JPM, ECB Hint At Arrival Of "Helicopter Money" In Europe Following Next "Significant Downturn"

Moments ago, ECB governing council member and Bank of Italy governor Ignazio Visco had some very troubling comments.

He said that while helicopter money is not currently part of the discussion in the Governing Council that "no policy tool within our mandate can or should be dismissed a priori." The reason for this startling admission is "the importance of expectations of low inflation in determining wage outcomes, and thus giving rise to second- round effects, may be increasing.”

He cited Italy’s recently signed collective contracts where "it was agreed that parts of future pay rises will be revised downwards in the event that the inflation rate falls short of current forecasts" adding that a "a generalized adoption of this type of contract would significantly decrease the rate of growth of wages and this would in turn be reflected in the dynamics of consumer prices."

He went on to defend existing monetary policy which has so far only resulted in savings hoarding, ongoing deflation and a slammed banking sector, saying that "Regarding Italy, the effects are estimated to be somewhat stronger: absent the monetary impulse, the Italian recession would have ended only in 2017; inflation would have remained negative for the whole three-year period."

But back to helicopter money: Visco also said that: "such an extreme measure would undoubtedly be subject to operational and legal constraints."

Is the ECB really this cloase to helicopter money? It appears so, because as he notes "the redistributive implications and the close ties with fiscal policy would all make it very complex, all the more so in the euro area given its institutional framework." He concluded that a discussion on the measure "is noteworthy, not much per se, but because it underlines the concern that monetary policy is left to act in isolation."

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What catalyzed this dramatic shift in perception? It may be the following research note from JPM's David Mackie titled "Helicopter money may come to a Euro area airport near you."

In it JPM writes that "over the past few years, the ECB has provided monetary stimulus by cutting interest rates, providing forward guidance, purchasing assets, and making low-cost loans to banks. Even though these policies have been successful in helping to lift the real economy and sustain inflation expectations, there is widespread concern that we have reached a point of diminishing marginal returns. If this is correct, policymakers may need to consider other options in the event of a significant economic downturn. Helicopter money is one of the options that is often suggested."

Here is how Mackie summarizes his thoughts:

  • Helicopter money should be viewed as the combination of a fiscal expansion and an expanded QE program
  • As such, it is possible to imagine helicopter money in the Euro area in the event of a significant downturn
  • Fiscal and monetary coordination may be limited, but that may not matter too much
  • Additional benefits would come from greater risk sharing across the ECB balance sheet, but this is uncertain

Some more highlights:

Against this backdrop, it was perhaps not surprising that at the March press briefing, ECB president Draghi was asked “theoretically, does your toolbox also include helicopter money, either in the form of direct financing of public investment, for example the EIB, or in the form of direct money to consumers?”

 

What was surprising was Draghi’s answer: “We haven’t really thought or talked about helicopter money. It’s a very interesting concept that is now being discussed by academic economists and in various environments. But we haven’t really studied yet the concept.” Clearly, Draghi did not dismiss helicopter money out of hand. 

 

A week later ECB chief economist Praet was asked, “In principle the ECB could print checks and send them to people?” To which he answered: “Yes, all central banks can do it. You can issue currency and distribute it to people. That’s helicopter money. Helicopter money is giving to the people part of the net present value of your future seigniorage, the profit you make on the future bank notes. The question is, if and when it is opportune to make recourse to that sort of instrument which is really an extreme sort of instrument.” Instead of dismissing helicopter money, Praet seemed to be sympathetic.

How it works mechanistically:

JPM's take on the consensus view behind helicopter money:

Many commentators see helicopter money as the answer to the problem of limited traction of monetary policy. While monetary policy impacts spending indirectly, by changing borrowing costs and asset prices, helicopter money seeks to impact spending directly, by putting money straight into the hands of households and non-financial corporates. They could still save the money, but most proponents of helicopter money assume it would be spent, providing a direct boost to demand

How it will be pitched:

In our view, helicopter money should be viewed as the combination of a fiscal expansion and a QE program, essentially a money-financed fiscal expansion. The benefits relative to a QE program alone come from the fiscal expansion. There may also be benefits of a money-financed fiscal expansion compared with a bond-financed fiscal expansion, especially in an environment of elevated government debt. This could be particularly important in the Euro area. The benefits of helicopter money could be even larger in the Euro area if a money-financed fiscal expansion involved much more risk sharing than a bond-financed fiscal expansion, but that would not necessarily be the case. Risk sharing in the current QE program is limited.

