Should the ECB Helicopter Adjust Its Dropping Zone?

“Let us suppose that one day a helicopter flies over this community and drops an additional $1000 in bills from the sky…” This pleasant image conveyed by Milton Friedman’s famous metaphor is taken to new heights by Mario Draghi, who promised to inject €60 billion of new money per month in the Euro Area! Unfortunately, Mario’s helicopter is not the same as Milton’s. Friedman made us dream of a helicopter dropping money all over us, Draghi chose a specific dropping zone: public and private debt markets! According to him, his targeted money drop, i.e. the ECB’s new expanded asset purchase programme, should strengthen Euro Area demand enough to bring about “a sustained adjustment in the path of inflation which is consistent with our aim of achieving inflation rates below, but close to, 2% over the medium term”.[1]

Draghi’s plan might work. Willem Buiter[2] recently provided a rigorous analysis of Friedman’s parable, extending it to the case of a central bank dropping money by buying sovereign bonds. Buiter shows that, under very plausible conditions, central banks can always use quantitative easing to boost aggregate demand, even in the severest of liquidity traps. He concludes that “helicopter money drops could raise aggregate demand and thus lift the economy from the ZLB [zero lower bound] floor.”

The ECB President, however, should not party too early. In practice, targeted money drops, like quantitative easing (QE), do not spread instantaneously throughout the economy. Like a vaccine, money is injected at one place and then disperses more or less quickly to other areas. Stephen Williamson[3] and Olivier Ledoit[4] have closely looked at how a money injection moves through the economy. They both use a model in which different economic groups trade randomly and repeatedly with each other. According to their results, the group that gets the initial injection of money will be better off than the other groups, but the difference disappears progressively as groups trade. The conclusion is that money injections have (at least) temporary distributive effects: they increase inequality if a richer group gets the money first, and decrease it, if the newly created money goes to a group that was relatively poorer.

What are the chances that these effects play out in the Euro Area and that the ECB’s recent targeted helicopter drop increases inequality? Ayako Saiki and Jon Frost[5] provide interesting insights on this based on their study of the impact of the Bank of Japan’s QE on income inequality. They find that the benefits of QE materialized mainly through capital gains, and were limited to stock and bond owners, which are typically upper income households. This resulted in a significant increase in income inequality in Japan after QE. The Euro Area might be different from Japan, but the potential distributive effects of QE have not remained unnoticed at the ECB: The following reference from an October speech by Yves Mersch[6], member of the ECB Executive Board, is a case in point: “non-conventional monetary policy however, in particular large scale asset purchases, seem to widen income inequality, although this is challenging to quantify.”

Fortunately, an increase in inequality through QE is avoidable. As suggested by Williamson’s and Ledoit’s models, the crucial question is: which groups get the initial injection of money? If it goes to richer households, inequality is likely to increase, but if it is the poorer households that get the new money, inequality may actually be reduced.

This is the starting point for what Mark Blyth and Eric Lonergan[7] propose! They argue convincingly that instead of dropping money on debt markets, central banks should change their target zone and “aim for the bottom 80 percent of households in terms of income”. For them, such a differently targeted helicopter drop would jump-start the economy by affecting “demand directly, without the side effects of distorting financial markets and asset prices”. As a result, it would be more efficient than traditional QE, and would allow central banks to print much less money than what they do now to achieve the same effects. It would also help reduce inequality by injecting money at the bottom of the income pyramid to the poorest households.

Against this background, it may make sense for Draghi’s helicopter to review its dropping zone. Or, at least, the pilots should explain to us why they are targeting the top of the pyramid rather than its bottom.