Seven years on from the great financial crisis and despite central banks being seen by many as ‘the only game in town’, there has been a renewed push for monetary policy to experiment even further. One of the latest proposals is the revival of Milton Friedman’s ‘helicopter money’. But have all the implications of what many see as central banks’ ‘nuclear option’ been fully appreciated? This column argues that this is not the case. Realising the benefits that its proponents claim exist would require giving up on interest rate policy forever.…
Given the intrinsic features of how interest rates are determined in the market for bank reserves (bank deposits at the central bank), the central bank faces a catch-22. Either helicopter money results in interest rates permanently at zero – an unpalatable outcome to most, including those that advocate monetary financing1 – or else it is equivalent to either debt or to tax-financed government deficits, in which case it would not yield the desired additional expansionary effects.This seems wrong to me. The central bank could continue to set rates by paying IOR. [Scott Fullwiler addresses this in the comments.]
This seemingly innocuous technical detail has major implications. The central bank can of course implement a permanent injection of non-interest bearing reserves and accept a zero interest rate forever (scheme 1). This produces the envisaged budgetary savings but at the cost of giving up completely on monetary policy. If the central bank wishes to avoid that outcome, it has only two options.3 It can pay interest on reserves at the policy rate (scheme 2), but then this is equivalent to debt-financingfrom the perspective of the consolidated public sector balance sheet – there are no interest savings.4 Or else the central bank can impose a non-interest bearing compulsory reserve requirement equivalent to the amount of the monetary expansion (so that excess reserves remain unchanged – scheme 1), but then this is equivalent to tax-financing – someone in the private sector must bear the cost.5 Either way, the additional boost to demand relative to temporary monetary financing will not materialise.Seems to confuse monetary and fiscal. What actually acts like a tax is not paying interest on debt, which would increase the aggregate net financial assets of non-government, with the helicopter infection doing so instead.
The difference is that the liability in this case would slow up on the books of the central bank rather than the Treasury.
What would disappear is the illusion of the intertemporal budget constraint, replaced by the illusion of "free money." Money is never "free" in that it is a financial instrument and financial instruments are always recorded as a liability on the issuer's balance sheet.
Helicopter money: The illusion of a free lunch
Claudio Borio, Head of the Monetary and Economic Department, Bank for International Settlements; Piti Disyatat, Director of Research, Bank of Thailand.and Anna Zabai, Economist, Bank for International Settlements