural problems, and not generating growth. If dropping interest rates to zero was Unorthodox Policy #1 and QE was Unorthodox Policy #2 then it seems very possible Helicopter Money will be Unorthodox Policy #3. Whether this new level of expansionism, with all the hopes and theoretic power it is supposed to hold, can generate growth of the red-hot rather than lukewarm kind remains to be seen.
However in so much as it could potentially raise nominal GDP, it may become an increasingly more attractive policy option around a global economy (especially DM) economy that faces many natural and structural growth concerns in the year ahead. Forcing the nominal economy to grow into the problems of the bubble era could be the most realistic policy choice over the remainder of the decade.