The debate on whether central banks should ‘go direct’ and distribute “helicopter money” directly to the public keeps gaining momentum. A review of more than 30 academic papers covering 200,000 households in 20 countries show overwhelming and converging evidence that helicopter money will significantly boost the economy.
With interest rates at the zero lower bound, what tools does the European Central Bank have left to stimulate growth and keep inflation close to the 2% target? A recent report of the French Council of Economic Analysis – a government affiliated think tank, makes a bold case for adopting “helicopter money” as a last resort tool, in case of persistent low inflation.
Under “helicopter money”, central banks would distribute money directly to people instead of just buying more financial assets as they do under quantitative easing. In the Eurozone context, citizens could be given around 1000 or 2000 euros as a lump sum payment.
Positive Money Europe and other helicopter money advocates have long argued that such an approach would stimulate the economy more effectively and immediately than asset purchases. But is that really true? What if people just saved everything under their mattress? Or what if they spend too much, and push inflation out of control?
To answer these questions, we have examined more than 30 studies on the spending behavior of households who receive windfall gains, such as lottery prizes, tax rebates, stimulus checks, or other hypothetical payments.
The findings, summarized in this document, are overall based on more than 200,000 households in about 20 countries (Europe, US, Israel, Singapore). They rely on various methodologies, ranging from traditional surveys to cutting-edge macroeconomic modelling to the statistical analysis of confidential fintech data.
The results are unanimous. Consumers always spend a significant fraction, often between 40% and 70%, of the additional money they receive. We can thus reasonably expect that households would likewise spend a significant fraction of helicopter money, if the ECB did implement it.
The fraction of the windfall gains that households spend, also called the marginal propensity to consume (“MPC” in the economic jargon), depends on several factors, such as how much money would be distributed as helicopter drop, or the financial situation of the recipients. Here are a few findings from the literature
Smaller payments get spent more
First, not every household is the same. Some spend all their windfall gains. Others save everything. And yet others save a fraction and spend the rest.
Their spending response also depends on the size of the windfall gains. Obviously, the more they receive, the more they spend. However, the fraction they spend decreases with the size of the payment they receive.
A study of Norwegian lottery winners illustrates this point. The luckiest winners, who received 10,000 euros or more, spent about 50 percent of their prize within a year (and 84 percent after four years). By contrast, the less lucky winners, who “only” received 1,000 euro, spent everything within a year.
While a small helicopter drop of 1,000 euro would offer the most bang for the buck, a larger drop of 10,000 euro would still be effective. Indeed, 50 percent of 10,000 euro is still a lot more extra household spending than 100% of 1,000 euro!
Another determinant of the spending response of households is how “liquid” they are, that is, how much of their wealth is deposited in their bank accounts or invested in liquid assets (bonds, stocks, but not housing). Many studies show that less liquid households spend a larger fraction of their windfall gains. The most liquid Norwegian lottery winners “only” spent 45% of their prize while the least liquid winners, who presumably needed the money more, spent a larger 62% of their prize. These illiquid households tend to be poorer, but not necessarily. For example, a wealthy household who used all its savings to buy a new house could be as illiquid as a poorer household.
One surprising result is that there is no unanimous effect of wealth or income on the marginal propensity to consume. The study of Norwegian lottery winners finds that low and high-income winners spend a comparable fraction of their prize. While a few studies find that low-income households spend a larger fraction of their windfall, one study finds the opposite. Understanding better what precisely drives these contradictory results represents an exciting avenue for future research in this field.
Lottery winners may feel they have a license to spend and enjoy life. As a result, they may tend to spend a larger fraction of their gains. However, households who received more “serious” money, such as the stimulus checks sent during the crisis of 2008, 600$ per adult and 300$ per child, also spent a significant fraction of their windfall, between 50 and 90%. These checks seem to represent a real lifeline for some recipients, with much improved financial and mental health.
Unlike helicopter money, stimulus checks paid by fiscal authorities imply an increased public debt. Households who receive a fiscal stimulus check may thus be less inclined to spend their check, because they expect they will have to pay more taxes at some point to pay back the debt. This is the so-called “Ricardian equivalence” concept, which is still hotly debated among economists. However, with helicopter money paid by money creation by the central bank, we can conjecture that such Ricardian equivalence will be less at work, and that helicopter money will be at least as effective as debt-financed stimulus checks.
What if people spend too much?
While these studies give us confidence that a macro-economically significant fraction of helicopter money will be spent, a number of open questions remain. First, we do not know the exact inflationary effect of helicopter money. All economic theories predict that an increase in money supply will be inflationary. This would be desirable to help the ECB achieve its 2% inflation target, but there could also be a risk that inflation gets out of control.
The closest experiment we have to helicopter money is the stimulus checks sent by the United States in 2008 and 2020. It is impossible to determine with certainty what their inflationary effect exactly was, since we do not know what inflation would have been if these checks had not been sent. However, they do not seem to have caused hyperinflation, suggesting that the hyperinflationary fears associated with helicopter drops of comparable amounts may be exaggerated.
The limited risk of hyperinflation is confirmed by the recent report of the French Council of Economic Analysis. It predicts that a helicopter drop of 1% of GDP (about 385euro per citizen) would (only) increase inflation by 0.5%!
In either case, if inflation were to pick up above a reasonable level, the ECB could still increase its interest rates, or reduce its asset purchases programmes, to force the economy to slow down.
While there remains many uncertainties about the effects of helicopter money, the economic research is at least unanimous on one point: a significant fraction of helicopter money will always be spent. Without a doubt helicopter money would thus be a valuable macroeconomic policy tool for central banks to have at their disposal.
For the last decade, despite having introduced negative rates and expanded its quantitative easing programmes to 4 trillions, the European Central Bank has failed to deliver its inflation target of 2%. Continuing the current overreliance on asset purchase programmes will also expose the ECB to political constraints, risk of new legal complaints, and ultimately the risks of reputational damages on its independence.
Under its ongoing strategy review, the ECB is now considering adjusting its inflation target regime in order to tolerate inflation somehow above 2%. However, whatever new inflation target the ECB choses, it will lack credibility if it does not have better tools to achieve it.
If Christine Lagarde is sincere in her conviction that the European Central Bank’s strategic review should be open-minded and “turn each and every stone”, she must task the ECB to carry out an honest and thorough cost-benefit analysis of helicopter money.
Credit picture CC Suomen Pankki