Helicopter Money (Part 1)

What is helicopter money?

Photo: BegoBego. Source: Morguefile

“Helicopter money” is a concept first floated fifty years ago by Milton Friedman, where he proposed – theoretically – that the government fly over a community and drop thousands of dollars, financed by the central bank. What would that do to the economy, he wondered. This notion was revived by Ben Bernanke in 2002 when he gave a speech on preventing Japan-like deflation here in the United States. The speech earned him the nickname “Helicopter Ben.”

In a recent blog post, Bernanke revives the idea as a potential tool of the central bank. Obviously, he didn’t suggest fleets of Sikorskys flying over the country. But a money-financed tax cut or spending boost would be essentially the same thing. In technical terms, “helicopter money” is an expansionary fiscal policy financed by a permanent increase in the money stock. It’s an increase in public spending or a reduction in taxes financed by a permanent increase in the Fed’s balance sheet.

To effect this, the central bank would credit the U.S. Treasury’s “checking account,” and those funds would be used to pay for the spending. Alternatively, the Treasury could issue zero-coupon perpetual bonds, which the Fed could buy. This would have a number of effects:

First, households would have more money, either because there’s more employment on government projects or because after-tax pay goes up. The bigger the helicopter-drop, the bigger the impact on income. Second, inflation would pick up. When more dollars chase the same amount of goods and services, prices—the clearing mechanism—have to increase. You can’t repeal or suspend the law of supply and demand. Third, because the spending is financed by the Fed, there would be no expectation of future tax increases; there’s no way for them to shrink their balance sheet back down. All this is intended to boost the economy.

Bernanke concludes his piece by saying that helicopter drops aren’t very likely to be needed in the US. We still have a growing economy and moderate inflation. In fact, there are some signs that inflation is picking up. But this sort of thought-experiment is kind of like physicists thinking about trains and elevators moving near the speed of light. It helps us build our understanding of how things work.

But we know that light-speed trains are impossible. Helicopter drops—money-financed government spending—are quite possible and have been used many times throughout history. And the result is always the same: hyperinflation. It’s not pretty. Let’s hope we don’t go there.

Douglas R. Tengdin, CFA

Chief Investment Officer

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