From negative rates to helicopter money
Is Japan likely to be the first economy to opt for distributing cash as a temporary fiscal stimulus, also known as helicopter money?
Many developed countries continue to suffer from falling prices and a stagnant economy. Take, for example, Japan. In the 17 years between 1999 and 2015, consumer prices in Japan increased by 2.4 per cent, 1.6 per cent and 0.7 per cent in one year each, by 0.2-0.4 per cent in four, and declined in the other ten years.
After growing annually at an average of 10 per cent in the 1960s, five per cent in the 1970s, and four per cent in the 1980s, Japan has been growing at anaemic rates since 1991. After 1991, the economy has contracted in six years, grown by zeroone per cent in five, one-two in seven, two-three in four, and by 4.7 per cent only in one. Furthermore, the yen has gained in value from 360 per US dollar during 1949-1971 to around 100. Stopping it from appreciating further is proving to be a challenge. Export-oriented Japan suffers when the currency appreciates. Stimulating domestic demand and promoting growth are proving to be formidable challenges.
Bank of Japan (BoJ), the country’s central bank, has been trying to achieve its target of two per cent inflation without much success. Pushing interest rates down was expected to help stimulate demand as well as encourage capital outflows and stop the upward pressure on the yen. On January 29, 2016, BoJ announced that remuneration of -0.10 per cent would apply to any future increases in reserves. Banks would have to pay the central bank for keeping their additional money. Interest rate was negative. This was expected to encourage banks to extend more credit to clients.
Japan is neither a pioneer nor alone in introducing a negative interest rate. For over 14 months from July 8, 2009, Sveriges Riksbank, the central bank of Sweden, paid negative interest on overnight deposits. The European Central Bank (ECB) in the Eurozone, after not paying any interest for two years, started charging a penalty of -0.10 per cent on overnight deposit of banks from June 11, 2014. Before the end of the year, threatened by capital inflows and currency appreciation, Denmark and Switzerland, two neighbouring countries not in the Eurozone, followed with negative interest rates on selected instruments.
Negative interest rates entail lending ~100 today to receive less than ~100 at a future point of time. There are limits to which such rates can be negative. Hoarding cash, not only for saving households but even for businesses, with large cash flows and the consequent security and accounting problems, may become more attractive at highly negative interest rates. Furthermore, even in the Eurozone or Japan, allin-costs of bank loans are above zero for customers.
Zero or even negative interest rates may have delivered some results, but not spectacularly. Policymakers have been reminded of a metaphor attributed to John Maynard Keynes, namely, using monetary policy to fight a recession is like ‘pushing on a string.’ Grim expectations about the future, including even lower prices and less employment, income and demand, may act as a bind on consumption and investment. Central Bank’s monetary expansion may get caught in what Keynes called a ‘liquidity trap’ — further injections of cash may not reduce interest rates any further.
To fight the great recession, advanced countries have launched stimulus packages, and such packages have included almost all that is known to work in economics, including a supportive expansionary monetary policy. For example, Japan has been following ‘the three arrow strategy’ unveiled in December 2012 and named Abenomics after Prime Minister Shinzo Abe. It includes BoJ increasing money supply and weakening the yen, tax cuts and public spending to boost growth, and structural reform. Abenomics emphasises inclusive growth.
Now, beyond the standard macroeconomic tools, what remains is ‘helicopter money’. In 1969, Nobel laureate Milton Friedman in a celebrated paper said, “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 members of the community.” This idea of distributing cash came to be known as helicopter money. In 2012, US Federal Reserve Chairman Ben Bernanke had commented that helicopter money will “…certainly be an effective stimulant to consumption and hence to prices.”
Helicopter money can be seen as a temporary fiscal stimulus financed by a permanent monetary expansion. Is Japan the first advanced economy that is finally going to move from the standard economic prescription of fiscal and monetary stimulus to ‘helicopter money’?
Last Wednesday, Mr Abe announced that he will introduce a ¥28 trillion package to boost the flagging Japanese economy. It is equivalent to six per cent of the country’s gross domestic product (GDP). The “inclusive” stimulus package, whose details are not yet known, is likely to include ¥30,000 cash hand outs to each of the nation’s 10 million elderly poor, building more nursing homes for elderly care and public child care facilities, and making more temporary workers eligible for child care leave. A way to operationalise the idea of helicopter money would be to finance this additional government spending with a perpetual BoJ loan with zero rate of interest.
There is, however, no robust indication that it is the pursuit of helicopter money by Japan. Signalling such a policy would require the BoJ announcing a step-up in its policy of quantitative and qualitative easing (QQE). The BoJ, after its two-day meeting starting on Thursday, has not announced any such stepping up of its QQE policy.
The unease of BoJ and its Governor Haruhiko Kuroda with helicopter money is understandable. Friedman, while discussing helicopter money, has added an important assumption — “Let us suppose further that everyone is convinced that this is a unique event which will never be repeated.” But will it? There is the enormous risk that the government may get used to funding populist tax breaks and expenditure programmes with newly printed money beyond the recession, even in good times.