We Can't Just Drop Money Out of Helicopters
"Helicopter money” is, in essence, exactly what it sounds like: money falling from the sky. Newly minted money is pushed into the economy in the hopes that it will create demand for goods and services, spurring economic growth and inflation. It bypasses the bank lending function that injects quantitative easing dollars into the economy, and combined with ultralow or even negative rates, it has the capacity to become very interesting very quickly.
Central banks appear to be in a tight spot, since economic growth, in nearly every country and region, is anemic. But here’s the thing—most central banks are not supposed to care (directly) about growth. Rather, central banks are almost universally tasked with achieving a certain level of inflation, known as inflation targeting. The U.S. Federal Reserve’s mandate is to achieve “maximum employment, stable prices, and moderate long-term interest rates.” Notice that there is no mention of economic growth in there.
The ubiquity of the inflation mandate for central banks should cause some concern. Growth is not a zero-sum game, but inflation may be. This is where the mandated goals of global central banking (prices and jobs) deviate from the perceived political goals of running a country (growth and stability).
It is this incongruence that makes helicopter money problematic for central banks: it would work against their stated mandates. Certainly, there are instances where figuratively throwing money from the air could be successful. It might cause short-term, likely one-time increases in inflation expectations. But these pressures would dissipate quickly, and could even reverse.
More to the point, by injecting a significant amount of money into an economy, inflation pressures would rise domestically as capacity utilization increased and the demand for labor—and therefore wages—rose. But “helicopter money” would likely be perceived—and, in practice, executed—in a similar fashion to the now-mundane practice of quantitative easing. And like QE, the policy would have the effect of weakening exchange rates vis-à-vis countries that do not implement it.
For the European Central Bank and Bank of Japan, when attempting to spur inflation in a low-growth environment, exchange rates matter. There is a near certainty of retaliation from other policymakers, who would find themselves disadvantaged as their own currencies appreciate. Increasingly extreme policy stances from the ECB and BoJ would spur an even stronger dollar. And while the dollar has weakened recently, it may still be too strong to spur commodity-based inflation. The easiest way for central banks to accomplish their policies is to let the dollar fall modestly.
The European Central Bank and Bank of Japan, as well as the Fed, have thus far failed to attain their inflation goals for even a moderate amount of time. But helicopter money is not the answer. Inflation expectations—the rate of inflation in the medium term—tend to follow oil and energy. This is where helicopter money runs into the trouble of mandates. If either the ECB or BoJ uses helicopter money, there is a chance that oil, copper and others would initially move higher, but the one-time nature and lack of permanence in the demand surge would render it transitory at best. The prices of dollarized commodities would likely move lower.
The U.S. economy has grown—albeit slowly and choppily over the past couple of years, despite a strengthening currency and weakening global growth. ECB policies have deviated so much from the Fed that their “shadow policy rate” is estimated to be running at about negative 4.6 percent, creating a differential of nearly 5 percent according to the Wu and Xia model. This explains the strength of the U.S. dollar, but also the amount of stimulus already being undertaken by the ECB. It will be difficult for ECB policies to deviate much further from the Fed without causing significant disruption to asset markets, and to inflation expectations.
It would be far more prudent for the ECB and BoJ to avoid the helicopter and maintain the current path of monetary policy. Janet Yellen and the Federal Reserve have retreated to a more dovish stance in the past couple of months, and this is weighing on the dollar. The ECB and BoJ have a chance to generate inflation, as a weaker dollar also relieves some of the downward pressure on commodity prices, including oil. It is most likely to be only transitory, but any victory would bolster public sentiment. Having pushed the dollar higher, it may just be time for the ECB and BoJ to let it fall.
As the Federal Reserve backs away from its dot plot (and therefore the prediction of a 1 percent Fed funds rate) while the dollar weakens, there may be a bit of a growth headwind for the ECB and BoJ, but it would be a boon for their inflation expectations. Central banks are certainly not out of tools, but the use of helicopter money would backfire on central banks attempting to reach their mandated inflation targets.
There may be a time to fire up the helicopter, but it would do far more harm than good at the moment.
Samuel Rines is the Senior Economist and Portfolio Strategist with Avalon Advisors in Houston, TX.
Image: Flickr/Mauro Parra-Miranda