In the third of a series on the Fed’s remaining monetary tools, Ben Bernanke says "helicopter money" should be on the table as a last resort, and he proposes solutions to some issues implementation that would have to be resolved before it could be us...
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“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. Let us suppose further that everyone is convinced that this is a unique event which will never be repeated.” (Milton Friedman, “The Optimum Quantity of Money,” 1969)
“The deflation speech saddled me with the nickname ‘Helicopter Ben.’ In a discussion of hypothetical possibilities for combating deflation I mentioned an extreme tactic—a broad-based tax cut combined with money creation by the central bank to finance the cut. Milton Friedman had dubbed the approach a ‘helicopter drop’ of money. Dave Skidmore, the media relations officer…had advised me to delete the helicopter-drop metaphor…’It’s just not the sort of thing a central banker says,’ he told me. I replied, ‘Everybody knows Milton Friedman said it.’ As it turned out, many Wall Street bond traders had apparently not delved deeply into Milton’s oeuvre.” (Ben Bernanke, The Courage to Act, 2015, p. 64)
In previous posts, I discussed tools that the Fed might use in response to a future slowdown in the U.S. economy. I argued that, even if the scope for conventional interest-rate cuts is limited by already-low rates, the Fed has additional policy tools available, ranging from forward guidance about future rate policies to additional quantitative easing to targeting longer-term rates. Still, so long as people have the option of holding currency, there are limits to how far the Fed or any central bank can depress interest rates.  Moreover, the benefits of low rates may erode over time, while the costs are likely to increase. Consequently, at some point monetary policy faces diminishing returns.
When monetary policy alone is inadequate to support economic recovery or to avoid too-low inflation, fiscal policy provides a potentially powerful alternative—especially when interest rates are “stuck” near zero.
However, in recent years, legislatures in advanced industrial economies have for the most part been reluctant to use fiscal tools, in many cases because of concerns that government debt is already too high. In this context, Milton Friedman’s idea of money-financed (as opposed to debt-financed) tax cuts—“helicopter money”—has received a flurry of attention, with influential advocates including
In this post, I consider the merits of helicopter money as a (presumably last-resort) strategy for policymakers. I make two points. First, in theory at least, helicopter money could prove a valuable tool. In particular, it has the attractive feature that it should work even when more conventional monetary policies are ineffective and the initial level of government debt is high. However, second, as a practical matter, the use of helicopter money would involve some difficult issues of implementation. These include (1) the need to integrate the approach with standard monetary policy frameworks and (2) the challenge of achieving the necessary coordination between fiscal and monetary policymakers, without compromising central bank independence or long-run fiscal discipline. I propose some tentative solutions for these problems.
To be clear, the probability of so-called helicopter money being used in the United States in the foreseeable future seems extremely low. The U.S. economy has continued to strengthen and is not today suffering from the severe underutilization of resources and very low inflation (or even deflation) that would justify such an approach; and, as I’ve noted, the Fed has other tools still available. Nevertheless, it’s important that markets and the public appreciate that, should worst-case recession or deflation scenarios occur, governments do have tools to respond. Moreover, with central banks in Europe and Japan struggling to reach their inflation targets, money-financed fiscal actions may receive more attention outside this country.
What is helicopter money and how does it work?
As I learned when I spoke about it in 2002, the imagery of “helicopter money” is off-putting to many people. But using unrealistic examples is often a useful way at getting at the essence of an issue.
The fact that no responsible government would ever literally drop money from the sky should not prevent us from exploring the logic of Friedman’s thought experiment, which was designed to show—in admittedly extreme terms—why governments should never have to give in to deflation.
In more prosaic and realistic terms, a “helicopter drop” of money is an expansionary fiscal policy—an increase in public spending or a tax cut—financed by a permanent increase in the money stock.
To get away from the fanciful imagery, for the rest of this post I will call such a policy a Money-Financed Fiscal Program, or MFFP.
To illustrate, imagine that the U.S. economy is operating well below potential and with below-target inflation, and monetary policy alone appears inadequate to address the problem.
Assume that, in response, Congress approves a $100 billion one-time fiscal program, which consists of a $50 billion increase in public works spending and a $50 billion one-time tax rebate. In the first instance, this program raises the federal budget deficit by $100 billion. However, unlike standard fiscal programs, the increase in the deficit is not paid for by issuance of new government debt to the public. Instead, the Fed credits the Treasury with $100 billion in the Treasury’s “checking account” at the central bank, and those funds are used to pay for the new spending and the tax rebate. Alternatively and equivalently, the Treasury could issue $100 billion in debt, which the Fed agrees to purchase and hold indefinitely, rebating any interest received to the Treasury. In either case, the Fed must pledge that it will not reverse the effects of the MMFP on the money supply (but see below).
From a theoretical perspective, the appealing aspect of an MFFP is that it should influence the economy through a number of channels, making it extremely likely to be effective—
even if existing government debt is already high and/or interest rates are zero or negative
. In our example the channels would include:
- the direct effects of the public works spending on GDP, jobs, and income;
- the increase in household income from the rebate, which should induce greater consumer spending;
- a temporary increase in expected inflation, the result of the increase in the money supply. Assuming that nominal interest rates are pinned near zero, higher expected inflation implies lower real interest rates, which in turn should incentivize capital investments and other spending; and
- the fact that, unlike debt-financed fiscal programs, a money-financed program does not increase future tax burdens. 
