The Federal Reserve just wrapped up its latest meeting this week. As expected, there was no change in its target rate range of 0.25% to 0.5%.
With all of the talk about rate hikes for well over a year now, the Fed has only managed to raise its key rate by one-quarter of a percent. It is leaving open the possibility for a hike at its next meeting in June, but we can expect some excuse on why it has to wait more.
Despite the low federal funds rate, the Fed has been in tight money mode with respect to the monetary base. The Fed has been keeping the base money supply stable since QE3 ended in October 2014.
This has not been the case in Europe or Japan. The European Central Bank and the Bank of Japan have been aggressive with monetary inflation, even experimenting with negative interest rates.
The ECB and BOJ are desperate for positive price inflation. But their policies are just making things worse by continuing to distort their respective economies.
It is also interesting that negative interest rates may be doing the opposite of what they intended, as some people are withdrawing their money and holding it tighter than ever. The weak economies and the policies of the central banks (which are linked) have created an environment of fear, which has only kept price inflation down in the short term.
There is so much desperation that there are some people suggesting that the ECB and other central banks try a policy of helicopter money. This is in reference to dropping money out of a helicopter, an idea originated by Milton Friedman.
The ECB — or any other central bank — would not literally drop money out of a helicopter, but find a way to directly inject new money into the system.
How Central Banks Create New Money
In order to understand helicopter money, it is first important to understand how the process works now. Let’s take the U.S. central bank as an example.
When the Fed wants to create money out of thin air, it will purchase U.S. Treasuries (U.S. government debt) from primary dealers, which consists of some of the big financial institutions.
The dealers buy the Treasury securities from the federal government — specifically the U.S. Treasury. The dealers will then sell these Treasuries or bonds to the Federal Reserve.
The dealers, which are big banks, do not actually get any of the new money, except for a commission. It is basically the same thing as if the Fed had bought the debt directly from the government. The dealers are middlemen that collect a small commission, although it is not that small when you are talking about billions or trillions of dollars being traded.
When the Fed purchases these securities, it does so by adding digits to the bank’s balance sheet that sold the debt.
As an example, the big bank (a primary dealer) buys $1 billion worth of U.S. Treasuries. The bank’s account balance goes down by $1 billion. Then the Fed buys the Treasuries for $1 billion. The bank’s account balance goes up by $1 billion, plus a small commission. The bank’s account balance is the same, plus the commission.
The government now has an extra $1 billion at its disposal. It collected $1 billion from the bank in exchange for a certificate (Treasury bond). The bank is in the same situation as it was before, aside from the commission. The Fed now owns the Treasury bond, but where did it get the money to buy it?
The Fed added digits back to the bank’s balance sheet through a computer entry. It created the money out of thin air, just like that.
Once the government spends the money, then this will end up in the hands of various individuals and businesses, which will most likely deposit this money into their bank. So the overall bank deposit money will go up, but the banks don’t technically own this money.
The banks can loan out some of this money (fractional reserve lending), but that has not largely been the case since 2008, as the banks have amassed a pile of excess reserves.
The Fed can reduce the money supply as well by selling its assets. This is the reverse of the same process.
As a side note, since 2008, the Fed has tried some monetary inflation by buying mortgage-backed securities instead of just government debt. In this case, it really was money given directly to the banks in exchange for their bad assets. Prior to this time, the Fed only owned U.S. government debt as far as we know.
Helicopter Money
The idea of helicopter money has had different meanings, but most people suggesting it now are thinking along the lines of the central bank just bypassing the government. Instead of creating new money to fund government deficits, the new money would go directly to people.
All monetary inflation redistributes wealth in some form. The early receivers of the new money benefit at the expense of the late receivers. Debtors can benefit at the expense of savers and creditors. Since the government is spending the new money, it tends to be those connected with the government who are the biggest beneficiaries. Of course, the inflation distorts the entire economy, so on net, it is destructive of wealth.
If new money were handed out directly to people, it would still be a redistribution of wealth, although perhaps not to as large of a degree. It would be impossible not to have that, unless you just added a zero to everyone’s money.
Would money be handed out based on how much you already have? Or would equal amounts be handed out to each individual? Would it include children?
While the whole idea sounds ridiculous, which it is, at least helicopter money would go to the people first instead of to the government to spend. In that sense, it might actually be less damaging than the current system we have.
There are a couple of things that make helicopter money unappealing to central banks and politicians. First, it means that politicians will have less money to spend if it is a diversion of the monetary inflation from funding the government to directly funding the people.
Second, it may be too direct and not complicated enough, which means people will see the silliness of the whole thing. It might demonstrate too clearly what a joke the whole system is.