Helicopter Drops - The Way Forward?

Eric Lonergan talks to Jeremy Stangroom about the advantages of directly transfering money to individual households to combat the effects of recession.

Stangroom

Can you say something about what the idea of a “helicopter drop” involves? It’s actually quite a simple notion, isn’t it?

Lonergan

It’s a very simple idea, and that’s part of its problem, I think - people tend to want grandiose solutions to grave problems.

The idea of a helicopter drop is simply that a central bank ought to be given the power to transfer cash to individual households. In a recession people become extremely pessimistic, and they want to save their money. The consequence is lower spending, lower profitability, lower incomes, and a negative spiral that results in unemployment and a lot of suffering. In this circumstance, the obvious solution is to give people more money to spend, and there are big advantages in giving a central bank the power to do this. That’s all the idea involves, really.

Stangroom

What do you see as the advantages?

Lonergan

There are many reasons why giving money directly to households would be preferable to the current system, which actually is fairly arbitrary, the consequence of a series of historical accidents.

The central banks were set up in the 1800s largely to do two things. They are called central banks because their original function was to provide liquidity to banks. If you deposit money in a bank account, you’re actually lending to the bank. But the bank only has access to a fraction of the money that it is lent, which means you’ve got big problems if everybody decides to withdraw their deposits at the same time – the bank just doesn’t have access to the money. The idea is if you get this sort of banking panic, then the central bank functions as a lender of last resort, providing the bank with liquidity, which allows the bank to give customers their money, thereby stopping the panic.

The other reason central banks were set up was to create a financing vehicle for the government. It makes sense for a government to borrow - perhaps, for example, to finance capital expenditure - and central banks provide a government debt market.

Essentially the core functions of central banks haven’t changed. They have the same tools available to them they’ve had since the 1870s. They can provide liquidity to banks, and they can buy government bonds. So quantitative easing, the buying of government bonds, is exactly what the Swedish central bank was doing in the 1870s.

Stangroom

“Quantitative easing” is a phrase we’ve become used to hearing. What exactly does it involve?

Lonergan

Quantitative easing is basically the printing of money. It’s a bit more complicated than that in practice – the government sells bonds to institutions such as insurance companies, and then the Bank of England prints the money, and buys the bonds. In effect, what they’re doing is buying government bonds by printing money.

In the 150 years since the creation of central banks more and more responsibility for economic policy has been given to them. Thirty or fifty years ago the idea was that you would use tax and spending to get out of a recession. Basically, the government would spend a bit more to counteract the pessimism of the private sector, and also cut income tax - with the effect that people’s disposable income would rise - to encourage consumer spending.

In principle, that’s fine, but the problem is that governments just aren’t very good at managing this process. They are incompetent for a number of reasons. First, there’s a political/electoral cycle – a government want to get re-elected, so it might cut taxes just at the wrong point, because it cares more about the election than the economy. This is one reason for boom/bust cycles. The other problem is that tax cuts and government spending involve large conflicts of interest – who gets the tax cuts, where do you spend and on what?

However, if you give autonomy to a central bank, you largely avoid these difficulties. In particular, the electoral cycle no longer has any significance. The beauty is that a central bank is made up of technocrats, not politicians, and they’re not influenced by the need to get re-elected when they make decisions aimed at smoothing the economic cycle. The other advantage is that it’s very easy for a central bank to make decisions. If the 12 members of the Bank of England monetary committee decide to cut interest rates, it can be done instantly, it just requires a meeting.

But there is a problem with all this: although central banks now have responsibility for managing the economic cycle, they’ve still only got two basic tools at their disposal – they can buy government bonds and they can provide liquidity to banks by changing interest rates.

So what I’m suggesting, now along with many other economists, is that we need to give central banks some new tools, such as the ability to transfer money directly to householders.

Stangroom

Is part of the problem now that the traditional tools have become ineffective, because there are significant deflationary pressures in place (in part to do with globalization)?

Lonergan

Absolutely. The tool with which people will be most familiar is the manipulation of interest rates. The trouble is interest rates changes don’t work if they are already as low as they can go, because there’s no extra stimulus to be found. In this situation, if you’re trying to encourage people to spend more, the obvious thing to do is to increase their income directly.

Stangroom

Why would that work? Might they not simply save any extra money they’re given?

Lonergan

Well, that’s a possibility, but actually I like the idea that you give people a choice. They should be able to choose what they do with the extra money. This is an ethical argument – people know best what their most immediate needs are. So rather than somebody in a central bank deciding whether people should borrow more or save less, people should really be deciding for themselves what they do with their money.

All the empirical evidence says that directly increasing people’s income will result in significantly more spending. Some people are in desperate need, so they’ll gladly spend. Basically, the evidence is that people on low incomes will spend nearly everything extra they get, because they have immediate needs. Economists talk about this group as being credit constrained. They can’t get a loan to make big purchases. People on higher incomes may spend less, because spending isn’t going to make as much difference to them, and some of that group might save any extra money they receive.

Stangroom

A potential ethical objection to a helicopter drop is that it rewards equally regardless of whether you’re deserving or not. So the person with two jobs is no more benefitted than the person who spends their day on the golf course. That might be seen to be unethical.

Lonergan

Right, in an ideal world, you would hope to reward the deserving. But rather than drawing the contrast with an ideal world, how about drawing it with what happens in the real world.

