The Difference Between Quantitative Easing and Helicopter Money

I just read a report from a major international bank this morning(who shall remain nameless) that claimed helicopter money was already being implemented in a few countries, herein defined as monetary financing of fiscal deficits.

This is wrong, and they’re confusing quantitative easing (QE) with helicopter money (HM). The difference between the two is more than just semantics, despite the superficial similarities between the two in largely involving central bank buying of government bonds.

The easiest way to show this is via an example. Let’s say the private sector has $100. The government wishes to borrow $50 to finance its spending. So the private sector buys $50 worth of government bonds, the proceeds from which the government uses to spend on goods and services. But that money goes back to the private sector, so the asset side of the private sector balance sheet now reads $100 cash and $50 in bonds. The private sector balance sheet has expanded, as has the government’s.

Now that we’ve set the stage, we can work out how QE and HM affects the economy.

Now let’s say the economy falls into recession and the central bank implements QE. It prints money, which it uses to buy up the $50 government bonds from the private sector.

What happens to the private sector’s balance sheet? There is no change in size – it’s still $150 – but there is a change in the composition of assets held by the private sector, which is now all cash. The main effect will be on the prices of assets, specifically government bonds, which have risen in price because of central bank buying. Since market interest rates are mostly pegged to government bonds, the yield curve falls and borrowing becomes cheaper, which allows for greater private sector investment and consumption. There might be an increase in the private sector’s assets (since central bank buying of those bonds drives up prices over and above their previous price), but the impact will be mostly on the yield, not the balance sheet.

How much of an inducement to spend this actually becomes depends a great deal on the degree to which businesses and households think greater investment or consumption is worth it (not always a given when demand is depressed), and how much cheaper borrowing costs fall. Nevertheless, QE is nothing more than an extension of normal monetary policy operations, except that it involves influencing the yield curve directly rather than through changing the central bank policy rate – useful when the policy rate is up against the zero interest rate boundary.

Let’s say that the central bank implements helicopter money instead. The government issues another $50 in bonds to the central bank, financed by printing money, which it then spends into the economy whether through cash transfers or investment or tax cuts.

What happens to the private sector balance sheet? It expands by another $50 to $200. Because no private sector resources are being used to finance the government’s additional purchases of goods and services, the private sector retains its previous cash and bond holdings, while at the same time benefiting from the additional spending by the government.

Even if you skip the intermediate stage (for example, direct crediting of private sector bank accounts by the central bank), the essential point remains the same – HM causes a one to one increase in the size of the private sector balance sheet.

From the foregoing, here are the salient points:

1. QE causes a change in the composition of private sector assets which may or may not increase the private sector balance sheet (we can assume the change is marginal), and the impact will largely be on the price incentives facing private sector agents;
2. HM on the other hand increases the size of private sector holdings of assets directly;
3. QE is a purely central bank operation, but HM is effectively fiscal policy and is as much a political decision as an economic one. Note also that HM implies a de facto increase in government borrowing and spending, while QE does not.

That’s why fears of the inflationary impact of QE are misplaced; it does not cause the phenomenon of too much money chasing too few goods, because it exchanges one asset (cash) for another (bonds). HM on the other hand directly places more cash in the hands of the public, and the inflationary impact can be taken as given (assuming a closed economy; the more open an economy, the more the impact will be on the current account and the exchange rate).

Even then, I think the central bank reluctance to pursue the nuclear option of HM is less on its potential inflationary impact, but more the subjugation of monetary policy to fiscal policy. Given the political dimension within fiscal policy, central bankers are right to be wary of losing their independence and the long term credibility of monetary policy by deploying HM.

In “normal” circumstances, monetary policy should act as an offset to fiscal policy – at full employment, fiscal stimulus must be met with monetary tightening, and fiscal austerity with monetary easing. Political pressure on monetary policy outside of the normal business cycle would result in greater booms/busts, and higher overall inflation, which would be at odds with most central bank mandates.

But to return to the main point: there is a big difference between QE and HM, even if the modalities look the same (monetary financing of fiscal deficits). The key to understanding the effects is not the amount of money being printed by a central bank, but how that money affects the composition and size of private sector assets.

One last point – you can pretty much achieve the same thing with fiscal policy as you can with helicopter money. Which should give countries like Japan room for pause, on whether HM will really be any more effective than what has been tried before.