Tuesday, July 26, 2016
Helicopter money, Canadian-style
Proponents of helicopter money have been getting a lot of press lately, but I don't really get what all the excitement is about. I live in Canada, and no nation is closer to implementing helicopter money than mine. But if I work through the basic steps involved in implementing Canadian helicopter money drops, I'm underwhelmed. As far as I can tell, deploying loonie-filled CH-147 Chinooks just doesn't do anything that other government tools don't already achieve.
Helicopter money means using the nation's central bank to fund government spending. If a government wants to spend money, it typically auctions bills and bonds to the public and uses the money to fund programs, all the while paying interest on the debt it has issued. Cue the helicopter money advocates: why not have a central bank create money from scratch and gift it to the government for spending? This certainly seems to be a more stimulative approach than regular debt-funded government spending. The added bonus is that the government gets to provide extra services to people without having to pay interest on bonds.
As I said earlier, Canada is the closest nation to implementing helicopter money. This is because the Bank of Canada is permitted to credit the government's account with newly printed money by direct purchases of Federal government bonds at government debt auctions. Canada is unique in this regard; the U.S., Europe, U.K., Japan and most other central banks have set up a fence between the nation's central bank and its executive branch that prevent the latter from financing the former. Central banks can acquire government debt, but they can only do so by buying from the private sector in the second hand market for bonds, i.e. *after* the public has first acquired government debt. This means that central bank can't create new money for the government; they can only create new money for the public, specifically banks.
Ok, so what—the Bank of Canada has no fence. While it can provide new money directly to the government, this money is free, right? After all, in order to get its hands on the funds the government still has to provide a bond to the Bank of Canada and pay interest on that bond.
But this ignores the fact that the Bank of Canada is owned by the Federal government and therefore pays all its profits to the government in the form of dividends. Thus any interest that the Federal government pays to the Bank is simply returned to the government. So the lack of a fence between the two institutions really does mean that the Bank of Canada can gift the Federal government with free money. The Bank buys new government bonds at government bond auctions, creates fresh money for the government, and re-gifts all interest it receives back to the government.
Not only does Canada lack a fence between central bank and government, but it has been making extensive use of this feature for the last five years. In 2011, the government announced a measure called the Prudential Liquidity Management Plan (PLMP), the goal of which was to increase Federal government cash reserves by an amount sufficient to cover at least one month of net projected cash flows, or around $35 billion. The Bank of Canada was to directly supply around $20 billion of this amount.
To understand how it went about this, consider that the Bank usually buys around 15% of each government bond auction. It does so in order to maintain the size its existing portfolio of government bonds. After all, bonds are always maturing and need to be 'rolled over' if the funds are to stay invested. By raising the proportion of new Government of Canada bonds that it directly purchases at government securities auctions from 15% to 20%, the Bank of Canada's rate of purchases began to exceed the rate at which bonds matured, thus leading to a steadily growing balance in the Government's account at the Bank of Canada. That's right; cue helicopter money.
The arrow on the following chart illustrates what the 5% increase in participation did to the liability side of the Bank of Canada's balance sheet:
Note how the Federal government's deposits (in red) have grown quite considerably as a result of the PLMP. By the way, if you are interested in more details on the PLMP, I've blogged more fully about it here and here.
Canada hasn't fully gone down the path to helicopter money. To qualify as helicopter money, the funds must not only be created but also be spent. While the Bank of Canada has loaded up the helicopters, the Federal government has not yet allowed any of the $20 billion to be rained down on Canadians. That is understandable since the PLMP was always supposed to be a rainy day fund.
But let's say it did deploy the helicopters. Imagine that next month Justin Trudeau, Canada's new Prime Minister, decides to spend the $20 billion in PLMP funds held at the BoC by mailing a $1000 check to every adult Canadian. Would anything out of the ordinary happen?
The heli drops complete, Canadians will deposit these checks in the banking system, either saving the funds or spending the funds. Whatever the case, the $20 billion that had previously been held in the government's account at the Bank of Canada does not disappear. It flows out of the government's account at the Bank of Canada and into the accounts that private banks maintain with the central bank. In the chart above, the entire red area would be replaced by a large jump in the green area.
The Bank of Canada pays interest to depositors at a rate that is quite close to the rate that the Federal government pays on treasury bills. Interest payments made to banks reduce the Bank of Canada's profits, which means that the dividend flowing to the Federal government is much smaller than if the helicopter drop had not been deployed.
In the end, the government ends up in the same position as it would have if it had funded its mailing of cheques with traditional bond financing. Consider the traditional way of doing things. Trudeau issues $20 billion worth of T-bills to the market at 0.5%, paying interest of around $100 million yearly. Canadians all get nice fat checks. If Trudeau instead routes his efforts through the Bank of Canada, it is the Bank that ends up paying $100 million in interest each year to private banks given a deposit rate of 0.5%. This in turn reduces government revenues by $100 million because interest costs reduce the size of the dividend that the Bank of Canada is able to pay. Either way—traditional financing or helicopter money—we get to the same ending point; Canadians get $20 billion to spend and the Trudeau government faces a cost of $100 million.
So there seems to be no difference between Justin Trudeau providing cheques to Canadian via helicopters or the regular bond-financed route. Why then are so many people quite keen on helicopter money? I'm not sure, but it could be that the advocates already know that helicopter money isn't special. Instead, helicopter money is just a way to get increased government spending without calling it government spending. Add a veneer of central bankishness to anything and it becomes sterile and boring, effectively removing any political charge that new spending brings with it.
Or maybe not, I could be missing some good reasons for why helicopter money is a truly unique tool. Feel free to correct me in the comments section, although please illustrate using Canada as your example; it's always easiest to work off of real world data.