Helicopter money: the illusion of a free lunch
Central banks are increasingly playing a prominent role in financing fiscal budgets. A controversial debate regarding the topic has already been going on for some time but has gained momentum during the Covid-19 crisis. In that debate the term ‘helicopter money’ is often mentioned as a potential tool. In its original definition this concept goes back to Milton Friedman. It is, however, often not interpreted the way it was intended, namely as an ultimate weapon of a central bank to fight off the danger of deflation. The concept of ‘helicopter money’ was not designed as an easy tax instrument. It is an illusion that simple money creation can somehow easily bypass the classical allocation problem of scarce resources. That choice needs to be made by the budgetary authorities in a transparent and accountable way. Unfortunately, there is no such thing as a free lunch.
The response of most central banks to the outbreak of the Covid-19 crisis has been forecful. Central banks are fulfilling their role as lender of last resort for the financial system quickly and efficiently. However, they are going much further than that. They are giving in to the increasingly loud call for them to play a prominent role, explicitly or implicitly, in the financing of the fiscal budget. This controversial debate had been going on for some time and gained strength during the Covid-19 crisis. The so-called Modern Monetary Theory, among others, is strongly arguing in favour of this role.
In that debate the term ‘helicopter money’ appears, often with different definitions. Firstly, the most common definition is the direct financing of government expenditure by the central bank, via a direct line of credit for the government or via the purchase of government bonds issued to finance fiscal deficits. The Fed and the ECB currently promise de facto unlimited purchases of government bonds if necessary. This is an explicit financing promise to the fiscal government. The Bank of Japan already has a long tradition of doing so and the Bank of England recently announced that it would provide direct credit to the government, removing even the need to issue new government bonds.
Secondly, the term is also used for the distribution of, for example, a certain amount of money per person (for example through a check or via a one-off tax credit), as is also part of the current package of support measures in the US. In this case, there is no new money created, but existing money is redistributed through the fiscal budget. Therefore the term ‘helicopter money’ in this case is strictly speaking incorrect.
Thirdly, there is the original definition that goes back to Milton Friedman, whereby the central bank (the ‘helicopter’) creates new money and gives it directly to the private sector. Crucially, this is not a loan to be repaid, but a permanent gift. The only major conceptual difference of Friedman’s concept with the first definition lies in the fact that the monetary ‘helicopter’ flies without the direct involvement of the fiscal authorities.
Intended as ultimate safeguard against deflation...
The idea of ‘helicopter money’, in whatever specific definition, is often not interpreted as it was intended. When Milton Friedman used the term as a metaphor in 1969, his message was that a well-executed monetary expansion can, if really necessary, always halt a malign deflationary spiral. The message was definitely not that central banks have loads of ‘free’ money to finance all kinds of expenditures without damaging side-effects.
On several occasions, former Fed president Bernanke repeated this point, and applied it specifically to the Japanese deflationary environment. His conclusion was that, in a system of fiat money, helicopter money is indeed an effective emergency safeguard against persistent and malign deflation.
In order to make the intuition behind this reasoning clear, Bernanke used the image of a modern alchemist. Suppose that this alchemist finds a verified way to produce an unlimited amount of new gold at virtually no meaningful cost. He then credibly announces that he will soon start that unlimited production. In an efficient market, the value of gold will rapidly collapse. Something similar would happen to fiat money. It derives its value from its relative scarcity. The unlimited creation of money ending up in the real economy used to purchase goods and services (which will happen when fiscal expenditure is financed by money creation), will, just like in the example of gold, reduce the value of money. Hence, a sufficiently large injection of fresh money to finance real expenditure is a welcome remedy for deflation, but it must not go beyond that. Otherwise, it would inevitably jeopardise the stability of the currency in the longer run.
...but not as an easy tax instrument
There is currently no imminent risk of deflation. Consequently, there is no convincing case for helicopter money, created by the central banks’ money printing press. There is no doubt that, in response to the Covid-19 crisis, large-scale public support measures are needed and need to be financed. However, this is, and will always remain, a task for the fiscal authorities. It is, after all, a matter of spending and allocating economic resources that are, unfortunately, scarce. It is an illusion that money creation can somehow bypasses this allocation problem. Money creation also amounts to a tax, albeit a non-transparent one. As Milton Friedman also continued to emphasise, there is unfortunately no such thing as a free lunch.