A helicopter money drop is a form of monetary policy in which a Central Bank prints money and distributes it directly to households/consumers. The aim of helicopter money is to boost nominal GDP, overcome deflation and help reduce unemployment. In normal circumstances, printing money will be inflationary. Economists usually suggest helicopter money in a liquidity trap and period of deflation.
The idea of a ‘helicopter money has been referred to by Milton Friedman and picked up by the Chairman of the Federal Reserve, Ben Bernanke. One image of ‘helicopter money is a helicopter dropping cash from the sky, which presumably would be picked up and spent pretty quick. On a more practical vein, it could involve the Central Bank sending a cheque in the post to people across the country.
In a period of severe deflation, the cash sent could even have an expiry date. Meaning you have to spend it in 6 months or lose it. This expiry date will prevent people just saving it.
Purpose of Helicopter Money Drop
Increase the money supply
Target higher inflation
Increase aggregate demand in the economy when conventional monetary policy has failed. (e.g. in a liquidity trap with zero nominal interest rates)
Recently, I was researching a post on US v EU unemployment. No.1 on Google (a news result) was a post with some observations on EU vs US economic policy. This paragraph caught my attention
…But many European countries have completely mismanaged their budgets for continued government stimulus, which lends to the argument of free market supports that Keynesian economics is unsustainable. Greece is relying on the most recent bailout to pay its bills and creditors want to see further cuts. Spain is also cutting spending, while dealing with a revived separatist movement of the Catalan province that does not want to pay the country’s bills. Both of these countries have the eurozone’s highest unemployment rates of 25 percent apiece. (AIM.org)
A few observations sprang to mind:
Europe is not pursuing Keynesian economics! To slash spending in a recession is the opposite of what Keynesian economics proposes. You could argue Keynesian economics (stimulus spending in a recession) is not going to be helpful, you could argue fiscal stimulus is undesirable when bond rates are rising; but, I don’t even think the most ardent critic of Keynesian economics would try to argue countries in the Eurozone are actually pursuing Keynesian economics.
The amount of debt interest a government needs to pay depends on two factors:
The amount of outstanding debt.
The interest rate on government bonds.
Higher bond yields will increase the cost of future borrowing.
Note: There are quite a few different ways of measuring government debt / financial liabilities, therefore you may come across slightly different statistics for debt interest payments as a % of GDP. I have indicated source of data where possible.
Debt interest payments as a % of GDP / Tax revenue give a reasonable guide to how manageable the government’s debt situation is. For example, Japan has a national debt of over 220% of GDP, yet net debt interest payments are forecast to be only 1.4% of GDP in 2013. Italy by contrast is facing a higher interest burden, with over 5% of GDP going on net debt interest payments.
It is worth noting that in the case of UK and US, net interest payments are not exceptionally high as a % of GDP.
Recent unemployment data from the US shows a sharp fall in the unemployment rate. EU unemployment remains stuck at 11.4% – the highest since the introduction of the Euro in 1999. The diverging unemployment rates highlight the different stages of economic recovery between the two economic zones. However, sluggish EU recovery and a continued EU …
The fiscal multiplier looks at how much an initial change in injections affects real GDP. For example, if increased government spending of £1bn causes overall GDP to rise by £1.5bn, the multiplier effect is 1.5
If £1bn worth of tax rises causes real GDP to fall by £0.5bn, the multiplier effect is (0.5)
Since 2009, countries in the Eurozone (and others such as the UK) have pursued deflationary fiscal policy – reducing spending and increasing taxes to reduce their budget deficits.
These austerity measures have led to sharp falls in the rate of economic growth, suggesting the negative multiplier effect is larger than may be expected in usual situations.
As a rule of thumb, the IMF expect a fiscal multiplier of 0.5. This means if you tighten fiscal policy by 1%, you can expect a fall in the rate of GDP growth by 0.5%.
For example, the UK has tightened its cyclically adjusted budget balance by 3.8%, and (Real GDP % growth – trend) fell by 3.9%. This suggests a fiscal multiplier of 1.0.
However, in other countries such as Ireland and Spain, the fiscal tightening led to a bigger fall in GDP giving a fiscal multiplier of over 2.0. This suggests in the current climate of the Eurozone, fiscal tightening comes at a big cost.
There have been cases where countries, e.g. Canada 1990s, can pursue fiscal tightening with relatively limited impact on Real GDP. This is because they can:
Pursue expansionary monetary policy; e.g. cutting interest rates to provide a monetary stimulus. (i.e people have higher taxes, but have lower mortgage payments so overall there is no change in spending)
Depreciation in the exchange rate. If a country pursues fiscal tightening but monetary loosening there is likely to be a depreciation in the exchange rate. This makes exports cheaper, and imports more expensive. This helps to boost domestic demand.
External Demand. It is usually easier to tighten fiscal policy if neighbouring countries are growing strongly. Export demand can help overcome the fall in government spending.
Situation of the economy. If there is spare capacity, then fiscal tightening is likely to cause a bigger negative multiplier effect. This is because the shock of falling demand is harder to absorb. If the economy is growing strongly, fiscal tightening may help reduce inflation and be easier to absorb.
Confidence. If austerity measures improves confidence in future public finances, people may continue to spend. But, it is more likely austerity worsens confidence because of headline concerns over jobs and spending cuts.
Readers Question: What would happen if a major currency, such as the dollar gets backed by gold again?
If a major currency was backed by gold it means the government must hold sufficient gold to convert representative money into gold at the promised exchange rate.
It means that the country would not be able to increase the money supply (without an increasing the supply of gold)
It means that the exchange rate should be fixed against other countries (unless the government decide to devalue or change the exchange rate.)
Outcome of A Major Currency Backed by Gold
Lower Inflation. Without the ability to print money and expand the money supply, inflation is likely to be lower. Low inflation is often put forward as the main virtue of the gold standard. It is argued this can give greater stability in the economy encouraging investment and growth.
The 1920s was a period of deflation and low economic growth. Britain left the gold standard in 1931
Deflation. The problem is that if there is limited expansion in the money supply and an overvalued exchange rate, an economy could easily end up with deflation. Most modern economies see significant growth in the money supply during a period of economic expansion. Without the expansion of the money supply, growth is likely to be curtailed.
When President Holland was elected in the summer, he suggested that Europe would turn against austerity and promote economic recovery as the most important objective. However, despite his early promises, the French budget is strongly deflationary. Given the state of the current French and Eurozone economy, this budget is likely to push France into prolonged …
