Banco de España

The world is changing. After the financial crisis of 2007/2008, economic growth was supposed to recover, but it did not. Central banks all over the world cut interest rates sharply to just above zero percent. It did not help either. Then, quantitative easing was invented: if the standard recipe does not work, why not try something less conventional? Again, it did not work. “So, what is your solution?”, people may have asked Mario Draghi. Draghi concluded that the new policies were not powerful enough and decided to push the cut in interest rates and the pursuit of quantitative easing even further. Will this help? Nobody knows. But if it does not, not everyone will be surprised.

What else can be done? A policy that has not been tried thus far is to rely on helicopter money. The term helicopter money stems from a famous quote by Milton Friedman in 1969: “Let  us  suppose  now  that  one  day  a  helicopter  flies  over  this  community and  drops  an  additional  $1000  in  bills  from  the  sky, … Let  us  suppose further  that  everyone  is  convinced  that  this  is  a  unique  event  which  will never be repeated”. Concretely, helicopter money could take the form of central banks crediting money to everybody’s bank accounts (or to let governments offer tax credits to tax payers). This may sound crazy, but wait. What central banks are doing now is printing money, that is handing out money for free. This is very similar to the idea of helicopter money. But helicopter money policies may be more effective. The purpose of free money is to increase spending on consumption and investment in order to boost economic growth. The route taken now relies on commercial banks borrowing this money from central banks and lending it to firms and households. However, helicopter money is given directly to households and firms; the impact on consumption and investment may therefore be stronger.

let me give you a reassurance (or disappointment): it will not happen

Personally, I do not like the idea of helicopter money. But before explaining, let me give you a reassurance (or disappointment): it will not happen. Why? Because there are numerous ways to allocate money over the population: focus on low incomes, focus on high incomes, give equal amounts to everyone regardless their income, give more to special interest groups, and so on. The political and legal issues that arise look so complicated that helicopter money policies will never be implemented.

But let us for the moment sidestep this issue and ask what would be the economic effects of distributing free money to consumers and firms? Would it work? Well, not for sure. Consumers and firms alike may distrust the central banker’s or government’s intentions and reason that in the future taxes will be increased. Hence, they may decide to set the free money apart and spending on consumption and investment may fail to increase. On the other hand, if consumption and investment do increase, the question is for how long. In the end, more money means higher prices, which will again reduce output.

free money will depress labour force participation

But these are not the reasons I dislike the idea of helicopter money. What are these reasons then? Well, there are two; the first is that free money will depress labour force participation. Intuitively, this seems quite obvious. Why should one work for money if it is handed out for free? But it is not only intuition. Economic experiments on the effects of a negative income tax done in the US tell us the same: people reduce their working hours if they are given money for free. And non-experimental data echo the same message: non-labour income correlates negatively with labour force participation.

a policy of helicopter money cannot be a one-off experiment

The second reason is that a policy of helicopter money cannot be a one-off experiment (although this is a popular assumption in the literature). Even a small positive effect on spending would lead people to consider the experiment a success, because the costs of the experiment are virtually zero. In any democratic society, the experiment will be repeated over and over again and the policy will become permanent.

The combination of these two aspects is explosive. Because even when the negative effect upon labour force participation were small, it would be great if the experiment were continuously repeated. Now, lower labour force participation means lower output, lower income and thus lower consumption. Even thus in case helicopter money would first stimulate the economy, the economy would eventually shrink rather than grow.

The long-term costs of helicopter money policies exceed the immediate benefits. Or, as the English say: penny wise, pound foolish.