It is not helicopters but old fashioned government spending – funded by debt or cash – that will be called into action to get developed market economies going again.
The notion (metaphor) of helicopter money was first invoked by the foremost monetarist Milton Friedman and revived by Ben Bernanke, later Governor of the US Fed, to indicate how central banks might overcome a theoretical possibility that has in reality become a very real problem for central bankers today. The problem for the central banks of the US, Europe and especially Japan is that the vast quantities of extra money they have created in recent years, quantities of money that would have been unimaginable before the Global Financial Crisis of 2008, have been bottled up in the banks who have held on to the extra cash received rather than used it to make loans that would have helped their economies along.
The cash was received by the banks or their customers from the central banks in exchange for the government and other securities bought from them in the credit markets and directly from the banks themselves. The cash shows up as extra deposits held by the private deposit taking banks with their central banks – the bankers to the banks. It has been a process of money creation described as quantitative easing (QE) that has led to trillions of dollars, euros or other currencies of extra assets held by central banks – matched by an equal growth in their liabilities, mostly to the banking system in the form of extra deposits held with the central bank (see below).
The banks receive the extra cash directly from the central bank in exchange for the securities previously held on their own balance sheets or who may receive the extra central bank cash firstly with the deposits made by their clients when banking the proceeds of their own asset sales. Their clients deposit the cheques or, more likely, EFTs issued by the central bank in their private banking accounts and the banks then receive an equivalent credit on their own deposit accounts with the central bank as the cheques on the central bank are cleared or the EFTs’ given electronic effect. And so in this way, through asset purchases by the central bank acting on its own initiative, extra central bank money enters the financial system, a permanent increase that can only be reversed when the central bank sells down the securities it has bought.
The banks have an option to hold the extra cash rather than lend it out to firms or households, who would ordinarily spend the cash so made available. And banks in the US, Japan, England and Europe and Switzerland have done just this in an extreme way. They are holding the extra cash supplied to them by their central banks as additional cash reserves way in excess of the requirement to hold reserves.
The US Money Base shown below is the sum of currency and bank deposits (adjusted for reserve requirements) held with the central bank (see below the US Money Base that has grown in line with excess reserves held by the Fed and the extraordinary growth in the deposits held by Swiss banks with the Swiss National Bank).
And so the call for the imaginary helicopters to bypass the banking system and jettison bundles of cash that people would pick up gratefully and spend on goods and services so reviving a stagnant economy (stagnant for want of enough demand, not for want of potential output and employment that is the usual economic problem).
The helicopters however will have to take a different form. They will have to be ordered by governments and budgeted for in Congresses or Parliaments. Central banks can buy assets in the financial markets and directly from banks. They cannot order up government spending that they can help fund. That is the job of governments who decide how much to spend and how to fund their spending. Governments can fund spending by taxing their citizenry, which means they will have less to spend. This is never very popular with voters. They can fund government spending by genuine borrowing in the market place – competing with other potential borrowers – crowding them out by offering market-related interest rates and other terms to lenders. Or they can fund their expenditure by calling on the central bank for loans that, as a government agency, they cannot easily refuse to do.
In taking up the securities offered to them by the government the central bank credits the deposit accounts of the governments to the same (nominal) value as the debt offered in exchange. Both the assets and deposit liabilities of the central bank then increase by the same sum as the extra debt is bought by the central banks and the government deposit credited. As the government agencies write cheques on their deposit account – or do the EFTs on them – the government deposit runs down and the deposits of the private banks with the central bank run up. In this way, the supply of cash held by the private sector increases, just as it does in the case of QE.
And the private banks and their customers will have the same choice about what to do with the extra cash held on their own balance sheets. Spend more, lend more or pay back debts or hold the extra cash, as they have largely been doing.
But there is an important difference when the money is created to fund extra government spending. Spending by government on goods services or labour or perhaps welfare grants will have increased, so directly adding to aggregate spending. By spending more, the revenues of business suppliers and the incomes of households will have risen with their extra money balances received for their services or benefits. This is why spending by government – funded with extra money is usually highly inflationary – can be highly inflationary as it was in the Weimar Republic of Germany after World War 1 or as it was in Zimbabwe not so long ago or as it is now driving prices higher in Venezuela.
But the current danger in the West is deflation, the result of too little rather than too much spending. Inflation seems very far away, as revealed by the very low or even negative interest rates offered by a number of governments to willing lenders for extended periods of time. For some government issuing debt – at negative interest rates that produces an income for the government – is cheaper than issuing cash that gives only a zero rate of interest.
The continued weakness of developed economies suffering from a lack of demand, despite low interest rates, calls for money and debt and or money creation by governments. The call for less austerity or more government spending relative to taxes collected is being heard in Japan. It is a voice being sounded loud and clear in post Brexit Britain. The Italians are very anxious to use government money to revive their own failed banking system. The Germans with their own particular inflation demons will however resist the idea of central banks directly funding governments, but for how long? Hillary Clinton promises spending on infrastructure. Donald Trump worries about government debt – for now as far as we can tell.
How long can weak economies and very low interest rates and abundant supplies of cash co-exist? It will not take helicopters but unhappy voters to stimulate more government spending, funded with cheap debt or cash. And the voters appear particularly restless on both sides of the Atlantic and, for that matter, the Mediterranean. 1 August 2016
A fuller account of the above discussion can be found here: Money supply and economic activity in South Africa – The relationship updated to 2011