Should Bank start the helicopter?

Chinook helicopter Should the Bank of England just deliver Christmas bonuses from on high?

Lord Turner said on Thursday the headwinds facing the UK recovery are so serious, the UK authorities might have to throw away the rule book to overcome them, in both bank regulation and the approach to monetary policy.

Robert Peston debates the implications for financial regulation in his latest blog. Given that Lord Turner is one of two leading contenders to succeed Sir Mervyn King, I'm wondering what "still more innovative and unconventional" monetary policies might look like.

The outgoing FSA chief doesn't spell it out in his speech. But in the past, he has talked privately about the possibility of pure money financing of the deficit.

The most well known example of this is the so-called "helicopter drop". For example, the government could simply send every family in the country a one-off "Christmas Bonus" of £1,000, directly financed by money created by the Bank of England.

When a person's "private" comments have been mentioned publicly by so many different people, the word private rather loses its meaning. But it is fair to say that Lord Turner has never publicly proposed this kind of money drop, or suggested that it should happen right away.

Still, as I said on the 10 o'clock news last night, the fact that a man of Lord Turner's position and experience is even hinting at this kind of solution to the UK's problems might be thought to indicate how serious he thinks our position is.

Of course, it also reminds George Osborne that Lord Turner would not be a cautious or placid Bank of England governor. But I suspect he already knew that very well.

Manna from heaven?

Radical or not - would a helicopter drop actually work? To even begin to answer this question, we need to understand how this policy would differ from what the Bank of England is already doing, with its quantitative easing.

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We find ourselves - as Lord Turner more or less admitted last night - trapped in a nightmare where trying to do the right thing to strengthen banks has the paradoxical and wrong outcome of undermining economic recovery and further debilitating the banks”

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After all, on paper, it looks rather similar: the Bank of England is creating money electronically, then using it to buy government bonds or IOUs. Doesn't that amount to the Bank paying for a large chunk of government spending?

Supporters and bank insiders say there is a difference, because the Bank is not simply giving the money to the government. It is lending it, in exchange for a claim on the Treasury in the form of a gilt (government bond) which it buys on the open market more or less like everyone else.

But many economists would say this is not quite the difference it's cracked up to be, not least because both the Bank and the government are all part of the UK public sector (actually, the Bank is technically a private company, but for national accounting purposes it might as well be a public one).

In fact, the difference between quantitative easing and "printing money to fund the deficit" comes down to one thing: when and whether the money is paid back.

That is where the "helicopter drop" proposal comes in.

If you really want to understand all this, you should read David Miles' speech last month to the Scottish Economic Society (NB: If you're scared off by the graphs, just read pages 10-11.)

Showering money (file photo) How much of this more "unconventional" form of financing would get to the real economy?

Since joining the Monetary Policy Committee he has regularly made it his business to explain in his speeches what quantitative easing really is - and try to dispel some of the myths about how it works. The fact that he regularly does this suggests he does not think people understand it yet. He's probably right.

Prof Miles says the easiest way to think about a "helicopter drop" is as a lump sum temporary tax cut - or a one-off reverse poll tax - financed by new government bonds which are purchased by the Bank of England on the secondary market, but with all interest and redemption payments etc transferred back to the Treasury.

This is similar to quantitative easing, to the extent that it is one part of the government lending to and acquiring claims against another. It is also, as Prof Miles notes, similar in that it is reversible. The government could have a one-off tax increase, two years later, to get back the money that has been paid out, just the Bank can now sell back the gilts it has bought under QE.

For Prof Miles, the only real difference between QE and even more "unconventional" money financing is that, with QE, the terms on which the money is created "are flexible and sensitive to inflationary pressures" - whereas in the case of a helicopter drop, the terms are more open.

As long as Bank rate is near zero and the Bank of England buys new gilts to replace the ones that mature, quantitative easing looks an awful lot like a "helicopter drop". But as soon as the Bank starts raising interest rates and selling back those government bonds, the similarity with Zimbabwe starts to disappear.

Sky-high prices

For Prof Miles, this raises an obvious question: what, exactly, do we get out of a "helicopter drop" - or the bank just extinguishing all the gilts it has bought - which we do not get out of the policy we have now? For him, it can only be one thing: unwanted inflation.

