Free Money
How much money is too much money? In 1969, Milton Friedman wrote a paper The Optimal Quantity of Money. The idea behind it seemed absurdist, but in fact sought an answer to a pertinent question in Macroeconomics: are Central Banks allowing enough money to circulate in the economy? His hypothesis was that if 1000$ was dropped from the sky to people, they would hastily collect it. This would cause more money to circulate in the economy, creating demand-pull inflation — more money chasing the same goods.
It turns out we really need this inflation. Now, in the 21st century, this question has been revisited, and this time Central Banks are very seriously considering his words. Riddled with slowing economies, with near-zero interest rates and even deflation, it is being seen as an escape measure. Developed economies across the globe, faced with weakening demand and stagnant growth, are desperate to inject momentum into their economies. In theory, they believe that the increased money in circulation would heat the economy to the desired inflation level.
How did we get here?
Shinzo Abe, the Prime Minister of Japan came into power with this idea of monetary policy (famously called Abenomics). Japan is reeling under deflation, and is falling desperately short of its 2% inflation target.
US too, is facing slowing consumer demand, causing weak growth. With interest rates already near zero, and with the 2008 financial crisis, they were in a do-or-die position. Under the leadership of Ben Bernanke, the US Fed underwent a program called Quantitative Easing to create demand in the economy. More recently, they launched ‘QE for the people’, which is essentially helicopter money. Mario Draghi, the President of the European Central Bank stated in March, 2016 that he found the idea of such a stimulus interesting.
Clearly, as the image shows, interest rates have hit rock-bottom in major part of the developed world. This creates unique problems of its own — conventional monetary policy will no longer work.
Conventional Monetary Policy
In traditional economic theory, the ideal way to spur demand when it is low is to reduce interest rates. This is because interest rates represent the ‘borrowing cost’ of money — the more expensive it is for them to borrow, the less they will borrow. So when interest rates are high, people are content to leave their money in the bank, thereby leaving less money in circulation.
Conversely, when interest rates fall lower, it makes less sense to simply store it in the bank, as there may be more productive avenues elsewhere. This is the basis of monetary policy — drop interest rates to heat the economy, and raise them to cool it.
However, in the developed world, interest rates are already near zero! This means that Central Banks can either no longer use this channel to promote growth, or they must let interest rates become negative. This essentially means that people lose money on the amount stored in the bank. As ridiculous as it may sound, Japan already has negative interest rates. No one really knows how this could affect the economy, as it is unprecedented.
Clearly, to tackle the problem of deflationary pressure, Central Banks must now adopt the unconventional — tools like negative interest rates, quantitative easing, and most intriguingly, helicopter money.
Helicopter Money
Perhaps the most radical of the three ideas, it is an extremely aggressive form of monetary stimulus. In fact, it is historically unprecedented — the effects it could have if a major economy undertakes this form of stimulus are completely unknown.
Helicopter money is basically printing money out of thin air, and distributing it to people. The Central Bank prints money, and then lends it to the government as a perpetual bond with 0% interest rate. This means that the government can choose to pay the Central Bank at any point of time in the future, with no interest. What this really means is that the government got the money for free, with no fixed repayment. The government then uses this money to either lower tax rates, or distribute money to all their citizens. The net effect is the same — more money in people’s hand. The assumption behind the idea is that people will choose to spend this excess money, causing demand-pull inflation and helping these economies reach their inflation target.
It seems to be perfect — everyone is getting more money, and no one is getting affected in the process. But several economists are worried about the spill-over effect on other economies, such as developing countries which depend on foreign currency flows, as well as on the legality of the whole process.
Role of the Central Bank
In all major economies, the Central Bank is independent of the government, so that it can pursue an independent monetary policy and not be affected by government pressure. However, in this case the Central Bank is acting in conjunction with the government. Moreover, monetary policy is set by the Central Bank, and fiscal policy by the government. But helicopter money is a mixture of both — it is monetary policy as the Central Bank is printing money, yet it is fiscal policy as taxes are being reduced. Is the Bank allowed to affect fiscal policy directly? By the laws written, no. Countries will have to tear up old regulations on functioning of banks and re-write them to let this happen.
Are there no side-effects?
The honest answer is, economists are thoroughly divided on the issue — some believe that desperate times call for desperate measures, while others feel that it is far too radical a measure, especially without background measure. When this was attempted in smaller countries like Zimbabwe, it led to hyperinflation. At one point, a 100 trillion Zimbabwe dollar bill wasn’t enough to buy a bus ticket in the country’s capital. It is unlikely this could happen with stable currencies like the dollar or the yen, but several laws have been written to prevent this from happening anyway.
Should it be done?
The Economics profession has been vilified and openly questioned in the wake of the 2008 financial question. While criticism was directed at how none of them predicted the crisis, it is more telling that in the decade that has followed, economies around the world are still feeling the ill-effects. Furthermore, the global economy remains in a fragile state.
Conventional methods of reviving aggregate demand have not worked, due to the unique condition of near-zero interest rates. This has left economists with a conundrum on how to solve the issue. They have devised several unconventional tools, like quantitative easing, negative interest rates and the topic of interest, helicopter money. Helicopter money seems like a plausible solution, but there must be more research and evidence that it will not harm the global economy (which includes developing countries who are affected by foreign capital flows) in the long-run. Thus, we believe that there must be a more thorough review of the policy, while clarifying on the role that Central Banks play in the modern economy. Finally, it is likely that the given global fragility hints at structural imbalances in the economies, issues which cannot be solved by monetary policy alone. For example, Japan and Europe are also fighting shrinking working-age populations at the same time, which has no doubt played a part in weak growth. Thus, it is unlikely that helicopter money will be the ultimate solution. In fact, it must be reviewed carefully, and used only as a last resort, If all else fails.
References
1.Buiter, W. (2005). New Developments in Monetary Economics: Two Ghosts, Two Eccentricities, a Fallacy, a Mirage and a Mythos. The Economic Journal, 115(502), C1- C31. Retrieved from http://www.jstor.org/stable/3590368
Cover Image Reference. angelolucas, pixabay.com
Originally published at www.freelunch.co.in.
