Minneapolis Fed, Report: Helicopter Drops and Liquidity Traps

“During the 2008 global recession, nominal interest rates in the developed world dropped to zero. Lacking the ability to further reduce nominal rates, central banks utilized new policy instruments to manage the ongoing liquidity trap. Among these, quantitative easing and forward guidance eventually became a part of the monetary policy toolkit.”

“When nominal rates again reached zero during the recession generated by the COVID pandemic, central banks continued to rely on these new instruments. Yet, the extreme downturn and questions about the adequacy of central banks’ policy toolkit generated a quest for further policy options.1 One that has received substantial attention is “helicopter drops”—that is, a policy by which a central bank prints money and gives it to the public.2 The unorthodox feature is that unlike conventional monetary policy operations, the use of helicopter drops involves an increase in the central bank’s monetary liabilities without a corresponding increase in its assets.”

“We argue that helicopter drops during a liquidity trap are a credible way for the central bank to commit to an expansionary monetary policy in the future. We highlight that open market operations remain irrelevant in a liquidity trap in our environment. However, when the central bank expands the money supply without a corresponding increase in assets, this generates expectations of lower interest rates going forward, which imply high output and inflation in the future that help mitigate the recession today. In a simulation, the optimal helicopter drop achieves a degree of stabilization that comes close to the optimal policy under commitment. The downside, however, is that helicopter drops induce a more protracted period of inflation.”