“Let us suppose now that one day a helicopter flies over this community and drops an additional $1,000 in bills from the sky, which is, of course, hastily collected by the members of this community. Let us suppose further that everyone is convinced that this is a unique event which will never be repeated.” This thought experiment developed by the US economist Milton Friedman in 1969 appears to be experiencing a renaissance in these days. Behind this is the assumption that there is a close relationship between inflation and deflation and the amount of money people have in their account, as well as the question of whether a one-time financial injection has a positive effect on the economy.
It is clear that, for the European economy to avoid falling from a nominal interest rate of zero and very low inflation into a deflationary spiral, new strategies are needed. “At the moment the ECB’s monetary policy options for investment incentives are shrinking,” states Professor Michael Neugart, Head of the Institute for Public Economics and Economic Policy at TU Darmstadt. The expert, who has analysed the effects of helicopter money in his latest study together with Dr. Uros Djuric, believes the instruments at the disposal of the central bankers in Frankfurt have been exhausted. Until the economic crisis of 2007, lowering the nominal interest rate was considered to be a standard tool for reviving the economy. For the lower the interest rate, the greater the willingness of business banks to borrow money from the ECB and to pass on the favourable terms directly to their customers. Companies subsequently invest, saving becomes unattractive because of low interest rates and people buy consumer goods.
However, this base rate cannot fall below zero. Currently it is zero, which means this option is no longer available to the ECB to pump money into the economy. Instead it has resorted to buying up government bonds in the bond market, a strategy which is controversial, because it could be a form of hidden state financing. The Federal Constitutional Court has already set limits for this reason: The ECB may only hold less than one third of all of the government bonds issued by the country concerned. Here too the limit is therefore in sight.
Instrument “Helicopter money”
“It is no surprise that people are thinking again more or less out loud about unconventional instruments such as helicopter money,” explains Neugart. However, the fascinating question being asked not only by the economists of TU Darmstadt is: Would it actually be good, beyond its metaphorical meaning, for providing a boost to the stagnating economy in the eurozone? And would it have a positive impact on people’s buying behaviour and therefore on prices and inflation?
Currently experts are discussing two ways of distributing the helicopter money among the people. In the first method, the governments of the EU member states receive money from the ECB and pass it on to their citizens, for example by way of a tax refund. However, as this is government financing not covered by the mandate of the ECB, the second method appears to be better: The ECB sends the money directly to the households by cheque or transfer.
Neugart and Djuric have considered both channels in their behavioural economic study. They wanted to know what the people would do with such a financial injection, what expectations they attached to the helicopter money and their opinion of it as an instrument of monetary policy. The experts compared four scenarios. In the first, the participants had to imagine that they and all other citizens in the eurozone receive a one-time payment in the amount of EUR 1,200 from the Ministry of Finance, financed by money from the ECB. In the second, that they obtain this amount in the form of a cheque directly from the ECB and in the third, that the EUR 1,200 is paid out in twelve monthly instalments. Scenario four – a lottery win of EUR 1,200 – served as the control group.
I am very sceptical whether an instrument which will more likely make the people uncertain and which possibly will have no effect on the inflation rate should be used.
All scenarios produced a central result: The interviewees would spend around 40 per cent of a windfall such as the helicopter money, put around a further 40 per cent in their piggy bank and use the remainder of around 20 per cent to repay their debts. What is interesting from the viewpoint of the researchers is that a phenomenon known as the “Ricardian equivalence” clearly does not apply here. According to this theory, people will act cautiously when they receive a monetary gift from the government, if the government has only borrowed the money itself. The fear that they will have to repay it sometime under these conditions results in such a payment not having any effect on consumption. “We did not observe this in our study,” explains Neugart.
The around 40 per cent which would be spent on consumption is considered by the researchers to be a very positive sign. “The helicopter money could perhaps help us to come out of recession initially. However, we cannot predict whether it will have a lasting effect.” Overall, the study proves that the spending behaviour in all helicopter scenarios would be no different than in the case of a lottery win. In addition, the majority of interviewees do not expect prices to rise as a result of such an instrument, nor do they expect it to have an effect on the overall economic situation. Instead, Neugart believes that the wide scatter of answers shows that many participants are uncertain, because they do not know what they are really dealing with with the helicopter money.
“Overall I am very sceptical whether an instrument which will more likely make the people uncertain, whose medial effect is not predictable and which possibly will have no effect on the inflation rate should be used,” stated the expert. He recommends a different strategy for solving the problems in the eurozone and backs fiscal policy measures which encourage investment in industries of the future such as road construction, mobility, the energy sector or digital infrastructure instead of an “ultra relaxed” monetary policy: “These are good opportunities to invest in and I would suspect that these projects have a return that is greater than zero.”
Data base and framework
The data used in the study “Helicopter money: survey evidence on expectation formation and consumption behaviour” of Uros Djuric and Michael Neugart originates from the representative panel of German Social Sciences Infrastructure Services (GESIS) e.V. In this mixed mode panel, around 4,900 participants aged between 18 and 70 were interviewed. The study questions were answered in the spring of 2016. At this time, GDP had risen compared to the previous year by 1.5 per cent, the unemployment rate had fallen further to 4.1 % and the inflation rate was 1.67 %.