Helicopter Money

Helicopter money (HM) is the name given to a policy designed to stimulate demand in an economy when more conventional monetary and fiscal policies have failed or been ruled out. The term originates with Milton Friedman who imagined a Central Bank (CB) scattering bank notes from a helicopter; the idea is that those who pick them up will spend them.

More realistically, HM could involve the CB posting cash or cheques directly to households; or a joint operation by the government and the CB: the government cuts taxes (or increases its expenditure) and issues interest-bearing bonds to finance the resultant deficit; the CB buys these bonds using its legal power to increase base money (cash held by the public and commercial bank reserves), i.e. print money, to do so. In both case, if we treat the CB and the government as a single entity the volume of government bonds held outside the government remains the same.

Why should HM be more effective at stimulating demand than (1) the CB cutting its official interest rate; (2) quantitative easing (QE); and (3) conventional fiscal policy?

  1. If the CB cuts its official interest rate this tends to cause other (nominal) interest rates to fall. Lower real expected interest rates (nominal interest rates minus expected inflation) mean lower expected real costs of borrowing, and thereby encourage firms to carry out investment projects or consumers to spend. If nominal interest rates are close to zero then cutting them much further may be impossible or difficult, and so this route for stimulating the economy is blocked. As we explain below, in such a situation – known as the liquidity trap or zero lower bound – HM can be seen as a way of cutting real expected interest rates.
  2. QE is really the second part of the joint HM operation described above – the CB’s creation of money to buy (usually longer-term) government bonds or other assets. Its aim is to drive up the price of these assets and hence drive their interest rate down. But with QE there is no accompanying fiscal expansion. Furthermore, the CBs which have carried out QE usually say that to avoid a conflict with their long-term inflation target they will reverse any increase in base money when the economy is back to normal. By contrast, in the case of HM the increase is supposed to be permanent. And since, in the end, an x% increase in base money implies that future prices will be x% higher, HM implies that between the current and some future periods there will be x% inflation. This in turn means that the real interest rate will be lower even though the nominal interest rate is at its floor – and so spending will be stimulated. (As this suggests, HM has similarities with a policy of stimulating demand by announcing a higher inflation target; and “permanent” QE would have a similar effect.) Is there an additional HM effect? After all, if people are holding more money then since base money is not formally redeemable, i.e. the CB is not obliged to demand it back, they appear to be wealthier; wouldn’t this stimulate spending too? Possibly, but, as previously explained, an x% increase in money will lead to an x% increase in prices, so in the end the real value of money holdings will be unchanged. If people realise this then they should not feel wealthier.
  3. Fiscal policy involves the first part of the joint HM program but not the second. The bonds issued to finance the tax cut or expenditure increase are bought by the public, implying an increase in government debt. The interest payments on this debt have to be paid for – and the debt possibly redeemed. If people realise that this means higher future tax payments they could, under admittedly stringent assumptions, save any tax cut rather than spend it in order to be able pay these future taxes; or, for the same reason, they could cut their own expenditure to offset, partially at least, any increase in government expenditure. On a more practical level many governments, rightly or wrongly, have ruled out fiscal measures which raise their debt levels.