Combatting Eurozone Deflation: QE for the People

Yves here. This post describes why having the ECB give money directly to citizens would do a better job of fighting Eurozone deflation than the US version. The author starts from the premise that QE worked in the US, when there is ample reason to believe it worked only for financial institutions and a small portion of the population. Here, the ECB would engage in what amounts to a fiscal operation, which also would have dome more to stimulate the economy than the Fed’s QEs.

By John Muellbauer, Senior Research Fellow, Nuffield College; Professor of Economics, Oxford University. Originally published at VoxEU

Eurozone deflation is likely to become reality when the annual inflation figure for 2014 is announced in January. This column argues that the ECB should develop a strategy that works in the Eurozone’s unique financial setting, instead of following the Fed’s lead. The author proposes that the ECB should pursue ‘quantitative easing for the people’, such as sending each adult citizen a €500 cheque.

The US was the first to try quantitative easing (QE), which success depended on special features of the US financial setting. The Fed initially provided liquidity support for the banking system and bought government bonds to drive down yields and put cash into the financial system. It also rapidly brought down the policy interest rate to close to zero. There were spill-over effects on corporate bond yields, equity prices, and mortgage rates, closely linked to treasury yields.

In later rounds of QE, the Fed bought large volumes of mortgage-linked agency debt issued by Fannie Mae and Freddie Mac. This directly lowered mortgage rates and added to credit flows available for financing mortgages. Very likely, the QE also lowered the dollar exchange rate, pressuring central banks around the world to ease policy to prevent excessive appreciation of their currencies against the dollar.

US Mortgages and QE Effectiveness

A crucial part of the US transmission mechanism operates via mortgages, the housing market, and the household sector – where the subprime crisis had triggered massive contractionary forces (Duca et al. 2011). The collapse of residential investment alone reduced GDP by around 4%. The fall in house prices had a direct negative effect on consumer spending by reducing the collateral backing for borrowing. The ratcheting up of foreclosures and payment defaults radically reduced the asset base of the banking system. Therefore, together with far higher risk spreads on non-bank loans, credit availability for households fell sharply, particularly in the mortgage market. This was a double whammy for consumer spending.  Reversing these trends and repairing this part of monetary transmission was a central and successful aim of Fed policy. The housing market began to recover in 2012, household deleveraging came to an end, and building activity gradually began to pick up.

In our research, we can track the impact of lower house prices on consumer spending, on the contraction of availability of mortgages and consumer credit, and on the subsequent recovery (Duca and Muellbauer 2013). We can also measure the effect of higher equity prices on consumer spending and the effect of lower interest rates on spending. The direct effect of the latter was substantial in the US, in addition to the indirect effects via housing and equities. The reason is that total US household debt is large relative to total liquid assets. Indeed, between 2001 and 2008, debt actually exceeded liquid assets, as was also the case in the UK. Lower interest rates benefit borrowers and hurt savers. Another important element in monetary transmission in the US, despite mainly fixed rate mortgages, is the ability to refinance at a typical cost of only about 1% when mortgage rates fall. The combination of low interest rate and QE worked in the US, even though at first the headwinds from the subprime crisis were so massive that some concluded that the policy wasn’t effective.

Reasons Why US-style QE is Less Effective in the Eurozone

  • In Germany, and to a lesser extent in France, the total liquid asset holdings of households are far larger than total household debt, so much so that lower policy rates translate into lower deposit rates, and reduce total household spending – the opposite of what occurs in the US and the UK.

Moreover, households in the Eurozone hold far less in equities relative to income than do US households, so the undisputed uplift on consumer spending from higher stock market valuations is small compared to that in the US.

  • The housing collateral channel does not work in the core Eurozone, and the down-payment constraint for mortgages is far tighter than in the US.

As our research confirms, higher house prices in France and Germany reduce total consumer spending.1 In Germany, France, and Italy, higher house prices spur non-owners to save more for the mortgage down payment and inspire caution among tenants, who expect future rent hikes. And the housing wealth of existing owners does not translate into significantly higher spending, given the lack of access to home-equity loans and cheap mortgage refinancing.2 The ECB, therefore, deserves praise for excluding mortgage lending from its targeted long-run refinancing operation (TLTRO), its version of the Bank of England Funding for Lending Scheme, which aim was to offset some of the credit crunch due to the contraction of bank credit.

  • When it comes to credit provision, capital markets do far less of the heavy lifting in the Eurozone (where banks matter more) than in the US.

As a result, bringing down yields on government, corporate, and asset-backed bonds has less impact. That is an important reason why ECB intervention to provide liquidity support for the banking system, for which it was the global leader as early as August 2007, accounted for a much larger share of its balance sheet expansion compared to the US.

  • The final factor impeding QE’s impact in the EZ is the fact that low bond yields, by increasing measured pension-fund deficits, make some companies reluctant to invest and thus more likely to raise contribution rates and limit pension benefits.

