A hot topic
Claudio Borio and colleagues (2016) have recently posted a very interesting and thought-provoking comment on the currently highly debated topic of “helicopter money” (HM) and its use to fight secular stagnation in advanced economies.
Their contribution does not take on the question of the efficacy of HM as a demand management tool relative to alternative instruments. Rather, the points they make concerns the fiscal cost of using HM and its implications for monetary policy.
They argue that a money-financed fiscal program becomes more expansionary than a debt-financed program only if the central bank credibly commits to setting policy at zero once and for all. Thus, as typically envisioned, HM comes at the heavy price of giving up on monetary policy forever. In their view, therefore, there is no such thing as a free lunch associated with HM.
Below I take issue with their arguments, trying to make the case that indeed
- HM is a “free lunch” policy option available to policymakers to help stagnating and heavily indebted economies to grow out of large output gaps and persistent low inflation, and
- its adoption does not imply any surrender of monetary policy.
Is HM a surrender of monetary policy?
Borio and colleagues start from premising that
“There is broad agreement that helicopter money is best regarded as an increase in economic agents’ nominal purchasing power in the form of a permanent addition to their money balances. Functionally, this is equivalent to an increase in the government deficit financed by a corresponding permanent increase in non-interest bearing central bank liabilities… The central bank credibly commits never to withdraw the increase in reserves.”
This, of course, amounts to the central bank prejudging any change in its future course of monetary policy. Yet this is not at all a necessary implication of HM.
Especially after Buiter (2014), the claim whereby HM effectiveness requires the central bank to credibly commit never to withdraw the increase in reserves seems to have gained broad acceptance across discussants of HM. I would argue, in fact, that such conception of “permanence” is incorrectly placed. The effectiveness of HM has nothing to do with central bank reserves being issued with a commitment to never withdraw them in the future. Let’s see why.
HM injections can be effected:
- either by financing the government budget, with the central bank issuing reserves to purchase government debt, or
- by financing the private sector directly, with the central bank crediting the accounts of selected categories of individual economic agents with newly created reserves. (I will not dwell here on the technicalities of the many ways this could be done, as this is not relevant for the purpose of this discussion).
When HM is conducted through the government budget, permanence resides in the central bank committing to purchase the debt and to hold it permanently (Turner 2013). Under such commitment, the government debt purchased is monetized forever, its related future financial obligations are suppressed (de jure and de facto), and the government budget constraint is relieved permanently as a result.
Under such “permanence” commitment, purchases of government debt via HM operations can take place
- either in the primary market, whereby the government would get the money and finance the extra deficit deriving from larger expenses or tax cuts, or
- in the secondary market, whereby an equivalent amount of public debt obligations would be cancelled and the government could use the related budgetary savings to finance new spending or tax cuts.
The new resources injected through HM would be used by the government to support nominal GDP growth.
When HM is conducted by financing the private sector directly, the newly created central bank reserves increase the nominal financial wealth of the private sector permanently. However, this does not imply that the central bank is giving up on future monetary policy. If circumstances so require, the central bank may in all cases considered above tighten monetary conditions at any time in the future.
It should be noted that indirect monetary instruments (such as, for instance, open market operations (OMO)) would act on the composition of wealth, by changing interest rates and inducing agents to replace money with bonds in their portfolio, whereas HM affects wealth directly. It should also be noted that a central bank wanting to undertake OMO to offset HM injections would have to use debt instruments in its possession other than those purchased under the original HM and permanently monetized. Alternatively, the central bank could issue its own non-money debt liabilities in the form, for instance, of debt certificates.
Abstracting from optimal allocation and distributional considerations, the most direct way to “undo” the wealth created by HM is through taxes, which could take the form of government general taxation on the economy or quasi-fiscal taxation like a higher reserve requirement by the central bank on the commercial banks. If HM consists of the state creating and transferring nominal resources to the economy, taxation would be the way for the state to withdraw the same nominal resources from the economy and to transfer them back to itself. The new financial wealth created by HM injections can change both composition and market value over time, depending on changes in agent liquidity preferences and monetary policy innovations, but it is going to be permanent until it is taxed away by fiscal or quasi-fiscal interventions.
In any case, whatever policy instruments are used to reverse the effects of HM, its effectiveness does not require the central bank to credibly commit never to withdraw the increase in reserves induced by the original injection(s).
Does HM bear fiscal costs, or is it really a free lunch?
The arguments by Borio and colleagues on this issue are the following:
“The central bank can of course implement a permanent injection of non-interest bearing reserves and accept a zero interest rate forever…This produces the envisaged budgetary savings but at the cost of giving up completely on monetary policy. If the central bank wishes to avoid that outcome, it has only two options. It can pay interest on reserves at the policy rate, but then this is equivalent to debt-financing from the perspective of the consolidated public sector balance sheet – there are no interest savings. Or else the central bank can impose a non-interest bearing compulsory reserve requirement equivalent to the amount of the monetary expansion…but then this is equivalent to tax-financing – someone in the private sector must bear the cost. Either way, the additional boost to demand relative to temporary monetary financing will not materialise.”
