The European Central Bank could turn to so-called helicopter money as a way of stimulating the eurozone economy in a future financial crisis, a former Irish central bank governor said Nov. 27, while acknowledging that political realities would present a high barrier to such a plan.
An actual program of helicopter money might not work as a method for distributing newly created cash across the eurozone, but a scheme based on the principle could, former Irish central bank Governor Patrick Honohan said in a speech at the Florence School of Banking and Finance.
"Scholars have debated the possible effectiveness of helicopter money and several have argued that it cannot really have that much of an effect. And I think that view is mistaken," said Honohan, who headed Ireland's central bank from 2009 to 2015.
The notion of helicopter money was introduced in 1969 by U.S. economist and statistician Milton Friedman, who suggested that people would likely spend money dropped from a helicopter and therefore that doing so in a metaphorical way could prove an effective means of stimulus. The term gained widespread recognition much later, when Federal Reserve Governor Ben Bernanke mentioned it in a speech as an anti-deflationary policy tool in 2002.
Honohan said models that predict that helicopter money would have little impact on the economy assume that consumer expectations and spending behavior are fully adapted to any shock that has occurred and make a comparison based on a long-term equilibrium in the economy.
"But the call [for helicopter money] is not made at time when we are in a full equilibrium," he said. "It's made when the economy is far from equilibrium, and when many economic agents are ... constrained not by their lifetime resources but by liquidity constraints."
Such constraints are not taken into account in those models, Honohan noted.
But Honohan acknowledged that should the ECB ever suggest a monetary helicopter drop, it would likely be seen as exceeding its mandate and "entering into activities lacking democratic legitimacy, and a legal challenge, I expect, would be successful.
"But much the same effect could be achieved by an understanding between the governments and the ECB that the ECB would maintain financial market conditions through continued intervention in government bond markets to enable governments to make a needed coordinated expansion of spending to achieve the desired expansion of aggregate demand in the euro area, without this spilling over onto their cost of borrowing," he added.
"In its heart the call for helicopter money is a call for more expansionary fiscal policy. ... The independent central bank's role would be to ensure that it does not act in such a way that financial markets respond to the needed fiscal expansion by choking it off. Achieving this within the legal political structures of the euro area would be delicate and challenging but perhaps not impossible if it proved necessary, as it does not at the present moment, to bring inflation back on target. The moment has passed, but could come again," Honohan said.