Powerful weapon – helicopter money
So has the BOJ run out of options? We don’t think so. The central bank has yet to deploy its most powerful and, perhaps most controversial, tool – helicopter money.
An idea originally popularised by American economist Milton Friedman, helicopter money is defined as funding of fiscal expenditures via the creation of new base money and a promise that any increase in the monetary base will not be reversed.
Essentially, it means monetary authorities give people extra money in the form of a tax cut, vouchers or an increase in public spending. At the same time, the authorities make a "credible promise to be irresponsible"1 - pledging that they will not raise taxes at a later date to recoup this extra money. Assured that the extra money they receive will not be taken away later, people should then start spending that cash, boosting economic activity and inflation.
Let us suppose now that one day a helicopter flies over this community and drops an additional $1,000 in bills from the sky, which is, of course, hastily collected by members of the community. Let us suppose further that everyone is convinced that this is a unique event which will never be repeated.
Helicopter money scenarios
How can the BOJ engage in a helicopter drop of money? Much of the discussion on helicopter money has centred on former US Federal Reserve Chairman Ben Bernanke’s idea for a money-financed fiscal programme (MFFP). This would involve either an increase in public spending or a tax cut that is financed with newly printed money by the central bank.
However, in the case of Japan, years of fiscal stimulus have failed to boost domestic demand and lift inflation as the public increased their savings in anticipation of higher tax rates to come.
What makes more sense, in our view, involves a sort of debt cancellation. Former Chairman of the UK Financial Services Authority Adair Turner has proposed that policy authorities convert some or all of the central bank’s JGB holdings into perpetual non-interest-bearing bonds, in what we call Money-Financed Debt Relief (MFDR).
We propose a more radical option of MFDR – an outright write-off (see chart above).
Essentially, the central bank prints money to buy a government bond. It then writes it off.
At first glance, that might seem radical. But that option looks far less extreme when set against where current policies are heading to.
We propose a more radical option of MFDR – an outright write-off .
Assuming the BOJ’s debt buying programme runs into 2020 at the current pace, the BOJ’s total assets will have swollen to a record 150 per cent of GDP by mid-2020 (see Fig. 2). By then, its share of the JGB market will rise to a massive 63 per cent from 37 per cent today. Carrying on its purchases of exchange-traded equity funds at the present pace would take its share of Japan’s stock market – as measured by its total market capitalisation – to 10 per cent.
Cancelling even a small part of the public debt – let's say JPY10 trillion2 - can send a powerful message to the financial market and the wider public. In this case, the BOJ has permanently replaced JGBs with fresh base money worth JPY10 trillion.
We think MFDR should work well in highly indebted Japan. Debt write-offs will reduce the government’s outstanding debt and improve its credit profile. It can also promote private investment and consumption by incentivising businesses and households to reduce excess savings, leading to higher inflation.
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