“Helicopter Money”, the metaphorical term coined by economist Milton Friedman in 1969, has gained momentum in the discussion of what the BoJ’s next strategy may be. While there is no clear consensus on how Helicopter Money should be implemented, in theory it is the strategy of providing money directly to the private economy to boost consumption, therefore fuelling economic activity. It therefore circumvents the current issue: that money given to financial institutions through asset purchases does not enter the real economy. So far, Governor Kuroda has strongly refuted the idea of Helicopter Money, pointing to the fact that it is currently illegal under Japanese law. However, an ongoing poor performance of the Japanese economy have led economists and analysts to believe that it is an option they need to seriously consider. Mark Mobius, executive chairman of Templeton Emerging Markets Group, said in an interview with Bloomberg that he expects Kuroda to implement helicopter money as soon as next month. The benefits the new unconventional policy is aiming to achieve are clear to most, stimulating consumption by handing money directly to market participants.

The dangers, however, are more widely debated.

Raghuram Rajan, India’s central bank governor, been prominent with his criticism of the strategy. The first issue is the lack of control the Central Bank has over real money supply, as base money is expanded through the functions of financial institutions. Therefore, no one can fully predict the consequences of a release of fiat money into the private economy may have on money supply in the long term. In the worst case scenario, it could lead to hyperinflation as seen in Germany in the 1920s. Secondly, many assume that helicopter money will involve the BoJ giving more money to the government to distribute through fiscal policy measures, without an expansion of government debt. This bears the risk that the government will use this new power for political means, overstimulating the economy before elections, and targeting money for political purposes. Lastly, Rajan points out that Helicopter Money may, exactly like current measures, not ever fulfil their prime purpose – that of increasing consumer consumption. Helicopter Money as a policy communicates to consumers and investors that the BoJ is handing out large amounts of free money and, given the possible negative consequences outlined above, consumers which receive the cash benefits may be more inclined to save the money, rather than spend it, due to an uncertain economic future. Therefore, Helicopter Money may have weaknesses on both sides of the spectrum. On one it may lead to unintended overshooting of targets and therefore hyper-inflation and on the other hand, it may lead consumers to save more instead of less and strengthens current deflationary trends.

However, the success and side-effects of Helicopter Money will likely depend on the way it is implemented – opinions on this vary greatly.

One idea, which former Fed Chairman Ben Bernanke advocates, is to give controlled amounts of money to the government for investments in infrastructure. In this way, the money would reach the economy in form of higher employment and wages for workers in infrastructure sectors instead of free uncontrolled money to consumers or the government to spend as they wish. It would then create demand for construction firms to expand and invest, and reach consumers through higher incomes.

While this strategy may seem one to engage with further, one big issue remains.

Some factors always lie outside of the control of the government of central bank and artificially inducing liquidity to the market without a foolproof strategy to absorb it again if necessary can be very dangerous. We have seen cases where adding liquidity to the market has far overshot targets and lead to dire consequences. When the United States began quantitative easing, shortly after the global financial crisis, many emerging economies struggled to keep their currencies from appreciating greatly against the dollar. Especially Brazil used vast amount of resources to induce liquidity in their own market to keep the Brazilian Real down. When however, the United States successfully ended its expansionary policy measures and successfully managed to soak up excessive liquidity in in 2013 and throughout 2014, the Brazilian authorities were not able to do the same and the Brazilian Real went into freefall. With the current debate as to whether the Fed will hike interest rates any time soon, there is once again uncertainty about future strength of the dollar. Should Japan increase the money supply through more new, unconventional, and not fully understood measures, a rate hike and following appreciation of the dollar may have terrible consequences for the Japanese economy. Therefore, any future measures the BoJ will adopt, largely depend on the level of control they are able to assert over the money supply it creates. The benefits of Helicopter Money, should it ever come to play in practice, will depend on the way it is implemented.