In the US, more generous assumptions regarding discount rates are used to calculate pension-fund liabilities (see Bank of England 2014).

At the same time, one should question whether the euro exchange rate – the one mechanism whereby current policies could still make an important difference – can be pushed down much further. It could meet strong international resistance, given the EZ’s giant trade surplus.

Two Generic Problems with QE

  • One current generic problem with QE in the form of large-scale bond purchases when yields are already at record lows is that risks of significant losses for the central bank increase, e.g. should it need to reverse QE in the future.
  • The second problem is that if bond yields are driven lower, this tends to have adverse distributional implications because it channels more money toward the wealthy who own the assets whose prices are boosted by QE.

They have a lower propensity to spend, with little trickle-down to the poorer people who would use it to consume more.3 In the Eurozone, the distribution issue is also one between countries since institutional differences between countries can give the impression of discrimination among them. For example, purchases of corporate debt would favour countries with large corporate debts such as France.

€500 per Citizen

Clearly, the ECB must develop a strategy that works in the Eurozone’s unique system, instead of attempting to follow the Fed’s lead. Such a strategy should be based on Friedman’s assertion that ‘helicopter drops’ – printing large sums of money and distributing it to the public – can always stimulate the economy and combat deflation. But, in order to maximise the impact of such an operation, the ECB would also have to find a way to ensure fair distribution.

One simple solution would be to distribute the funds to governments, which could then decide how best to spend them in their countries. But the EZ’s rule against using the ECB to finance government spending bars this approach.

A more reasonable option would be to provide all workers and pensioners with social-security numbers (or the local equivalent) with a payment from the ECB, which governments would merely aid in distributing. Another alternative would be to use the electoral register, a public database that the ECB could use independently of governments. Of the roughly 275 million adults in the Eurozone, some 90% are on the electoral register. Nothing in EZ law forbids the ECB from undertaking such an independent action.4

There is an important difference between the ECB implementing a €500 per-adult-citizen hand-out as part of monetary policy and governments doing this as traditional fiscal policy. Economists have long worried about myopic politicians over-spending, for example, just before an election in order to influence the voters and thus creating a ‘political’ business cycle, or simply perpetually spending too much, and as a result running too high government deficits. That is an important reason why the ECB is not allowed to directly finance government spending. But it is quite a different matter for an independent central bank, subject to its governing council and the representation of different countries on that council, to directly hand out cash to households as part of its method of meeting its inflation mandate. That is why I would classify this as monetary policy and not just a devious way of by-passing Eurozone rules.

Would it Work? Evidence on the Spending Impact

In 2001 and 2008 there were tax rebates in the US, carefully studied by economists. A study of the 2001 rebate by Johnson et al. (2006) suggests between 20 and 40 % was spent in the quarter in which the cash was received – and about another third in the quarter afterwards – and the authors looked only at non-durable spending. The study of the 2008 rebate concluded that “Households spent 12-30% (depending on specification) of their payments on nondurable goods during the three-month period of payment receipt, and a significant amount more on durable goods, primarily vehicles, bringing the total response to 50-90% of the payments”, see Parker et al. (2013). In an Australian study of the 2009 tax rebate, called a ‘bonus’, Leigh (2012) suggests around 40% was spent in the quarter of receipt.

Such evidence contradicts simple textbook versions of the permanent income hypothesis of consumption. In our Kendrick Prize winning paper (Aron et al. 2012), we find time series evidence for Japan, the US, and the UK that the marginal propensity to spend out of permanent income is between about 40 and 60%, and not 100%. This is confirmed for Germany by Geiger et al. (2014) and for France by Chauvin and Muellbauer (2013). The implication is that between 40 and 60% of a surprise transfer of €500 would be spent fairly quickly.5 The US studies find evidence of heterogeneity between households, with poorer households and those with mortgage debt having higher spending propensities.

This would suggest that in Germany, where many households already have a lot in their saving accounts, the spending impact could be less than in the US but that, in Spain, Portugal, and Greece, where many households are cash-poor, the effects would be as large or larger as those in the US. I would, therefore, expect between 1.1% to 2% of GDP effects in Spain, Portugal, and Greece but probably as low as 0.5% in Germany.6

Beyond lifting the Eurozone economy out of deflation, such an initiative would have massive political benefits, as it would reduce resentment toward European institutions, especially in struggling countries like Spain, Portugal, and Greece, where an extra €500 would have a particularly strong impact on spending. In this way, the ECB could prove to disgruntled citizens as well as investors that it is serious about meeting its inflation target, and help to stem the rise of nationalist parties.

The Arguments Against

  • Like other types of helicopter money this proposal would be costly from the point of view of a public sector balance sheet combining the ECB with governments. Since households can see this clearly, they will increase their private savings to offset this cost and neutralise the addition to base money.

