Helicopter Money a la Friedman/Bernanke

Milton Friedman, Nobel prize winning monetary economist from the Chicago School first used the phrase ‘Helicopter Money’, in 1969 in his book Optimum Quantity of Money as a metaphor for direct transfer of money to individuals  to emphasize the potency of monetary expansion as a better alternative than fiscal policy to stimulate economy and arrest deflation.

Ben Bernanke resurrected the term in  2002 when he was discussing broad based tax cut financed by the budgetary deficit as an anti-deflationary measure to stimulate consumption and raise prices. He then referred to the tax cut financed by the government by borrowing from the central bank as equivalent to Friedman’s Helicopter money. The difference here is that tax cut financed by government borrowing is Keynesian tool and not Friedman’s policy, although Friedman would welcome tax cut to government expenditure as a more potent tool to reverse recession and give momentum to the growth process. The argument is that the tax cut would leave more cash balances in the hands people to spend.

When Ben was in Tokio recently, observers debated whether he would discuss helicopter money with authorities to cure their two decades long problem. In the wake of rising fiscal deficit and public debt Shinzo Abe raised the consumption tax from 5% to 8% in 2014, although it did not fit well in his Abenomics. Nobel prize winning economist Paul Krugman and Joseph Stiglitz had also urged the government not to raise  the consumption tax in 2014 and drop the further increase to 10% 2017. How far Ben succeeds in his mission now is to be seen in the light some setback Abenomics has received.

Japan’s Secular Stagnation

The diagnosis of Japan’s economic malaise suggests the problem being one of secular economic stagnation. After being on the forefront of record economic growth since the 1950s, creating massive export surpluses, huge build up of forex reserves and massive appreciation in yen, from yen 360= 1 dollar fixed in 1947 to its peak of yen 83.5 in 1995, until the late 1980s, Japan had to retreat under new economic philosophy of globalization.

Under the impact of colossal flow of capital and technology under globalization to China and other emerging market economies of Asia and Latin America, Japan’s export engine, the main source of its three decades long economic prosperity, moved into a low gear. Higher cost of labor in Japan shifted the center of exports growth to China and other emerging markets. Over the last three decades China’s economic miracle  has dented Japan’s growth momentum. Japan’s export surpluses disappeared and economic growth plummeted. Germany, Japan’s replica in Europe in its growth model, could have been in the same boat, had it not been for its political move for German unification and creation of Euro zone and Euro. Although Euro zone is in problem, Germany’s economic growth and export surpluses continue to be still strong.

Japan’s economic stagnation that began in 1990s emerged from the shift of its export markets to cheap labor economies, primarily China and South Korea. This trend is irreversible. Further, it is compounded by several other economic factors and policy matters which inhibit its growth momentum. In addition high cost of labor despite high productivity, it suffers from declining population, higher retiring population, and 1% annual decline in working population. Its high per capita incomes, standard of living and lowering population militates against boosting growth from domestic consumption to replace exports. And to top it all, the most important policy tool to tackle this problem was not tried vigorously until Shinzo  Abe came on the scene. For more than a decade the Bank of Japan did not try to depreciate yen to arrest the sharp fall in exports growth, its main growth engine.  

Unorthodox Monetary Policy in Japan

In this scenario Japan became the first country to test the zero interest rate policy. Initiated by the Bank of Japan in 1999, this unorthodox monetary measure did not have much impact in igniting the economic recovery. Disappointed by its failure BoJ started in 2003 QE, another  unconventional monetary measure to ignite growth through the boost to consumption and investment expenditure. The central banks buying government securities increases the reserves of commercial banks with the central banks which they draw down to increase credit.

Unfortunately, entire monetary system of the US, Europe and Japan is caught in the ‘Liquidity Trap’. Consequently, the QE which increased the high powered money or monetary base in the system is unable to expand money supply. QE as well as zero interest rates both did not succeed in expanding credit due lack of demand for the same. Central banks cannot expand money supply if the economy does not demand it. Such measures only result in central banks inflating their balance sheets than raising money supply. There is enough money and cheap money in developed economies than is needed. The unorthodox monetary measures have been proven to be impotent in achieving their target results. It only raised the bond price valuations and other asset prices at cost of the central banks multiplying their balance sheets. Now the central banks across the developed world are riding a tiger that needs to be tamed first before they can alight safely and without harm.

What is proven to have worked much better is the Keynesian remedy of pump priming  government expenditure through deficit financing. It has, however, increased the government debt in Japan from 13% of its GDP in 1991 to 72% in 2002 and to 126% in 2015. The great unorthodox monetary revolution has multiplied the combined balance sheets of top six central banks from $ 5 trillion in 2007 to $17 trillion in 2015, a rise from 14% of their GDP to 36%.

Even with the negative interest rates, economy is not showing any signs of revival. The only solution for Japan is to allow yen to depreciate to a level it can invigorate its export sector and stimulate investment.


Satyendra Nayak