 

Looked at in this way, the key constraint on helicopter money in the Euro area is on the fiscal side. The fiscal architecture is not well suited to a coordinated, area-wide fiscal expansion, especially given very elevated levels of debt in a number of countries. The ECB’s contribution via an expanded QE program looks straightforward by comparison. Some argue that an explicit coordination of monetary and fiscal policy is needed, perhaps as part of a signaling mechanism. Explicit coordination in the Euro area would be hard, especially if linked to the idea of the central bank becoming subservient to the fiscal authorities. In the event, explicit coordination may not be necessary to experience the benefits of helicopter money. Overall, in the event of a significant economic downturn, helicopter money as defined here would likely be implemented in the Euro area to some extent.

Of course, there are problems:

There are a number of perceived problems with bondfinanced fiscal expansions: crowding out through higher interest rates, Ricardian equivalence of future tax increases to redeem debt, and roll-over risks in refinancing operations. A money-financed fiscal expansion using irredeemable reserves overcomes these problems, even if interest is paid on the reserves. Money-financed fiscal expansions may also have a financing benefit if short-term interest rates are lower than long-term interest rates. In addition, in the Euro area there may be risk-sharing benefits if the risks of asset purchases by the central bank are spread out across the region in a way that sovereign bond issuance is not. However, risk sharing is not inevitable in the Euro area: risk sharing in the current ECB QE program is limited. But, it is very important to stress that helicopter money still involves the creation of a sovereign liability (central bank reserves) that will receive interest at whatever level the central bank sets for macroeconomic stability purposes unless reserve requirements are imposed.

JPM's concluding thoughts as first the ECB, and then all other central banks, prepare to embark on the final lap before it all blows up:

For many, the key distinction between helicopter money and QE is that helicopter money is viewed as permanent whereas QE is viewed as transitory. It is the irredeemable nature of the reserves created by helicopter money that matters. While this may be important in theoretical macro models, we doubt that it has much relevance in the real world. The efficacy of QE over recent years has not been limited by a broad-based perception that the policy will be reversed, but rather by the headwinds from balance sheet deleveraging. Essentially, despite low borrowing costs and elevated asset prices, banks have been reluctant to lend and households and non-financial corporates have been reluctant to borrow.

 

For other advocates of helicopter money, it is the absence of paying interest on reserves that is the key benefit of helicopter money relative to QE, as occurs in the example of helicopter money with the central bank sending out checks. Essentially, the idea is that there is a free lunch to be had from the creation of non-interest-bearing money that can be distributed to households. This is often referred to as the creation of an asset for the private sector without a corresponding liability for the public sector. In our view, this free lunch does not really exist. We would argue that the lunch has to be paid for either by future non-inflationary seigniorage income, the inflation tax, or a tax on banks through reserve requirements.

 

Some advocates of helicopter money argue that it has to involve an increase in the inflation objective. This is partly where the idea of coordination between the monetary and fiscal authorities comes from: there is an idea that the central bank has to be made subservient to the fiscal authorities. We would disagree. In an environment where demand is depressed, and inflation is running well below the central bank’s objective, monetary and fiscal easing is warranted by the need to restore macroeconomic balance in terms of full employment and price stability. Policy efficacy does not require an increase in the central bank’s inflation objective.

 

In our view, the main argument for helicopter money is that there are benefits to be had from a money-financed fiscal expansion rather than a bond-financed fiscal expansion, even if interest is paid on the reserves that are created. The fiscal expansion is important because it adds directly to demand. The monetary financing helps to contain drags from crowding out and Ricardian equivalence, which may be particularly important in the Euro area where government debt is elevated.

 

In the event of a significant economic downturn in the Euro area, something that looked a lot like helicopter money as described here would likely take place. Despite the fiscal compact, there would be a move towards fiscal expansion. And, the ECB would expand its asset purchase program for both price stability and financial stability reasons. In order for the fiscal expansion to be meaningful, however, there would need to be either a broad-based rethink or a suspension of the fiscal compact. It is unlikely that there would be much explicit coordination between the monetary and fiscal authorities, due to sensitivities around the ECB’s independence, although it is not clear that this would be essential. Potentially very important is the issue of risk sharing. In the event of a significant economic downturn, automatic stabilizers would drive deficits wider and fiscal easing would add to this. With debt already very elevated in a number of Euro area countries, further increases in debt would be uncomfortable. Additional QE should make this much more comfortable. Greater risk-sharing in a future QE program would likely add significant additional benefits. Many in financial markets would view this as de facto equivalent to a eurobond.

In short, the final all-in bet is almost at hand.