The Economics of Helicopter Money

by George Hatjoullis

The time has come,” the Walrus said,
“To talk of many things:
Of shoes–and ships–and sealing-wax–
Of cabbages–and kings–
And why the sea is boiling hot–
And whether pigs have wings.

I have written many blogs on this subject though generally under the heading of monetary financing. The latter is a specific form of Helicopter Money (HM). It seems worthwhile to provide a more general discussion as the idea is gaining some traction and the greater the clarity of understanding the better.

The key concept is potential output. This is the amount GDP can grow in any period (say a year) without triggering rising inflation. In an open economy we should also add , ‘or triggering a balance of payments problem’. It is the capacity of the economy to produce things people want (irrespective of who owns the capacity). The problem is that in a capitalist economy there is a structural tendency for aggregate effective demand to fall short of potential. The result is that the economy grows below potential which is deemed wasteful. People are unemployed and factories idle when they could usefully be put to work if only the goods could be sold. It is not that people do not want the goods but that the aggregate ability to buy the goods falls short. This arises for many different reasons though extreme income inequality may well be the key reason at the moment. Rich people hoard cash that poorer people would spend.

The so-called Keynesian solution is for governments to borrow hoarded cash and spend it. There are two problems in this solution. The first is an interesting theoretical issue known as Ricardian equivalence. The idea is that if governments borrow to spend, economic agents will reduce spending now because they recognise that they will have to repay the borrowing through taxes in the future. The net effect of government spending financed by borrowing is thus mitigated by reduced private spending now. The empirical validity of this idea is beyond this blog so let us just assume there is some validity to the concept. The second problem is on what governments spend their borrowed cash. If they borrow to invest, which is politically and intuitively appealing, it does not solve the problem. Investment, even by governments, improves the productive capacity of the economy so how can this resolve excess supply?

The need is for something that is intuitively abhorrent in a capitalist economy; free money. The need is for poor people to wake up and find the Bank fairy has visited in the night and left a wedge of cash that will decompose unless spent that very day on things made within the national boundaries, and preferably not requiring too much by way of imported raw materials. No new capacity is thus created and there is no fear of future taxes to repay national debts. The net result is that the products of idle factories and workers are demanded and these resources cease to be idle. This is win-win.

If money is just paper printed by the central bank this is not a complicated process. The CB can calculate, in principle, the excess supply (difference between aggregate effective demand and potential output) and provide everyone one with a time dated deposit that they can spend. The time date is to ensure that it is spent otherwise it disappears. Even now there can be some slippage as individuals might save more out of income and use the CB windfall to spend on what they would have spent in any event. Displacement is thus a serious potential problem with HM. It is thus important that HM is distributed to those for whom displacement is least likely. This is more complex than it sounds but is not a fatal flaw.

Most objections to HM are not that displacement activity might render it ineffective but that it might be too effective and lead to rising inflation. It has been tried and hyperinflation has resulted but this has been the result of abuse and is not a flaw in the basic idea. Clearly if you leave the calculation of excess supply to governments then they will have an incentive to over-estimate and print too much money and the result is rising inflation. If the calculation is left to independent central banks charged with price stability they are likely to err on the side of caution and underestimate excess supply. Needless to say, CB independence is a very (very) recent innovation.

The implementation of HM must not only account for displacement activity but also attitudes to work. If it comes to be expected as a policy tool in specific circumstances then the expectation will affect economic behaviour in unpredictable and unintended ways. It is a policy tool that must be used sparingly and only in exceptional circumstances. I have argued, and will continue to argue, that the global economy is in a deflation. It is most obvious in Japan but the problem is widespread and that such exceptional circumstances now apply. More prominent names are adding their voices. The time has come the Walrus said…