Katharina Fleiner 26/08/2016

Japanese economic data remains discouraging

This morning, a new set of Japanese economic data, published by the statistics bureau, showed that the Bank of Japans expansionary monetary policy measures have not increased inflation, the main measure of economic activity, in Japan. The National CPI came in at -0.4% for July, exactly where it was a month before and now decreasing for the fifth month in a row. This adds to a growing cohort of data suggesting that current measures to end two decades of deflationary economic developments, by both the government and the Central Bank of Japan, are insufficient. Japans All Industry Activity Index for June came in at 1%, also flat from May’s figures. Industrial production in June decreased by 1.5% compared to the same month the previous year. GDP growth for the second quarter of 2016 stood at 0% compared to the first quarter of the year. The Nikkei Manufacturing PMI for August came in at 49.6. Although this figure is 0.3 points higher than July’s figure, it still represents a contraction in manufacturing activity over the month. There is little data, if any, to suggest that the Bank of Japan’s extensive quantitative easing program has done anything to increase real economic activity.

Japanese history of QE and why it hasn’t worked

After years of strong economic growth, the Japanese economy began to falter in 1990s and has since experienced the most prolonged period of slow growth and a deflationary economic environment. In 2012, when Shinzo Abe took office as Japanese prime minister again, he introduced an aggressive strategy including fiscal and monetary stimulus to drive the Japanese economy towards growth. Since 2013, his government has tried to boost the economy with ever greater fiscal stimulus packages, the latest and greatest of ¥28 trillion being announced last month, in response to the UK’s decision to leave the European Union and the possible adverse effects this could have on economic growth around the world. The Bank of Japan, under governor Haruhiko Kuroda, began implementing similarly aggressive expansionary policies. A round of quantitative easing of between ¥60 trillion and ¥70 trillion a year began in 2013. This was expanded to ¥80 trillion a year in 2014, where it has since remained. Interest rates were lowered to record levels. However, neither fiscal nor monetary stimulus has translated in an increase in real economic activity and has failed to help the Japanese economy recover targeted growth and inflation levels.

Why has Japanese growth not returned?

Many economists, analysts and for sure the BoJ have wondered why all this stimulus has not helped the Japanese economy to return to growth. Reasons may be intractable, however, there are some factors which definitely have had an influence.

QE does not always enter the real economy

Firstly, quantitative easing does not necessarily have to induce money in the real economy. The money is given to banks and other financial institutions through the purchases of assets by the Central Banks. It will then only translate into economic activity if companies and private households take out loans form these financial institutions to spend money in the real economy. This however, has to a large part not happened. Pressuring businesses to invest in expansions and therefore driving economic activity through low, maybe even negative interest rates, has some shortfalls. A business may not be inclined to see a business expansion as a viable investment in a deflationary economic environment, characterized by low demand. Investing more money, if at low rates or not, bares the risk of failing to achieve revenue growth, which could potentially drive a firm out of business. Therefore, in a particularly deflationary environment where businesses are aware that there is little demand for products, the incentive to produce more is low and the risks of doing so are high.

Japanese households save more and spend less

In Japan, there is one particular factor which adds to this crisis. Japanese consumers tend to save more and spend less of their income. It is debatable what has driven this generally observable trend, but the current demographic crisis Japan is experiencing could have some impact. The Japanese fertility rate has been decreasing since 1970, being consistently below 2.0 since 1975 and in 2012 it stood at 1.41. Similar developments have been observed in European countries, such as Germany, however not at such alarming rates. Less births mean less people growing towards working age and, with extending life expectancy, this adds up to a rapidly aging Japanese population. This can for one have a direct effect on productivity in the economy, for the other part also incentivises people to save for their later years, rather than spend their income now, as the likelihood of getting a good state funded pension decreases with a decreasing number of working, tax paying adults. While this may not be all the factors, as international influences, such as the global financial crises, which caused a, still ongoing, economic slowdown on a global scale, they can at least in part explain why current strategies to stimulate the economy have not had the desired effect.

How long can QE continue?

Furthermore, it has also been continuously noted, that the BoJ may be fast approaching its limit on current measures, as it is running out of assets to buy to fuel its massive quantitative easing program. With no more assets to buy, what can the BoJ do to still be doing something? Helicopter Money – The next step for Japan?

Katharina Fleiner 26/08/2016