Economists have tended to make a complacent distinction between fiscal policy and monetary policy. But the truth is that monetary policy has the same distributional consequences as fiscal policy. If you change interest rates, then you’re going to favour particular demographics, and probably even particular geographies and parts of the income distribution.

At the moment what happens is that you arbitrarily favour some group – for example, borrowers – over another group – for example, savers. Imagine there are two families, one takes on a very large mortgage and the other thinks this is very risky behaviour, and then what happens is that you get a financial crisis, which simply wasn’t a factor in the thinking of the first family, but they end up being huge beneficiaries when the mortgage rates collapse. Or imagine the low income person, who spends their life saving small sums of money for their retirement, and then interest rates collapse, and all of the sudden there’s no retirement income.

Stangroom

Okay, but there is a difference here. If you’re a saver or borrower, then you contract in to varying interest rates, even into the possibility that a bank will go bankrupt. You were talking about consent earlier, and this seems relevant here. If you take out a mortgage, then you know that you might get hit by higher interest rates.

Lonergan

Well, there are things that you affect and things that you don’t affect, and it seems to me that desert is somehow linked to things you affect. No individual is able to affect interest rates, you really are subject to arbitrary movements. It isn’t clear that knowing the rules of the game is a big ethical difference.

But suppose you’re right, and there is this element of contracting in – it doesn’t seem to me obvious that people really contracted in to the possibility of zero interest rates. That fell outside of what had previously happened, what de facto would have seemed possible.

Take quantitative easing. It should not have been in anybody’s rules of the game calculation that the central bank would print money with the express intention of driving down interest rates, but this is what has happened, and it has had a direct distributional consequence.

Stangroom

The obvious objection to helicopter drops is that it will lead to inflation. As a child of the 1980s, one got so used to hearing that you can’t just print money. Wouldn’t directly increasing people’s income just result in people putting up their prices?

Lonergan

That’s a good question. Part of the problem at the moment is that central banks can’t actually reach their inflation targets. Clearly, it would be madness to increase people’s income directly if the economy was booming, but it isn’t – there’s a lot of spare capacity.

If you look at analogous policies, such as the tax rebates George W. Bush granted in the USA, which really were just cheques in the post from the government, and which happened at the same time as the US central bank was doing quantitative easing, you’ll find they don’t cause inflation. They help the economy to recover.

Also, this policy would be under the control of the Bank of England, and subject to its inflation target, so if there were any indication that it would be inflationary, they wouldn’t do it.

Stangroom

So what about exchange rates?

Lonergan

This is an unpredictable area. But even if it did cause a currency to fall, it wouldn’t necessarily be a bad thing – it could help an economy to recover.

My view is that giving money directly to households is just a fairer, more efficient, way of doing what we’re already doing. It has the benefits of fiscal policy, but with the advantage that it’s under the control of a central bank, so it can be done quickly and it’s separated out from political wrangling.

Stangroom

In political terms, the specific form of a helicopter drop can’t be decided by government, can it? I mean it’s hard to imagine a party getting away with campaigning on a promise to give everybody 3000 quid if they get elected!

Lonergan

Right. The division of labour is clear. It’s why governments have given control of interest rates over to central banks. What needs to be legislated on is the distribution rule – is every household going to get the same amount? And then the central bank decides when and how much. So the democratic accountability comes in deciding how you’re doing to handle the distribution. Do you want to favour the bottom 40%, for example? It makes sense that the government will decide on the distributional rule, but central banks should decide on the timing and how much.

Stangroom

It’s a simple idea, so why hasn’t it happened?

Lonergan

I think some of this is just an accident of history. When interest rates were between 5 and 15%, as they have been for much of recent history, there wasn’t a problem. The economy would respond to a change in interest rates and recover. The problem has come about because interest rates are so low.

There is also quite a lot of resistance to the idea. Mervyn King, for example, made noises about this being fiscal policy rather than monetary policy, which doesn’t make much sense, because there is no clear dividing line between the two. He also asked whether he could just give money to his friends - well, obviously not, because parliament would legislate on the distributional rule.

There is also a conservative impulse to the effect that money is too important to mess around with – we shouldn’t change the system. But I would say the existing system has already been breached pretty spectacularly if you’re printing money and buying government bonds to the tune of 20% of the GDP, and you’ve got zero or negative interest rates. You’re already messing with the financial system. In a way, giving a sum of money to people that equates to a 3% tax rebate is less radical than what’s been going on.

The inflation concern you raised is something that a lot of people mention. But then they were worried about that with QE, and it never became a problem. My guess is that we’re one recession away from this happening.

If the trend continues, and the next recession requires even lower interests rates, and they’re not available, then I wouldn’t be at all surprised to see it happening.

Stangroom

Is this idea gaining wider acceptance among economists?

Lonergan

I originally wrote about this in 2002 in the FT, largely because I had studied Japan, a country that has had this economic dilemma for a while. Two former members of the Bank of England monetary policy committee are now in effect advocating it. Two professors at Oxford are advocating it. And then you’ve got political economists such as Mark Blythe behind it.

The bank of England doesn’t have a Plan B at the moment. Interest rates are already at zero. It needs a Plan B. The current government could give the Bank of England the power. That doesn’t mean it would have to exercise it, just that it would have this extra tool at its disposal if things became really bad.