The point of both QE and more "unconventional" policies is to create more economic activity and prevent deflation, in an environment in which private and public debts are being painfully brought down. Presumably, supporters of money financing would like the policy to be reversed or slowed down if it looks like it is simply creating inflation, with little or no positive impact on real activity.

But if so, that is also what the Bank is planning to do with QE.

In short: "Either money financing... is done in a way which pays no attention to the inflation consequences, in which case it is not a very attractive policy - or it is done in a way which is sensitive to the longer-term inflation consequences, in which case the differences with conventional QE largely evaporate."

Those of you have struggled this far might wonder whether, in an environment of massive private and public debts, a bit more inflation might not be such a bad thing. That is, after all, how a large part of the public debt built up during World War II was brought down.

It is also what many critics believe will ultimately happen as result of the drastic and unconventional tactics that the world's leading central banks have all taken in the past few years.

That is a subject for another day. But I think it would be hard to find anyone who supported a sharp and uncontrollable upsurge in inflation, as a way out of our troubles. Certainly not Lord Turner.

There are those who would like to see the inflation target raised or loosened somewhat. The key point is that this could also happen within the existing framework for QE. It's not clear - to David Miles anyway - that you get any extra benefit from resorting to a helicopter drop.

However, the Miles argument assumes that government borrowing might be the same, in either case. In fact, I think quite a few of those who talk about "pure money financing" of the deficit are really talking about a fiscal stimulus.

Lord Turner may well be right to say that the Bank and the Treasury will have to go further out of their comfort zone to get the economy back on track. But if so, many economists would say focusing all your unconventional attention on how government borrowing is financed misses the point.

For them, the point is not so much whether the money will ultimately paid back - but how and whether it gets through to the real economy.

Put it another way: it depends on how much the government is borrowing, and what it uses the money for. That is also known as fiscal policy. Even if Adair Turner does take over at the Bank of England, I suspect that will continue to be a job for the chancellor.

Stephanie Flanders Article written by Stephanie Flanders Stephanie Flanders Former economics editor

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  • rate this

    Comment number 182.

    180 1 question
    "Total nonsense ..."
    I did not mean to say this formula is correct - I personally think its rubbish, but if you look at the context of the discussion, I was using as an illustration to show that just because spending in an economy increases, it doesn't mean that prices automatically increase by the same degree. More often than not, output increases instead.

  • rate this

    Comment number 181.

    Truth is the only answer will be time, try this, try that. Maybe even sit it out, or have a really big war, which is very unappealing. But is not given the credit it deserves as opposed to Keynsian " new deal ". US recovery & growth had more to do with WW II than the "new deal".

  • rate this

    Comment number 180.

    "the formula MV=PQ - where M is money supply, V is velocity of money, P is prices and Q is output volumes."

    Total nonsense, equations / algebra / applied mathematics never have & never will apply to economics. They tried algorithms as a means of predicting market trends, it created the flash crash. They had to close the stock exchange, because the computers & dealers all sold in panic.

  • rate this

    Comment number 179.

    Helicopter money needs to be directed. Its no good showering the country with cash to buy cheap imports. Better to drop export coupons, redeemable at 50% of the value of goods exported. Make investments in exporting companies tax free. Close down bank casinos too.

  • rate this

    Comment number 178.

    176 Bradford
    "1. Isn't this level of QE experimental?"
    No the US already does it, see my comment 163 below.

    177 Eddy
    Yes that's kind of true, where I live (Reigate & Banstead) we have had new housing developments. As the houses have sold (for more realistic prices than current owners are willing to sell for), average house prices have fallen by £14,000 as a result.

  • rate this

    Comment number 177.

    The house price booms in recent decades did not coincide with corresponding increases in demand, nor did the crashes tally with fewer people needing places in which to live, did they?

    New build is only ever a small part of the market re existing stock anyway in the UK. It is the reluctance of existing owners to sell at true value which restricts supply.

  • rate this

    Comment number 176.

    171. Pleb
    1. Isn't this level of QE experimental? I don't know how you can say if "operated normally" when we have not had previous experience like this.
    2. Probably recapitalise would be a better word. If "Banks don't lend reserves" then how did their reserves become depleted by the failure of loan market ?
    3. Our debts are owned by China etc, selling more goods to them would be a start !

