Why are helicopter drops off limits for modern central banks and governments? Why do central banks and governments prefer to buy assets from banks and the rich rather than send money to the masses? There are three major reasons:
- If the central bank simply prints money out of thin air and credits it to the people, then it suffers a loss. If the helicopter drop is sufficiently large, then the central bank may even become technically insolvent. Although this has very few technical implications for the functioning of a central bank, the political implications are significant. Opponents of the stimulus will latch on to the losses as a sign of monetary irresponsibility. The political implications and fear of loss of central banking independence may even have a negative impact on the economy. Understandably, central banks prefer to avoid such a situation. By buying financial assets, central bank governors can at least postpone losses for long enough that it becomes the next governor’s headache.
- If the helicopter drop is financed by a bond issuance by the government, then many market participants fear that the government debt will increase to unsustainable levels that cannot be paid back.
- If the helicopter drop is financed by a bond issued by the government and bought by the central bank, then some commentators fear that we will have crossed the rubicon into the dangerous world of monetised fiscal deficits.
I have written in the past on how these concerns are largely mistaken. But perceptions matter, not least because markets are reflexive. So the question is: How can we design a systematic program of helicopter drops that tackles the above concerns? The below is one possible solution:
- The helicopter drop should be financed by a perpetual bond issued by the government and bought by the central bank. The perpetual bond pays an overnight floating interest rate equivalent to the Federal Funds rate.
The perpetual nature of the bond means that the government will never have to pay it back. The floating rate paid on the bond means that interest rate risk on the central bank’s balance sheet is negligible and it can hold the bond at par value on its balance sheet. The central bank’s inflation target is left unchanged which means that fiscal deficits cannot be monetised without limit.