Whether Japan admits it or not, helicopter money – thanks to Ben Bernanke – is here, and the market’s reaction this week was simply the first stage of pricing it in, as confirmed by the biggest drop in the Japanese currency this century.
Incidentally, we are “confident” that the SEC will inquire whether Citadel- Ben Bernanke’s official employer – was actually short the Yen ahead of its employee going to Japan and advising the Bank of Japan what to do, and how to crush its currency. Obviously that would be a grandiouse, and criminal, conflict of interest.
We won’t be holding our breath, but while we wait here is a useful primer for all those wondering just what is coming, courtesy of Goldman Sachs, which explains the nuances of monetary policy’s endgame: Helicopter Money.
Q1: What does helicopter money refer to in the first place?
A1: Literally, it is a policy whereby the government or central bank supplies large amounts of money, as if it were scattering money from a helicopter. A more practical definition, however, is a policy whereby the central bank has primary responsibility for funding to facilitate more flexible and active fiscal spending by the government. The concept of helicopter money has been around for years. Professor Milton Friedman was first to propose the idea in 1969, and in the early 2000s then Federal Reserve Board Governor Ben Bernanke raised it as one prescription to prevent deflation.[1] Very recently, a July 13 Sankei Newspaper article suggesting Prime Minister Abe and his advisers were considering helicopter money sparked debate on the subject in Japan.
According to Adair Turner (former chairman of the UK FSA), there are two specific schemes: (1) the BOJ directly underwriting JGBs, and (2) converting JGBs purchased by the BOJ on the secondary market into zero-coupon perpetual bonds.[2]
The first scheme is referred to as monetization. This was actually done in Japan under Takahashi fiscal policy in the 1930s, which served as a model for Abenomics (see Q4 for details).
The second scheme, although not involving direct JGB underwriting, is in effect very similar to the first one because it is no longer necessary for the government to pay interest on JGBs or even redeem them.
Either way, it would theoretically allow the government to fund fiscal spending of any amount it deemed necessary. It can be thought of as the ultimate form of fiscal and monetary policy unification.
Q2: Why is this a hot topic in Japan now?
A2: This is closely associated with the fact that Abenomics, which has monetary policy as its central plank, is faltering. The BOJ, under Governor Kuroda, launched unprecedented easing in April 2013, with the initial aim of achieving 2% inflation in two years by doubling base money. It has now pushed back the timeline for achieving this inflation target to the end of FY2017, and we, along with many other observers, believe it will take even longer.
The core CPI (excluding fresh foods) fell into negative territory in the most recent reading in May 2016, at -0.4% yoy. The BOJ’s new core CPI (excluding fresh foods and energy), which the BOJ has emphasized recently as a gauge of price trends, also slowed to +0.8% in May 2016, after printing strongly at +1.3% in December 2015. On top of this, the 2016 shunto spring wage negotiations ended on a sour note for the BOJ too, even though it had hoped for stronger wage hikes.[3] The real economy, meanwhile, is sluggish, oscillating between positive and negative growth since 2015. .
We also think the BOJ’s unprecedented easing policy is approaching its limits. Qualitative easing (ETF purchase in particular), part of the BOJ’s three-dimensional monetary easing, still has relative scope for expansion, but many observers are skeptical about the sustainability of the BOJ’s quantitative target of increasing the monetary base by ¥80 tn a year through JGB purchases.[4] The negative interest rate policy introduced by the BOJ in January 2016 as well has been met with a critical eye not only by financial institutions but also the general public.
If Prime Minister Abe and his advisors are indeed giving consideration to helicopter money, as the Sankei Shimbun article suggests, this may indicate that they are also sensing limitations to the BOJ’s three-dimensional easing.
Q3: Is helicopter money legally feasible?
A3: It is prohibited, in principle, but there is a gray zone here. Article 5 of Japan’s Public Finance Law prohibits the BOJ from underwriting any public bonds. However it goes on to say that in special circumstances, the BOJ may be able to do so within limits approved by a Diet resolution.