  • rate this

    Comment number 175.

    creating a housing shortage so creating a large homeless class in order to overinflate house prices is a recipe for revolution
    However social housing building in UK at the moment would not have a huge effect on house prices because the people who would occupy them are not from the owner/occupier market. Private landlords who charge exhorbitant rents would be the big losers

  • rate this

    Comment number 174.

    Any move that lowers the value of the pound and allows us sell our stuff would surely help? Giving money directly to individuals either allows 'us' to pay down debts now, or simply spend the money to survive, depending on how you currently stand seems a better way of getting the economy roling than giving to the banks simply to hoard yet again.

  • rate this

    Comment number 173.


    If the govt started to build more houses it would result in lowering demand which would in turn bring prices down which would basically screw many people who are relying upon their house value not going down..

    Sadly the govt and banks have ensured that we are all going to be stuck in the mire for a long time to come!!

    Only the rich will escape.

  • rate this

    Comment number 172.

    why cut the welfare system,,, increase tuition fees,,, cut the credit to private businesses,,, and then come up with this kind of funny idea. isn't it just the same?
    instead of giving money to people/businesses who need it now they want to give it to everyone.

  • rate this

    Comment number 171.

    1) QE (operated normally) doesn't increase the long term money supply so even within your economic view can't be said to be a permanent debasement of Sterling
    2) QE increases bank reserves, banks dont lend reserves, QE is supposed to encourage them to lend other money, also see @165
    3) growth is (effectively) spending, someone must spend if we're to have growth, the argument is who

  • rate this

    Comment number 170.

    OK. QE/helicopters have not yet led to undue inflation (although I find it difficult to see how anyone can argue that it's not inflationARY per se).

    However, are you really happy to see/do you think it's fair that your purchasing power is taken from you and is transferred to banks/financial assets? Without your permission?

    Beats me how anyone (except a govt) can be happy with that situation.

  • rate this

    Comment number 169.

    don't understand what you mean by bogeyman. Are you suggesting increasing the money supply is harmless?

    They've created a "printing money is bad" meme, they then describe things as printing money to deliberately frighten people.
    Manipulating money supply is a normal function of fiat currency management, it can be done appropriately or inappropriately with good &/or bad consequences

  • rate this

    Comment number 168.

    1. Quantitive easing will eventually rob everyone who has sterling assets or is paid in sterling by debasing the currency
    2. The QE is being used to recapitalise the banks (they are not lending it out but holding onto it) which is why there hasn't been inflation so far
    3. Spending in itself is not a solution to our economic malaise its a short term fix to bribe the electorate & gain / keep power

  • rate this

    Comment number 167.

    @164 Franco
    The UK QE has been used for designated purposes. The first tranches were used to buy Govt & other debt. The designated purpose for the last tranche announced early 2012 will find its way into the economy & could, eventually, cause inflation but that is some way ahead.

  • rate this

    Comment number 166.

    @164 Franco
    'Printing money is inflationary - that's obvious, surely.'
    ~ ~ ~
    Not necessarily. Printing money & handing it to consumers who all want to buy the same thing & that 'good' is in limted enough supply then it will create inflation. If QE went to food processors specialising in wheat products & to beef farmers, then current price of wheat would rise even further.

  • rate this

    Comment number 165.

    164 Franco
    Your idea comes from the formula MV=PQ - where M is money supply, V is velocity of money, P is prices and Q is output volumes.

    Assume V is constant: when M increases, it causes a combination of a rise in P and a rise in Q (output). When the economy is not at full capacity, it is mostly Q that rises not P. As businesses respond to greater demand by increasing output more than prices.

  • rate this

    Comment number 164.

    Re 161. Charles Jurcich - QE ... in Japan did not create excessive inflation, nor would it ... so long as the economy ... is not at full capacity. QE does not create inflation, but excessive deficts might when at full capacity.

    Printing money is inflationary - that's obvious, surely. Of course, there may be deflationary effects at the same time. Still doesn't excuse it, imo - it's still theft!

  • rate this

    Comment number 163.

    159 Golden Bear
    "Firstly, god help us if Lord Turner heads the BoE!"

    Why, this is exactly what the US Federal Reserve has been doing from the outset - returning interest payments it receives back to the Treasury. Not seeing any inflation threat in the US.


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