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Raghuram Rajan said consumers would want to save more because of uncertainty. Photo: Abhijit Bhatlekar/Mint
Raghuram Rajan said consumers would want to save more because of uncertainty. Photo: Abhijit Bhatlekar/Mint

Why Raghuram Rajan is right on helicopter money

If governments get a licence to expand spending, it may be difficult to stop them which can have damaging consequences in the long run

Reserve Bank of India governor Raghuram Rajan has cautioned against the use of the so-called “helicopter money" in advanced economies to revive demand. In a lecture at the London School of Economics on Tuesday, Rajan said: “It is not absolutely clear that throwing the money out of the window, or targeted cheques to beneficiaries will be politically feasible in many countries, or produce economically the desired effect" (See: Raghuram Rajan says helicopter money would be no panacea).

Once interest rates reached near-zero levels in some of the advanced economies and still failed to boost economic activity and prices, central banks decided to push rates into the negative territory. But it now appears that this policy experiment is also not yielding the desired results—unless policy makers are willing to push rates very deep into the negative zone which can have long-term implications for the financial system. However, it is not clear if it will work even then. In fact, negative rates have had exactly the opposite impact in Japan—the currency appreciated and the stock market fell. As a result, the Bank of Japan in its last policy review decided to leave rates unchanged. As the limits of negative rates are being tested, Milton Friedman’s idea of “helicopter drop" is now being actively discussed among economists and policy analysts as the next possible tool to revive demand (See: Milton Friedman’s ‘Helicopter Money’ Is Looking Less Crazy).

Helicopter drop basically means higher government spending by increasing the monetary stock. The government deficit is not financed by borrowings, as normally happens, but by printing new currency. The newly created money can go directly to consumers or can be used to finance public work such as infrastructure projects. Adair Turner of the Institute for New Economic Thinking and former head of UK’s Financial Services Authority in a recent paper explored the idea in detail (See: The Case for Monetary Finance – An Essentially Political Issue). Ben Bernanke in a recent blog post called it a valuable tool, at least in theory (See: What tools does the Fed have left? Part 3: Helicopter money).

The basic idea is that if, for instance, money is transferred to the accounts of citizens, they will go out and spend it. This will help central banks achieve inflation targets and will boost economic activity. Demand for higher government spending in advanced economies is not new, especially when interest rates are at near zero or are in the negative. Martin Wolf of the Financial Times, for example, in a column said that austerity obsession in advanced economies is lunatic and called for greater boldness (See: Helicopter drops might not be far away). There is widespread support for helicopter money among commentators in the Western world. Economist Anatole Kaletsky, who has beautifully put together the moving parts of the current debate in monetary policy on Project Syndicate noted: “Helicopter drops would not only be more effective than conventional monetary policies; they would also create fewer financial distortions, economic risks, and political protests" (See: Central Banking’s Final Frontier?).

Essentially, it is being argued that a helicopter drop will work better than other unconventional monetary policy tools such as negative rates and quantitative easing as they create financial market distortions and increase inequality by pushing asset prices which benefits the rich.

But is that accurate? It is possible that helicopter money will also suffer from the same problem as other unconventional tools. Near zero or negative rates, quantitative easing and the possibility of a helicopter drop essentially suggest that something is wrong with the economy which is not getting addressed, irrespective of the amount of money being thrown by the central banks.

In such an environment, as Rajan said, consumers would want to save more because of uncertainty. The other big problem is that if governments get a licence to expand spending, it may be difficult to stop them which can have damaging consequences in the long run. It is perhaps time to accept that the problem is not necessarily monetary. It is possible that aging population and drop in productivity is affecting economic outcomes in advanced economies.

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