Helicopter money: manna from heaven or poison pill?

Helicopter money: manna from heaven or poison pill?

28-12-2016 | インサイト

Central banks are doing everything they can to keep the global economy going. Now that their traditional measures are exhausted, governments may well consider going to the next level and hand out ‘helicopter money’ as a last remedy.

  • Marck  Bulter
    Marck
    Bulter
    Senior Portfolio Manager Global Fixed Income Macro
  • Victor  Verberk
    Victor
    Verberk
    Deputy Head of Investments

Speed read

  • (Un)conventional policy measures are exhausted and ineffective
  • Helicopter money: remedy that is worse than the disease
  • Portfolio implications would be negative for bonds

What’s the problem?

Today’s world is stuck in a situation of low growth and low inflation. The typical response from governments and central banks is monetary or fiscal expansion. But conventional and unconventional monetary measures by central banks, such as lowering rates, buying large volumes of bonds (quantitative easing) or even controlling the yield curve (Japan), are exhausted or are increasingly less effective.

The extreme low yield environment caused by Quantitative Easing (QE) also has significant ramifications for funding ratios of pension funds, causing either cuts in (future) pensions or higher current contributions. Furthermore, critics say that, rather than stimulating consumer spending, QE has primarily led to asset price inflation. The property markets in London, Frankfurt and Amsterdam, for example, have witnessed very significant price increases in the last couple of years.

Not only the effectiveness of central banks is questioned, the same holds for fiscal authorities. Even if the latter are willing to taper austerity measures, they can’t, as fiscal policies are already stretched to limits. Public debt-to-GDP ratios are closing in on post-war highs. In addition, at least in theory, EU countries have to respect the stability and growth pact, which caps the member states’ debt-to-GDP ratio at 60% and the budget deficit at 3%.

This leaves two other options. The first is helicopter money, the second is the do-nothing option. Or in other words, accept that both economic growth and inflation are lower than average.

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What is helicopter money?

Helicopter money is a response which is both monetary and fiscal in nature and which has been dubbed ‘helicopter money’ by Milton Friedman in his 1969 publication ‘The optimum quantity of money’. Helicopter money is a form of fiscal spending by a government, which is financed directly by its central bank. This means the government does not have to raise taxes or issue debt to fund spending. The money that is given should be perceived by the recipient as a gift.

Instead of being given to banks, the money is made available to the government or directly to the general public. Helicopter money can take the shape of tax rebates, handing out cash to the public, increased public spending on for instance infrastructure, or central banks writing off their holdings of government bonds.

So what’s the downside?

Handing out free money does come at a risk, though, the main one being creating high (or even hyper) inflation. In the past 100 years there have been several examples were helicopter has actually been used in practice and all of them have led to hyperinflation. A recent example is Venezuela. The financing of government expenditures via the printing press resulted in the following outcome:

  • 3000% growth in M2 money supply since 2009 (66% per year); this compares with 54% growth (6.5% per year) for the Fed and 30% (4% per year) for the ECB
  • 480% year-on-year Consumer Price Index (CPI) inflation in 2016 (IMF estimate)
  • GDP growth of -2% on average since 2013

Other little uplifting examples that might make one hesitant to resort to helicopter money were the Weimar Republic (1919-1933) and Zimbabwe.

Another important drawback from helicopter money is that the central bank’s independence is at stake, as the government and the central bank will need to cooperate closely. Also, as helicopter money will eat into the central bank’s capital, the public’s trust in the central bank as well as the value of money may start to sag. It remains to be seen whether this process can be controlled. A government needs to be strong enough to stop helicopter money once it’s no longer required, a challenge that may be especially hard to meet in election times.

Is it effective?

As helicopter money directly impacts spending, it is more powerful than QE. The actual effectiveness is determined by the way in which it is implemented. It is important that the money goes where it’s needed most and that it is actually spent rather than saved.

Talking about the pros and cons of helicopter money is far from a theoretical exercise, as both IMF and ECB have explicitly hinted at further cooperation between fiscal and monetary policy. It is not to say that helicopter money is around the corner, but evidence is building up that the discussion on helicopter money is becoming more mainstream.

Nothing wrong with lower growth and low inflation

Economic textbooks would reason that deflation will result in ever further postponing of consumption. But even for Japan, in practice there is no proof that deflation has such an effect on consumption. And is 2.0% that much better than 0.5% inflation, if the only way to get there is via a policy instrument which may be difficult to control?

We would advocate to refrain from helicopter money. The negative effects are far more prominent than the few possible positive effects. And even if a recession were to come, it does have an important function, as it results in an economic reset. As Winston Churchill said: “No crisis should go to waste”.

Portfolio implications: unfavorable for bonds

Should helicopter money ever become reality it potentially has far reaching effects on fixed income portfolios. The steep rise in inflation will have negative effects on bonds. The country that will be the first to start with helicopter money will debase its currency, which could lead to international tensions. The same goes for companies, where helicopter money would only postpone the inevitable, i.e. a much-needed restructuring of over-indebted companies, and would do little more than keeping zombie companies alive.

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