The first sentence prohibits the underwriting of JGBs in principle. This is based on lessons learned from the bitter experience, under the Takahashi fiscal policy in the 1930s, of JGB underwriting by the BOJ leading to a complete loss of fiscal discipline and ultimately to hyper-inflation (see Q5). The gray zone is the proviso in the second sentence. “Special circumstances” are usually interpreted to be limited to JGBs bonds issued to refinance JGBs held by the BOJ, and not ones issued to support active government fiscal stimulus measures. However, proponents of BOJ underwriting tend to believe that this proviso can be interpreted more broadly to include a more active role for the BOJ in financing fiscal measures.
Q4: What kinds of benefits are proponents of this policy expecting?
A4: We believe proponents are focused on two main benefits. The first is the direct demand-generating effect that comes from the ability to freely increase fiscal spending with no concern over how it will be funded. While households may opt to direct this money into savings rather than spend it if the policy is only in place for a very short period of time, the possibility of consumption picking up increases the longer the policy is in effect.
The second benefit is the “announcement effect” targeting the markets generated by the decision itself to adopt a very radical policy such as the BOJ directly underwriting public debt, long considered taboo (see Q5). For the currency markets, we expect this policy to place a downward pressure on the yen.
Q5: What are the risks?
A5: The largest risk is that once helicopter money is adopted it may not be able to be stopped. If the markets take the view that the policy cannot be reined in, there is a risk the government and BOJ may trigger a substantial collapse in confidence in the yen, resulting in excessive currency depreciation.
Under the Takahashi fiscal policy of the 1930s, on which Abenomics is modeled, the BOJ actually took the step of underwriting JGBs. Then Minister of Finance Korekiyo Takahashi attempted to pull Japan out of a period of severe deflation by supplementing the weaker yen that accompanied the exit from the gold standard with aggressive fiscal stimulus via the underwriting of JGBs.[5] While the BOJ’s underwriting of public debt was also viewed as taboo at that time, Finance Minister Takahashi considered it just a short-term expedient, and planned to rapidly exit the policy once Japan had escaped the deflationary cycle.
The Takahashi policy breathed life into the Japanese economy, but contrary to the Minister’s intentions, the BOJ continued to underwrite JGBs unabated. After the assassination of Minister Takahashi in 1936, what started out as a short-term expedient became the fiscal norm and the fiscal deficit grew sharply, ultimately leading to hyper-inflation. While the era of militarism only further accelerated the loss of fiscal discipline, it all began with giving the government a really convenient tool of the BOJ’s underwriting of public debt.
While some promoting helicopter money highlight the possibility of building a framework that will ensure fiscal discipline, such as linking the policy to the inflation target, given past Japan’s experiences noted above, many including us are skeptical about whether or not an effective framework can really be built.
Q6: Is helicopter money likely to be used in Japan?
A6: While we think the overt adoption of helicopter money is highly unlikely in Japan, we see a possibility that the market could come to associate future large-scale fiscal and monetary policy mix as a step toward helicopter money.
As explained in Q5, the main reason why we think helicopter money is unlikely in Japan is that the BOJ is acutely aware of the difficulty of exiting such a policy once it has been set in motion. Governor Kuroda is a notable proponent of fiscal consolidation, and is in our view unlikely to agree to a policy that is highly likely to result in a future loss of fiscal discipline.
That said, the point at which helicopter money begins is extremely vague. The BOJ’s net purchasing of JGBs is currently running at ¥80 tn per year. Although these purchases are made via the market and therefore do not amount to the underwriting of government debt in the strictly defined sense, the economic principle is the same. The government issues bonds that are purchased by private sector financial institutions who quickly sell them on to the BOJ. In terms of fund flow, the only difference from the direct underwriting of government debt is that in this case the bonds pass through private sector financial institutions.
Accordingly, if the Japanese government decides to implement a massive fiscal stimulus package and the BOJ concurrently steps up three-dimensional easing (particularly if it increases JGB purchasing), we think the market could react as if this is a step toward helicopter money in all but name.
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And here are some schematics from Jefferies
