In the past few weeks both ECB-president Mario Draghi and ECB-chief economist Peter Praet have answered questions about so-called helicopter money, where they stated it is a valid tool in the central bank’s tool box. That said, we don’t think it’s time to start looking to the skies in wait for free money falling down. The ECB’s helicopters will remain on the ground for the foreseeable future.
An idea launched by Milton Friedman in 1969 and put into a practical policy context by Ben Bernanke in a 2002 speech about deflation, helicopter money has long been recognized as a theoretical tool in the central bank’s tool box. Basically, the idea entails the central bank printing money and putting it directly into the hands of the end-users. This is an extension of the more conventional tools of a central bank, where the aim is also to get more money flowing in the economy, albeit through the credit channel of banks. The theory behind the idea is fairly straightforward: if the economy is facing a lack of demand, the central bank can print money and put it directly into the hands of consumers to generate more demand. Practically this could be done via a tax-cut/rebate financed by perpetual zero-coupon government debt paper, which is bought by the central bank. In theory this should work.
In reality, however, there are a lot of questions. For starters, it is doubtful whether households would actually spend the free money. It is well-documented that in uncertain times people tend to mainly save (or use for debt repayment) extra income which they view as a one-off. Suggestions to attach an expiration date to the ‘helicopter cheques’ would not meaningfully change this, as people could easily adapt to save more out of their regular incomes. More importantly, helicopter money could have a significant impact on confidence of all economic agents. In the past few years, it has become clear that such confidence issues can easily distort the theoretically expected effects of certain policy measures. As these confidence effects would essentially be impossible to predict, the overall result of an injection of helicopter money would be highly uncertain. It is quite possible (and even likely) that it would have such a destabilizing impact on confidence that the end result would be nothing like what was intended. On top of that, there would be serious issues of moral hazard and longer term expectations: after using it once, people could start expecting further helicopter money every time the economic engine sputters.
Helicopter money could work in theory, but has never been tried in fairly normal circumstances (it has been tried in war-time situations, but these are not relevant for the current situation). Basically, this would be a further monetary experiment, where even the ECB itself would have no clear view on what would happen if it tried it. As such, it should be seen as an extreme measure that could only be used in extreme circumstances. This is also how Praet characterized it in his recent interview.
If the ECB feels the need to do more, it still has plenty of room to go further along the current lines. It could cut interest rates further or further expand its asset purchase program. Whether or not this would make any real difference, is another question. In any case, before helicopter money could even be considered (if at all), the economic situation would have to become dramatically worse. The ECB’s helicopters will not take off any time soon.