Standard (debt-financed) fiscal programs also work through channels #1 and #2 above. However, when a spending increase or tax cut is paid for by debt issuance, as in the standard case, future debt service costs and thus future tax burdens rise. To the extent that households today anticipate that increase in taxes—or if they simply become more cautious when they hear that the national debt has increased—they will spend less today, offsetting some of the program’s expansionary effect.
In contrast, a fiscal expansion financed by money creation does not increase the government debt or households’ future tax payments and so should provide a greater impetus to household spending, all else equal (channel #4 above). Moreover, the increase in the money supply associated with the MFFP should lead to higher expected inflation (channel #3)—a desirable outcome, in this context—than would be the case with debt-financed fiscal policies.
the central bank prints money and gives it away—so-called “people’s QE
.” From a purely economic perspective, people’s QE would indeed be equivalent to a money-financed tax cut (Friedman’s original helicopter drop, although perhaps more targeted). The problem with this policy, which would certainly be illegal in most or all jurisdictions, is not its economic logic but its political legitimacy: The distribution of what are effectively tax rebates should be subject to legislative approval, not determined unilaterally by the central bank. I’ll return to the issue of MFFP governance in a moment.
the Fed (and other central banks) routinely pay interest on reserves
implications for the implementation and potential effectiveness of helicopter money
. A key presumption of MFFPs is that the financing of fiscal programs through money creation implies lower future tax burdens than financing through debt issuance. In the longer run and in more-normal circumstances, this is certainly true: The cost to the Treasury of spending increases or tax cuts – and thus the future tax burden – will be lower if the Fed provides the financing. In particular, when the Fed’s balance sheet has shrunk and reserves are scarce again, the Fed will be able to manage short-term rates without paying interest on reserves (as it did traditionally), or in any event by paying a lower rate on reserves than the Treasury must pay on government debt. In the near term, however, money creation would not reduce the government’s financing costs appreciably, since the interest rate the Fed pays on bank reserves is close to the rate on Treasury bills.
To the extent that that coordination is successful, some worry, it might put at risk the longer-term independence of the central bank. Another concern is that the option of using money finance might be a “slippery slope” for legislators, who might be tempted to use it
to facilitate spending or tax cuts when such actions no longer make macroeconomic sense
Should the Fed act, under this proposal, the next step would be for the Congress and the Administration—through the usual, but possibly expedited, legislative process—to determine how to spend the funds (for example, on a tax rebate or on public works). Importantly, the Congress and Administration would have the option to leave the funds unspent. If the funds were not used within a specified time, the Fed would be empowered to withdraw them.
 Ken Rogoff has discussed the costs and benefits of eliminating paper currency, at least bills of large denominations. I won’t discuss that or related options, like taxing currency, here.
 Under normal circumstances, expansionary fiscal action leads to higher interest rates, which tend to reduce private spending and investment. This “crowding out” effect diminishes the net impact of the policy on output and employment. However, if interest rates are “stuck” at or near zero, say because monetary policymakers are constrained by the lower bound on rates, then the crowding-out effect is avoided and fiscal action is more effective.
 In his development of the concepts underlying special relativity, Albert Einstein resorted to gedankenexperimenten—thought experiments—about hypothetical trains and elevators moving at high speeds in empty space. These examples helped Einstein build intuition, and their improbability did not detract from their usefulness in thinking about the actual physical world.
 Friedman’s example corresponded specifically to a money-financed tax cut. Like most contemporary proponents, I’ll include money-financed public spending under the heading of helicopter money.
 In other words, I am assuming here that the economy’s problem is a shortage of aggregate demand. An MFFP would not be helpful, and could well be counterproductive, if slow growth arises from other factors, like weak productivity performance.
 By “tax burdens” I mean actual tax payments to the government. It’s true that higher inflation acts as a de facto tax on money holdings, but that tax becomes relevant only if actual inflation rises, which would be a sign that the program is achieving its goal of stimulating spending.
 In a so-called Ricardian economy, in which households have perfect foresight and are able to borrow and lend freely, a temporary tax cut would be predicted to have zero effect on consumer spending. In this idealized economy, households recognize that the tax cut makes them no better off, since the extra funds received via the tax cut just equal the present value of the increase in their future tax obligations. Empirically, the offset of expected future taxes against current income appears to be much less than complete, that is, tax cuts affect household spending at least to some extent, even if debt-financed. In contrast, fiscal spending (as on public works) affects output and incomes even in a perfectly Ricardian economy.
 Specifically, the Fed now sets a target range for the federal funds rate, with the floor of the range corresponding to the so-called reverse repo rate paid to short-term investors with the Fed and the ceiling corresponding with the interest rate the Fed pays on bank reserves. Fed policymakers have indicated that they would like to return to the traditional method of managing the federal funds rate in the medium term.
 Presumably, in scoring an MFFP, the Congressional Budget Office would recognize that the $100 billion program involves no increase in debt or financing costs.
 This statement is not precisely true, in that one can imagine independent monetary and fiscal choices that, taken together, are equivalent to an MFFP. For example, ordinary fiscal policy actions together with a credible increase in the central bank’s inflation target could in principle provide similar stimulus to an MFFP. Part of the rationale for an MFFP, however, is that legislators may be reluctant to take independent fiscal action when the government debt is initially high; in that situation, explicit coordination between the fiscal and monetary authorities seems essential.
 The amount the FOMC allows in the Treasury account would also be the base for the bank levy described just above. So the two proposals of this post fit together nicely.