The Opportunity Cost Of Helicopter Drops

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Tyler Cowen links to a Wolfgang Münchau post advocating helicopter drops:

I have argued in favour of a 'helicopter drop', even before the recent deterioration in economic growth and the outlook.

A helicopter drop means that the ECB would print and distribute money to citizens directly. If it were to distribute, say, €3,000bn or about €10,000 per citizen over five years, that would take care of the inflation problem nicely. It would provide an immediate demand boost, and drive up investment as suppliers expanded their capacity to meet this extra demand. The policy would bypass governments and the financial sector. The financial markets would hate it. There is nothing in it for them. But who cares?

The ECB has not run out of ammunition but the number of effective policy tools is clearly finite.

I criticized this view in many different ways, so today, I'll use the "opportunity cost" argument. First of all, the ECB never runs out of ammunition, as there is an almost infinite set of assets that they could purchase, at least in principle. Second, while some types of asset purchases would be controversial, obviously, a helicopter drop would be 10 times more controversial.

Münchau's proposal could actually be seen as combining two distinct policies:

1. First, buy up enough assets to hit your inflation target, no matter what it takes.

2. Then give the assets away to the public. This would be like if Norway were to suddenly do a helicopter drop of its Sovereign Wealth Fund onto the residents of Norway.

Since step 1 already solves the AD problem, step two must be evaluated separately, on its own merits. Unless Münchau thinks it would be a good idea for the Norwegian government to suddenly drop all of its assets on the Norwegian public, there is no argument for helicopter drops.

Suppose the ECB were to use the "whatever it takes" approach, and buy €X trillion in assets. Then it could move from OMOs to a helicopter drop by simply giving away these assets. So what's wrong with that? One problem is that if the ECB is actually successful, then interest rates may rise above zero. In that case to prevent hyperinflation the ECB would have to buy back much of the money that's been injected. But what would they use to buy back the money? After all, they've given away their bonds in a helicopter drop.

Instead, Eurozone governments would have to raise distortionary taxes in order to recapitalize the ECB. This is just another example of the basic proposition that if a fiscal action can only be justified on the grounds that it would boost AD, then it's completely unjustified. Obviously, the Norwegian government would never do a helicopter drop of bonds on classical public finance grounds, which means they should never do a helicopter drop of bonds.

Münchau does briefly address the option of buying bonds instead of doing a helicopter drop, but in a completely unsatisfactory fashion:

My second recommendation is about measures that should not be taken - policy gimmicks. These are decisions that get some people excited but will not lift the rate of inflation. For example, the ECB should not buy bank bonds, or indeed any other form of corporate bonds, or equity. The reason banks are not lending is not a lack of funding but the presence of too many toxic assets on their balance sheets. It would be much better to address this problem directly.

This makes no sense. If you were going to buy exotic assets, then the whole point would be to raise inflation (or NGDP.) That is, you'd want to buy enough to boost inflation up to target. So it makes no sense for Münchau to suggest the policy might fail to boost inflation. If it were not going to be pursued aggressively enough to succeed, then what would be the point of doing it at all? And of course bank lending is completely beside the point, and has no relevance for whether OMOs would boost inflation. OMOs are inflationary because they boost the money supply relative to demand, and that sort of OMO would be inflationary even in an economy where banks did not exist at all.

The opportunity cost of doing a helicopter drop is that you forego a much cheaper option, merely relying on a "whatever it takes" set of OMOs, which do not require distortionary taxes to recapitalize the central bank.

Here's one of those rare cases where the common sense of the man on the street is correct. Dropping money from helicopters really is too good to be true.

PS. The anti-helicopter drop message of this post should not discourage fans of eurozone reflation. A helicopter drop would be very politically contentious. In contrast, much more effective tools such as OMOs are less controversial, and also superior policy options. It's a win-win. I very much doubt the ECB would even need to buy exotic assets like stocks and corporate bonds; God knows the eurozone has plenty of public debt to buy.