Note that the core argument here is the introduction of interest-bearing reserves,
- either because paying interest on reserves transforms their issuance in a source of perpetual financial obligation on the consolidated (central bank – treasury) public sector balance sheet,
- or because commercial banks holding reserves would face a positive opportunity cost from holding reserves, if the central bank were to exonerate them from receiving interest payments on reserves issued under HM or if the central bank were to recoup the interest cost through a separate levy on banks (Bernanke 2016). According to Borio and colleagues, this would amount to tax-financed deficit spending.
The real question, however, revolves around the rationale for paying an interest rate on central bank excess reserves. In this regard, it should be noted that remunerating excess reserves does not reflect any pricing mechanism signaling the value of central bank reserves, as interest rates do, for instance, in the case of debt obligations: central bank reserves are a perfectly liquid asset and do not bear credit risk. Thus, any remuneration on reserves adds to their intrinsic liquidity premium and introduces a price distortion under a deliberate central bank policy decision. The price distortion is a form of subsidy (or taxation) that the central bank uses to alter liquidity preferences in the economy. As a subsidy, it eliminates the opportunity cost that banks would otherwise consider to determine at the margin how many reserves to hold optimally vis-à-vis other less liquid assets. As a subsidy, as well, it de-links the interest rate formation from the amount of reserves in the system. Its use as a tax is evident when the central bank applies negative rates as a way to discourage commercial banks from hoarding reserves.
A positive remuneration on excess reserves transforms central bank reserves in cost-bearing monetary instruments for the consolidated public sector balance sheet, but the related fiscal cost has nothing to do with the nature of reserves as monetary instruments: their remuneration does not reward their holders for sacrificing liquidity or for taking risk. For this reason, the elimination of such remuneration does not imply an increased opportunity cost for banks, and in fact re-establishes the true opportunity cost of money, which in equilibrium should equal the (implicit) own rate of return on money.
As such, the elimination of interest payment on excess reserves (or its offsetting through the levy of an explicit charge on commercial banks, as suggested by Bernanke) would only amount to eliminating (or compensating for) the policy-determined price distortion discussed above. Consistently with this, the imposition from the central bank of a non-interest bearing compulsory reserve requirement equivalent to the amount of the monetary expansion under HM (or the levy of a charge to offset the interest net payments to commercial banks) would not represent a form of tax financing.
If HM effectiveness does not require the central bank to credibly commit never to withdraw the associated increase in reserves, if there is no intrinsic rationale for excess reserves issued under HM to pay interest, and if the elimination of such interest does not represent taxation on the private sector, the “free lunch” feature of HM is fully restored.
Fiat money can then be used at no cost to the consolidated public sector balance sheet as a way to mobilize unemployed or underemployed real resources and to accelerate price and wage dynamics in heavily indebted economies suffering from large output gaps and price deflation.
HM is a “free lunch” in the simple sense that, if it works and succeeds in closing the output gap, people won’t have to repay it through higher taxes or undesired (above optimal) inflation.
Bernanke B (2016), “What tools does the Fed have left? Part 3: Helicopter money”, Ben Bernanke’s Blog, Brookings Institute, April 11.
Borio C, P Disyatat, and A Zabai (2016) “Helicopter money: The illusion of a free lunch”, 24 May, VoxEu.
Buiter W (2014), “The simple analytics of helicopter money: Why it works – always”, Economics, vol 8, 2014-28, August.
Kocherlakota N (2016) “’Helicopter Money’ won’t provide much extra lift”, Bloomberg View, 24 March.
 I am very much grateful to Claudio Borio for discussing the issue of helicopter money at quite some length. Most likely my arguments will not persuade him and his colleagues, but might nonetheless invite their further reactions. I also wish to thank Charles Wyplosz for exchanging views with me a while ago on the “permanence” issue discussed below, and Larry Summers for sharing with me his doubts on the relevance of “permanent” commitment in real-world circumstances. Finally, I thank Marco Cattaneo and Abdou Sarr for their very helpful comments. Of course, the opinions here expressed are my own and I am the only responsible for any errors in the arguments reported in the text.
 Kocherlakota (2016) has noted this liability aspect of HM in the presence of interest-bearing central bank reserves.
 More precisely, Bernanke (2016) considers the possibility that, as an HM is announced, the central bank also levies a new, permanent charge on banks – based not on reserves held but on total liabilities – sufficient to reclaim the extra interest payments on the reserves issued under HM, thus leaving net payments to banks unchanged. This way, the net income of banks would be unchanged, and the charged levied would make explicit and immediately visible the cheaper financing of the fiscal program associated with money creation under HM.