Sometimes, a thought experiment turns into a policy suggestion.
More than 250 years ago, the occasional economist David Hume (and a good friend of Adam Smith) asked what would happen if we all woke up one morning with more money in our pockets. His answer was simple: we would all feel richer from the pleasant windfall and spend more for a while, but eventually all prices would double and nothing real would be changed.1 What Hume was suggesting is now referred to as the Quantity Theory of Money.
Almost 50 years ago, the full-time economist Milton Friedman asked a similar question of how a change in the rate of growth of money would affect the economy, and his answer was that inflation would eventually reflect that change. And yes, in his thought experiment, Friedman mentioned the example of a helicopter flying over a community and dropping cash.2 (Irony: the conclusion from his theoretical analysis, which is now called the “Friedman’s rule,” is that zero nominal interest rate and a little bit of deflation are the best for the society. Does it remind you of any country?)
Just 14 years ago, the economist-policymaker Ben Bernanke made use of the helicopter example and proposed something that was essentially the same but less comical: a coordination of the central bank and the fiscal authority, with the newly created debt from a fiscal expansion fully and permanently purchased by the central bank with newly created money.3
Okay, enough history of economic thought.
How is this policy different from quantitative easing, which also involves the central bank buying all sorts of government bonds, among other assets? Other than the explicit fiscal-monetary coordination, Bernanke’s helicopter drop of money emphasizes the permanent nature of the debt purchase. Unlike quantitative easing, which central bankers around the world keep telling us is only “an unusual tool in an unusual time” and that central banks will get rid of the assets once things are back to normal, there is no coming back once the helicopter is flown. The amount of debt expansion is forever eliminated by the central bank.
It is also different from a mere expansion of government spending or tax cut: people know that the government is constrained (just like the rest of us), and the expansion has to be paid by some future tax increase or spending cut. This forward-looking behavior (which is referred to as Ricardian equivalence, after the economist-investor David Ricardo) limits the effect of fiscal policy.
So, what about the hype that helicopter drop of money is exactly the kind of policy that Japan should (or even does) seriously consider for getting it out of the quagmire of low inflation and low growth? Will it work?
It depends on what you mean by “work”.
Inflation in Japan has been near zero for about 20 years, and there is no sign that it is going back to its 2 percent target anytime soon (though many promises were made, and then broken, by the Bank of Japan on this). Real GDP growth has been equally gloomy, hovering around zero since the 1990s. There is little evidence that things have improved since the start of Abenomics in 2013.
Abenomics is only a series of fiscal expansions juxtaposed with a series of monetary expansions, without any coordination or commitment to make any of them permanent.
As argued by Bernanke in 2002, a helicopter drop would hit two birds with one stone (or, more accurately, one drop): fiscal expansion will pull consumption and prices up, and the debt purchased by the central bank will eliminate the possible fiscal consequences (tax increase or spending cut). Even if consumption does not bulge, the rise in asset values induced by monetary expansion will indirectly make borrowing easier for businesses and households.
But real output growth is a matter of both demand and supply. One of the “three prongs” of Abenomics is structural reform, a set of policies that tries to boost aggregate supply by raising productivity and reducing inefficiency. As of now it is mostly talk with few concrete achievements, and I am doubtful that a higher dose of monetary and fiscal policies is enough to bring the growth rate up. Pumping more money into the hands of businesses and households is futile if they do not have anything attractive to invest in.
But I do think a helicopter drop of money, or what economists would prefer to call debt monetization, can raise inflation and its expectations. Why? It is because of the strong historical evidence behind it.
Then why is Haruhiko Kuroda, the governor of the Bank of Japan, so vehemently rejecting this idea?
I think risk or ambiguity aversion is the main explanation. The historical evidence I just referred to is not all bright and beautiful: quite often debt monetization is a dark force that is way too powerful, something that a broke or corrupt government uses to print its way out of a growing budget deficit, generating inflation that gets out of control. Zimbabwe since the late 1990s is a recent example (remember the note of one hundred billion dollars?), and for an older one we have the Weimar Republic of Germany. Having difficulties in paying off its war reparations and wage obligations, the government cooperated with the central bank and monetized more and more of its debt, leading to probably history’s most famous and influential case of hyperinflation.
As a decision maker at the central bank, it is just too daunting to figure out the right amount for the helicopter drop, and overshooting the goal of a 2 percent inflation is not something you want to put on your résumé as a central banker. In contrast, given the repeated failures by previous governors, being unable to reach the inflation target does not sound all that bad. When facing a substantial parameter uncertainty (i.e., not knowing how the economy will respond to the policy), a somewhat lukewarm quantitative easing may be the optimal strategy for the Bank of Japan to adopt.
Does Abenomics qualify as a form of helicopter drop in disguise? It does include both monetary and fiscal actions, but their coexistence does not make them a case of helicopter drop. What we have since 2013 is only a series of fiscal expansions juxtaposed with a series of monetary expansions, without any coordination or commitment to make any of them permanent. Sometimes we even see the two contradicting each other: the recent 28 trillion yen fiscal stimulus announcement was oddly followed by an underwhelming monetary decision. Such confusion and ambivalence are not making Abenomics more effective.
Japan is likely to stay as a no-fly zone for helicopters loaded with money.
1. From the essay “On Interest”. Retrieved from http://www.econlib.org/library/LFBooks/Hume/hmMPL27.html
2. From a chapter of his book, Optimal Quantity of Money, published in 1969 by MacMillan.
3. His speech can be found at https://www.federalreserve.gov/boarddocs/Speeches/2002/20021121/default.htm