The U.S. experience should lead the way

Despite of the European Central Bank’s (ECB) accommodative monetary policy stance, Euro Area inflation expectations remain persistently depressed. Financial intermediaries’ interest rate margins have been squeezed and the secondary market for sovereign debt is running out of bonds. As a consequence more and more European economists call for a tool of last resort – helicopter money. A contribution by Michael Hüther for The International Economy, a specialized quarterly magazine.

Helicopter money means transferring central bank money directly to households, in order to stimulate nominal demand and thereby boost inflation. Helicopter advocates argue more money in the customers’ pocket will lead to more expenditures.

But will it work? The effectiveness depends on the quantitative difference between the substitution and the income effect, since the helicopter drop can be used for higher expenditures now as well as in the future depending on the households’ time preferences. To evaluate this net effect we are lacking empirical evidence. However, in light of ageing societies the substitution effect is expected to be highly relevant.

Basically, we have two main insights into helicopter money’s characteristics: first, transferring the same amount to every citizen (ignoring technical problems) will have distributional consequences. Although many people might like these – inequality would decrease – it is highly doubtful that we want central bankers with no democratic legitimization to decide about our redistribution scheme just like that.

Second, helicopter money can be expensive. Transferring 200 Euro monthly to every citizen’s account for one year would cost the central bank more than 800 billion Euro – 8 percent of the Eurozone’s GDP. Yes, the central bank can “just print” money at very low marginal cost, but helicopter money is central bank money not backed by assets.

Once the money is wired to the economy there is no possibility to reverse the helicopter drop in case of overshooting inflation. We have no experience in conducting helicopter money, but there is historical evidence that all big inflations were caused by central banks doing quasi-fiscal policy. This is why helicopter money is dangerous: We wouldn’t know where we are going, but for sure we couldn’t go back. To be clear on this: Central banking is not an experimental laboratory. We cannot rely on central bankers to decide our future. Monetary policy did its job, now it is the governments’ turn.

Instead of applying untested tools, the US policy experience should lead the way. Unemployment is down from 10 to now slightly below 5 percent and expected to decrease even further – growth forecasts look promising. America’s economic performance appeals exceptional not only in comparison with sluggish growth in Europe, but also given that the US financial sector was the origin of our generation’s most devastating economic crisis – less than a decade ago.

Bold state-driven recapitalization of major US financial intermediaries paved the way for the economic recovery and probably for the Fed’s monetary policy normalization in the medium term. Contrary, the European muddling through approach, experienced by Italian banks today, led to a weak bank lending still slowing down economic growth. Strengthening a second corporate financing channel, the capital market, is unavoidable in this context. The Capital Markets Union initiative goes into the right direction.

Right now, recapitalization of the Euro Area’s banking sector is the trigger to stimulate bank lending. Moreover, the introduction of risk weights for government debt in European bank capital regulation is necessary. The current approach with a zero-risk-weight creates a bias for banks away from lending to the economy towards financing governments.