[dropcap]T[/dropcap]here has been plenty of talk regarding ‘Helicopter Money’ recently and how printing more money can alleviate most of our economic problems. In this article, I take a deeper look into the concept of “Helicopter Money”. But first, we lay the background with a quick overview of monetary policy tools available to Regulators/Central banks to control money supply in the economy. Broadly, there are three approaches to stimulate the economy during recessionary phase
1. Expansionary Monetary Policy
In this the Central bank lowers the interest rates (repo/reverse repo). This generally increases demand, boosting short term growth. However, this tool has its own limitations and is not efficient when the interest rates are near zero or negative.
2. Quantitative Easing (QE)
In more recent times, this method has been used by the US Federal Reserve to move the country out of Global Financial crisis of 2008-09. In QE, the Central bank buys financial assets from commercial banks without any reference to interest rates. This method is used when the inflation is low or negative & when expansionary monetary policy fails to stimulate the economy. The result of this should be lower long-term interest rates which would stimulate investment activity and consequently aggregate demand. QE essentially increases liquidity in the system significantly & is a way of debt refinancing of the government.
However, QE has its own risks and limitations. Most obvious being, unwillingness of Banks to lend further despite increased money supply. This may also lead to a liquidity trap wherein consumers may hold funds in cash savings with a belief that interest rates could soon rise .
3. ‘Helicopter Money’
Helicopter Money is a concept proposed by economist Milton Friedman wherein he equates this to dropping money from a helicopter to illustrate the effects of monetary expansion. The concept seeks to overcome transmission issue between the commercial banks & the general public. Here the central bank/govt issues direct payments or provides universal tax rebates directly to individuals & businesses. It is supposed to be used as an alternative to QE when the economy may be in a liquidity trap.
On the Central Bank’s balance sheet, Helicopter Money increases the liabilities without a corresponding increase in assets. This effectively means that balance reduction happens on the equity capital of the Central bank, which may lead to reduction in foreign investments in the country in the future.
On the other hand, QE, is essentially an ‘asset swap’ because the liability increase due to printing of money is compensated through equal purchase of assets from banks. Thus, theoretically QE is reversible in nature through future sales of the assets purchased when the economy grows stronger. However, Helicopter Money is irreversible in nature as there are no corresponding assets, leading to permanent monetization of budget deficits.
Risks of Helicopter Money:
Though Helicopter Money resolves the transmission woes in expansionary policy and QE, it has inherent risks:
>>Runaway Inflation: Infusing such huge volumes of money into an economy can result in uncontrolled inflation which can become a very difficult thing to control.
>>Creates demand & not supply: One of the main issues with the concept of Helicopter Money is that it creates demand artificially by funnelling money into the hands of consumers. On the other hand, QE channels the money through commercial banks to further lend it out to businesses & help create the supply to fulfil the corresponding growth in demand.
>>Risk of ending up in a liquidity trap: Even with Helicopter Money, the decision to spend lies with the end consumers. If the consumer confidence in the economy is low, then it may end up increasing the savings rate rather than kick starting the economy as envisaged.
>>Diminishing role of the Central Banks: Helicopter money can be used by governments for populist or political reasons rather than economically sound ones. In the long run this can lead to reduced public confidence in institutions like the Central bank.
We will do well to always remember that there are no free lunches. Everything comes at a cost and Helicopter Money as a tool may not be suitable for every economy.
[vc_row][vc_column][vc_column_text]Author Profile
Himanshu Mehra is a technology enthusiast and an experienced banker having worked in Commercial Banking domain with leading banks including HSBC, Citi and Yes Bank. He has a rich experience in Relationship Management and Business Development roles, engaging with C level executives and key decision makers both in Asia Pacific and globally. He keenly follows trends in technology, finance, and their application in everyday lives.[/vc_column_text][vc_column_text]
Disclaimer: The opinions expressed here are those of the author and does not reflect the views of FrankBanker.com[/vc_column_text][/vc_column][/vc_row]