The first point to make is that the overwhelming evidence cited above against the simple form of the permanent income hypothesis implies that, even if the basic accounting proposition were true, we can reject the hypothesis that households ‘can see this clearly’.7 Secondly, as Buiter (2014) shows, the objection is highly implausible even with full visibility. As long as money yields services such as transactions utility or liquidity services, and as long as households regard the addition as irreversible, household expenditure will increase. Such a helicopter drop relaxes the government budget constraint – unless an irrationally hair-shirted government insists on tightening fiscal policy to offset the helicopter drop.8 Indeed, the additional tax revenue from the initial round of spending increases and from the multiplier effects of the additional employment, income, and spending it generates will actually improve the government budget constraint.9

  • A second argument against is the possibility that the proposal could be subject to moral hazard of two types. First, the over-leveraged private sector would back off its efforts to de-leverage on the expectation that money printing would always rescue it from the consequences of its imprudence, which would increase future risks. Secondly, highly indebted EZ governments would step back from unpopular fiscal reforms.

The best way to de-leverage is to improve growth and the immediate effect of the policy is to improve both private and public sector balance sheets. Within the context of a highly disciplined inflation targeting policy it is unlikely that private sector expectations would be shifted in this direction any further than monetary policies pursued to date might already have done so. Structural reforms of labour and product markets should have priority over fiscal austerity since they address problems of competitiveness and growth. In principle, the ECB could make the €500 per adult conditional on credible reform commitments.

  • It will undermine ‘faith in the currency’.

This can only mean that the proposal will somehow lead to high future inflation. On the cusp of deflation and with the EZ in deep stagnation, this makes little sense.  Maintaining the credibility of its inflation target is a sure-fire way for the ECB to prevent such risks.

  • It will undermine the incentive to work.

High unemployment in the Eurozone is not the result of people simply being work shy or not wanting to work, much more a result of the jobs not being there.

  • Handouts to poor people who ‘don’t deserve it’ are unethical.

This argument neglects that conventional monetary policy and QE involves raising the prices of assets, which benefits the people who own the wealth. Some members of elites see this as a ‘natural’ benefit, but resist offering the same benefit to the poor. The rise of populist anti-euro parties is part of the popular response to this distorted point of view.

Concluding remark

After years of austerity, infighting, and unemployment, it is time to implement a QE programme that delivers what Europe needs.

See original post for references

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  1. Rene

    A helicopter drop would be such an exciting feature in a spreadsheet. I won’t argue that it doesn’t make more sense than QE, as it clearly does. But I don’t see why that money ultimately flows, and perhaps quite fast, to the same old ever growing 1%-stocks. It’s temporary relief, like handing out cash in a game of monopoly to extend your winning play. If you’d model it, it probably shows tbtf banks retrieving more repayments. It won’t help much putting extra fuel in a broken engine.

    1. not_me

      The new money will help eliminate private debt and THAT IS GOOD, even if the money ends up with the rich.

      Actually, almost no private debt is morally legitimate since government backing for private credit creation DRIVES people into debt.

  2. MyLessThanPrimeBeef

    We should make his proposal a feature, and not a bug.

    Then we will be on our way to demo-nomics, instead of bankonomics disguised as economics.

    Referring to giving money to the Little People: “It will undermine the incentive to work.” — I think when you print money for the government to spend, it will undermine its incentive to work (for the people). Why don’t we say that? Why do we pick on the Little People always? “Oh, please, please, don’t give money directly to them!!!!”

    The Little People, in contrast with the government (of the Little People, for the Little People, by the Little People), must never be given anything (in this case, be given something that actually belongs them). They must earn it. Good heavens, we mustn’t undermine that responsibility.

    “Let me (the government) spend (your money) so I can help YOU!!!” — if it trickles down to you.

    “Wait, I spent it on torture.”

    “Better luck next time.”

    1. MikeNY

      Testify, Beef.

      $525BN in the cromnibus to fund the military, and I keep seeing charities running commercials to raise $$ to take care of the returned troops.

      I want to scream.

  3. Code Name D

    I keep coming to this question over and over again. Does QE create money? I know Yves has already said the answer is no, but that answer just doesn’t track. Indeed, I am no longer sure I know what money is.

    Government issues bonds in exchange for money, than spends that money on programs. The fed buys back those bonds for fresh currency, even while the original currency used to purchase the bonds in the first place remains in circulation.

    That sure sounds a lot like money creation to me. It’s bastardized to be sure, which has the government barrowing its own money from the very banks that it’s supposed to supply it to.

    And then you have articles like this which proposes a popular version of QE where helicopter money is dropped in to the average person in order to combat deflation. If QE doesn’t create money, then how dose it combat deflation?

