Speaking at a news conference after the Federal Open Market Committee meeting, US Federal Reserve Chairwoman Janet Yellen stated that ‘helicopter money’ could be considered under certain conditions. This experimental monetary policy “is something one might legitimately consider. I would see this as a very abnormal, extreme situation”, Yellen said.

In Japan, with currency intervention effectively off the table for fear of accusations of being a currency manipulator, there is increasing speculation that the Bank of Japan (BoJ) may pursue further monetary policy experimentation. ‘Helicopter money’ could offer the BoJ a means of increasing the supply of yen vs. other currencies.

Nikko AM’s Multi Asset team has previously written about our concern that monetary policy is reaching the limits of its effectiveness, particularly when considering zero and negative interest rate policies and quantitative easing (QE). However, we believe that ‘helicopter money’ could actually prove effective. But it comes with significant risks.

‘Helicopter money’ is more directly supportive than QE

‘Helicopter money’ is essentially a cash transfer from central banks to the general population. The central bank creates new money and deposits it in people’s bank accounts, either through direct transfers or tax rebates. The hope is that this will encourage the population to spend, thereby increasing aggregate demand and spurring growth in the economy.

Central banks hope the direct route of ‘helicopter money’ will prove more effective than the more circuitous route of QE, which requires the added liquidity to be recycled through banks in order to reach the population. This seems like a reasonable assumption to us. If you suddenly received a few thousand dollars in your bank account, there is a good chance you might spend it.

However, there is also a risk you might just save it. If your government is in austerity mode, cutting spending and raising taxes, then the chances of you saving it increase considerably. So to be truly effective, there has to be a sensible coordination between fiscal policy and monetary policy to maximise the chances that the ‘helicopter money’ does not simply disappear under the mattress. If a country can manage this type of coordination, then in theory ‘helicopter money’ has a reasonable chance of working.

Does this sound a bit too good to be true? Critics of ‘helicopter money’ say it will end badly as the permanent increase in the money supply will result in runaway inflation. Supporters suggest that this is already happening anyway because QE is presented as a temporary increase in the money supply, but in reality can sit on the central bank balance sheet for years.

However, the risk of a hit to consumer confidence is high

In the Multi-Asset team, we can see the benefit to consumers of taking this next step. But we have a nagging doubt that once central banks ‘cross the Rubicon’ of temporary to permanent, the risk of a hit to confidence rises considerably.

The financial system is founded on confidence. Fiat money, fractional-reserve banking and central bank experiments are all based on the premise that the people believe the dollar they earn is worth more than the paper it is printed on. If central banks suddenly start creating these dollars out of thin air in massive quantities, there is a chance that people will start questioning what that dollar is really worth. If this happens, the foundations start to shake and gold is likely to become the asset of choice. It is not possible to assess the odds of this happening, but our guess is it is much greater than zero.

In theory, ‘helicopter money’ stands a real chance of being effective in boosting consumption. That said, there are considerable risks to people’s belief in the value of money. We hope that central banks are considering all the potential ramifications before embarking on this new experiment.