Quantitative easing and helicopter money – what are they and what are they for?

Times of crisis, times of innovation and extraordinary measures.

Over the past decade, central banks in the major developed countries have lost their main tool for intervention. Everyone understands that if you lend money to someone you receive compensation in exchange for the risk, you get interests. Also, the lower the interest rate, the more loans will be taken out.

But what happens when the interest rate is zero and, even so, nobody asks for credit? This is the current problem of banks: more and more often individuals and companies do not ask for enough credit to keep money in the system. Active loans are being repaid, the money disappears and is not replaced by new loan money.

It is up to the central bank to roll up its sleeves and inject money into the economy. To do so, it has two unconventional tools: quantitative easing and helicopter money.

What is Quantitative Easing?

In the process of Quantitative Easing (QE) the central bank creates money to buy medium and long term debt. It can be as well government debt as corporate debt or debt of investment funds. There is one asset: debt.

This is the way the ECB has chosen to inject money into the economy: more than 2.5 trillion euros in the last five years. And that was before the coronavirus pandemic was declared! This huge amount of money has barely helped inflation to reach one and a half points per year, far from the desired target of 2% per year.

Part of the problem is that the money issued tends to end up in the stock market and the real estate market. The money only reaches individuals if they take out loans or through government aid. The velocity of money, which is a measure of how much it changes hands in a given period, is very low. Not surprisingly, the money does not reach the real economy but remains tied up in some asset.

That is why alternatives are proposed, as imaginative as they are risky:

What is Helicopter Money?

The idea of helicopter money was proposed by Milton Friedman, often accused of being the father of neoliberalism, who was the first to imagine that in certain circumstances it might make sense to put bundles of bills in a helicopter and drop them on citizens.

What was an academic idea for desperate times has become a reality. Helicopter money is created by the central bank (digitally, not in banknotes) and distributed directly to the people. The central bank pockets the debt since people are not going to pay it back. It is not very clear what happens afterwards. By keeping a credit balance to which no one will respond, the central bank is technically bankrupt.

Since the money is distributed directly to ordinary people, there is supposed to be immediate spending and therefore the velocity of money is high, which is always good for the economy.

The biggest problem with helicopter money is that it opens a Pandora’s box from which no one knows what will come out. Will inflation soar?

If it is only used in emergencies, what are we to consider an emergency?

Are we putting in the hands of populist politicians a tool to buy votes?

Will citizens accept that “there is no money for such a thing”? Let’s think that “such a thing” can be the health system or scientific research, but also raising pensions, paying civil servants more or preserving the status quo for taxi drivers.

Helicopter money, like universal basic income, challenges the narrative that everyone is responsible for themselves, so it is highly controversial, and politicians and bankers generally prefer QE.

In 2020 we have seen how the US has launched a gigantic experiment in helicopter money: cheques for $1,200 have been sent home to more than 130 million people and, despite delays for 20 million more, it has been a success, from a humanitarian point of view, but also an economic one, as it has kept the economy going without generating inflation. In fact, I believe that 2020 will be remembered in history rather for this experiment than for the coronavirus.

Regardless of the pandemic, helicopter money should be far more effective than quantitative easing in improving the lives of the poor, meeting inflation targets, or avoiding fueling bubbles in the stock and housing markets. Therefore, there will be no choice but to explore its use, despite all the contraindications and dangers involved, which are not few.

We need new narratives to explain to people that sometimes money can fall from the sky, but that it cannot be the norm because it has consequences. And these consequences will have to be explained very well.

References:

Negative Interest Rates Explained, Economics Explained

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