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3 Things about Helicopter Money

Monday 25 April 2016

By Kotak Securities:



Get an insight on Helicopter money & its different kinds.
  1. 3 Things you should know about Helicopter Money

  2. What is Helicopter Money? Helicopter money is a reference to an idea made popular by the American economist Milton Friedman in 1969. In the now famous paper “The Optimum Quantity of Money”, Friedman included the following parable: Let us suppose now that one day a helicopter flies over this community and drops an additional $1,000 in bills from the sky, which is, of course, hastily collected by members of the community. Let us suppose further that everyone is convinced that this is a unique event which will never be repeated.”

  3. The basic principle is that if a central bank wants to raise inflation and output in an economy that is running substantially below potential, one of the most effective tools would be simply to give everyone direct money transfers. In theory, people would see this as a permanent one-off expansion of the amount of money in circulation and would then start to spend more freely, increasing broader economic activity and pushing inflation back up to the central bank’s target.

  4. The three different kinds of helicopter: According to Kames Capital, these are the three main variations of helicopter money.
    1) The Bernanke helicopter: Discussed by former chairman of the US Federal Reserve, Ben Bernanke, it involves transfers to households and businesses through a tax cut or rebate, coupled with incremental purchases of government debt. It is effectively a tax cut financed by money creation.

  5. 2) The Woodford helicopter: Discussed by economist Michael Woodford, it centres on a version of flexible inflation-targeting, in which the central bank commits future monetary policy to a permanently higher nominal target (such as the path of nominal GDP). This involves various tools within that framework, including permanent increases in the monetary base using fiscal transfers.
    3) The Turner helicopter: Discussed by former FCA chairman Lord Adair Turner, ‘Overt Monetary Financing’ means the Treasury issues interest-bearing debt, which the central bank purchases, holds and perpetually rolls-over (buying new government debt whenever the government repays old debt). The central bank also returns the interest income it receives as profit to the Treasury. Importantly, the central bank must credibly communicate and commit to this perpetual rollover in advance.

  6. So how is this different from conventional quantitative easing? Current quantitative easing (QE) programmes undertaken by central banks since the financial crisis involve large-scale purchases of assets from financial markets. These have predominantly been targeted at government bonds, but individual central banks have also bought up a range of alternative assets, including commercial debt, mortgage-backed securities and even stock market exchange traded funds. The major difference between QE as it has been carried out and helicopter drops as envisaged by Friedman is that the vast majority of purchases have been asset swaps, where a government bond is exchanged for bank reserves.

  7. While this alleviates reserve constraints in the banking sector (one possible reason for them to cut back lending) and has lowered government borrowing costs, its transmission to the real economy has been indirect and underwhelming. As such, it does not provide much bang for your buck. Direct transfers into people’s accounts, or monetary-financed tax breaks or government spending, would offer one way to increase the effectiveness of the policy by directly influencing aggregate demand rather than hoping for a trickle-down effect from financial markets.

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