Is Japan Edging Closer to Helicopter-Money Policy?

Written By: Darren Morris – Corporate Finance

The government of Japan and the country’s central bank have signaled that there is a need for more monetary interventions to save the domestic economy from falling into a recession. Japan was already reeling under a deflationary condition that saw the Bank of Japan (BoJ) moving to cut interest rates and devalue the domestic currency. But those efforts have largely fallen flat, and the Brexit vote has somewhat complicated the picture for Japan’s monetary and fiscal regulators. As much as Britain’s Conservative Party has put its house in order and a new administration has been formed by Theresa May as prime minister, it will take time, possibly years, before normalcy returns to Europe. But a bumpy economic ride in Europe will increase pressure on the “safe haven currency”, the yen, to appreciate, thus further complicating economic-stimulation efforts by the BoJ. The stronger yen is resulting in lower prices for imported goods, which could prolong deflation.

Because of the turmoil that Brexit has created in the global markets, there is even greater incentive for the government to roll out more aggressive and unconventional policies to boost demand domestically. “Helicopter money” is one unconventional economic measure that the government and BoJ could consider, and there are already sentiments to that effect among Japanese authorities.

A more robust easing should boost demand for risk assets.

The labor market is tight.

A tight labor market also complicates a return to inflation in the Japanese economy. Labor unions have tended to be weak in their push for wage increases, thus dampening efforts to pull the economy out of deflation. Given the prevailing condition of the Japanese economy, the time looks ripe for the BoJ to deploy helicopter money to stimulate the economy.

The BOJ lowered interest rates in January in order to lower the yield curve to negative territory. But the move has largely backfired, raising the need for more robust easing measures, which is why helicopter money is gaining traction. Helicopter money is different than quantitative easing or traditional deficit finance in that it combines the elements of both—extreme fiscal relaxation and monetary easing.

What is helicopter money?

Helicopter money deployment is an alternative to conventional quantitative easing. It describes a situation whereby the central bank directly finances government spending with the primary aim of increasing the supply of money in the financial system. In the case of Japan, helicopter money may be necessary to create inflationary pressure that would go a long way toward creating more demand domestically. The failure of interest-rate cuts to spur growth has increased pressure on Japanese fiscal and monetary regulators to think of unconventional ways to pull the country out of imminent recession.

The major advantage of helicopter money.

Unlike conventional fiscal easing, helicopter money eliminates the potential crowding-out effect, or a situation in which the private sector raises its savings surplus. Money supply in traditional quantitative easing is typically a temporary measure because the central bank will afterward embark on shrinking the balance sheet. But in the case of helicopter money, money supply is considered irreversible.

The problem with helicopter money.

One major problem with helicopter money is that it creates accounting headaches for the central bank because there is no asset purchase to facilitate balancing of the accounting books. In traditional easing, a bond is registered in the central bank’s books when the money goes out, which doesn’t happen in the case of helicopter money. Although negative equity can be created to help balance the books of the central bank, the existence of negative equity raises many questions regarding the ability of the central bank to maintain the purchasing power of the currency.

Troubles for the Japanese economy.

The absence of inflation coupled with a stronger yen has tightened the monetary conditions in the Japanese economy. Expectations for price increases have continued to soften at both corporate and household levels. The BoJ could resort to unconventional helicopter-money policy because there are limits to which the central bank can acquire bonds as it has been doing in recent times as part of its easing measures. That leaves helicopter money as a viable way to jumpstart economic growth.

Although selling foreign exchange to plug a fiscal deficit is another option that the BoJ could take to spur domestic growth, the impression that this creates could further drive down public sentiment about the economic condition of the country. Nevertheless, Japan currently has more foreign exchange than it needs for imports.

When can the BoJ act?

A move by the BoJ to more robust easing policy will largely depend on the path of the yen. In the event that the yen continues to gain strength, the central bank may consider moving quickly to roll out more solid economic stimuli in the coming months. However, a weaker yen might see the BoJ take a gradual path to monetary intervention to stimulate the economy.

The path to helicopter money likely paved.

The landslide victory of Prime Minister Shinzo Abe’s coalition in the upper house of the Japanese parliament has lifted investor sentiment that there will be more monetary interventions by the government and BoJ acting in concert. With a stubborn yen, it appears that the BoJ could be closer to helicopter-money policy than ever. BoJ officials are scheduled to meet on July 28 and 29, when the issue of deploying helicopter money to jumpstart the economy is expected to be discussed, perhaps more broadly than before. Growing investor hope of helicopter money can be seen lifting equities as the Nikkei 225 has registered a series of gains in recent weeks, recouping the losses it suffered following Britain’s stunning move to ditch the European Union.

An impediment to helicopter money in Japan.

While Japan’s economy has reached the point at which more aggressive monetary easing is considered necessary to avoid falling into recession, helicopter-money policy is currently not legal in Japan. This is where Abe’s winning of the majority of seats in the upper house comes in handy. With these numbers, the government can push for constitutional reforms that will pave the way for the central bank to directly foot the government’s bill in the matter of helicopter money. As such, moving to helicopter-money policy depends on whether lawmakers will agree to modify Japan’s constitution to make the monetary-policy move legal.

Therefore, even as BoJ officials meet toward the end of this month, they may discuss helicopter money, but their hands will remain tied to take any action with regard to financing government spending directly. If lawmakers agree to modify the constitution to accommodate helicopter money, perhaps the earliest the BoJ could move to implement it is September or thereabouts.

Japan needs bold stimulation of the economy.

In the case of Japan today, it doesn’t matter as much how but when monetary regulators will move to stimulate economic growth. It could be helicopter money or more quantitative easing or quantitative easing coupled with qualitative easing—what the market is looking for is when such measures will happen.

The reform of the constitution to put helicopter-money law in place and the trajectory of the yen will largely dictate the degree and speed of monetary-policy easing in Japan. When it comes to helicopter money, as is now widely expected given the failure of efforts such as interest-rate cuts, Japan is expected to do a softer version of helicopter-money policy to avoid ruining the economy in the long run.