    1. Alex Hanin

      Deficit spending is what creates ‘money’. The fact that the CB buys the bonds back doesn’t create anything, it just swaps bonds for cash, i.e. one financial asset for another.

      1. nothing but the truth

        too clever by half.

        except that one of the financial assets is cash.

        by defining cash as a zero duration zero interest bond does it make it not cash?

        insisting that QE is not printing money is like saying the cup does not have water, it has H2O.

        They have clearly said that QE will not be unwound. This cash is permanent.

        1. Auburn Parks

          The accounting is not kind to your POV. All Federal Govt spending increases Non-Govt dollar deposits in checking (reserve) accounts at the Fed. All Federal Govt taxing reverses this process. TSY security issuance simply exchanges dollars in checking accounts (reserves) for dollars in Term\CD savings accounts at the Fed. You wouldnt consider money in your CD account at Chase as “gone” just because its no longer in your checking account. So why would you think operations at our national bank (The Fed) are any different?

    2. financial matters

      There’s a lot here but asset appreciation would seem to be money creation at least for the owners of the assets:
      By John Nicolarsen

      “The other “solvency operations” during the financial crisis include the Fed lending, unsecured, to numerous European institutions, three rounds of Quantitative Easing plus a “Twist,” and the $29tn “pumping” operations [15] to special facilities which the Fed created, possibly illegally, under the then 13(3) section of the Federal Reserve Act.

      The result of the Quantitative Easing solvency operations has been a stock market bubble and inflated asset prices (for those who own them), fueling further wealth inequality and unequal income distribution by means of the “unconventional” and extraordinary measures taken in the protection of the absentee owners, the “kept class,” as Veblen would offer. The stock market stands adrift from real production with corporations artificially inflating their stock with repurchases while parking millions offshore in avoiding corporate taxes. Sanctioned, in effect, by our absentee government’s tax policies.”


      Also re illegal activity by the Fed this is an interesting notion on how their interest rate manipulations appears to help banks with their interest rate swaps:
      Ellen Brown

      “Interest rate swaps compose 82% of the derivatives market. Interest rates are predictable and can be controlled, since the Federal Reserve sets the prime rate. The Fed’s mandate includes maintaining the stability of the banking system, which means protecting the interests of the largest banks. The Fed obliged after the 2008 credit crisis by dropping the prime rate nearly to zero, a major windfall for the derivatives banks – and a major loss for their counterparties, including state and local governments.”

  4. ewmayer

    “[In the US] The fall in house prices had a direct negative effect on consumer spending by reducing the collateral backing for borrowing.”

    So bubble-priced real estate which is only rendered “affordable” by EZ-credit terms on one’s ensuing life term of debt slavery is a “success” of QE and a key to economic prosperity? Gotcha.

    I just love the myopia of these folks – it’s not the monstrous asset-price and debt bubbles behind the periodic manias that are the problem – no, it’s the inevitable painful, bad, wicked, naughty, evil deleveraging that follows! In other words, what these delusional clowns keep groping for is the mythical unicorn of modern Ponzi-conomics, the “self-sustaining asset-price bubble.”

  5. steviefinn

    What !!! – All those 500 euros replacing good ol’ credit card & payday loan lending – what next – a living wage, jobs for life, communism ?

  6. David Lentini

    It’s always seemed to me that QE has never been about economics; it’s all about power and preserving the bankrupt banks and bankers. If somehow the economy improved, that’s nice. But the real issue has always been pretending that the global financial system&mdahs;and the power the US derives from that—is here to stay forever and ever.

  7. Ben Johannson

    Note also the yield on Japanese 10-year bonds is at 0.34%, signalling an inflation expectaton of zero.

    I have no doubt inflationphobes will continue comparing the country to a lake of gasoline waiting for a match, even though they aren’t confident enough to wager on it.

    1. Jim Haygood

      Gasoline … match … are you borrowing my metaphor, Ben? Or lighting a fart?

      Anyhow, a more direct reading on Japanese inflation expectations can be obtained from its JGBi linker bonds, which currently yield -1.02%.

      Unlike most other countries, Japan doesn’t allow individuals to own JGBi’s. Inflation protection is for Japan’s institutions, not the mina-san little people. They’ll just have to hunker down under the kotatsu and tough it out.

    2. Jim Haygood

      Breakeven inflation in Japan (0.33% nominal yield minus -1.02% real yield on the JGBi 10-year linker) is at 1.35%, not so different than 1.68% breakeven inflation in the US.

      1. Ben Johannson

        Irrelevant, and a poor attempt at a deflecting argument. Long-term bond yields are a reflection of future inflation expectations. Current “real yield” has nothing to do with it, nor was it the subject of the comment.

        1. Moneta

          And you really think that inflation expectations out there are right? That all this financial engineering and lack of productive investment will guarantee deflation forever?

          Not so long ago, Russian rates were less than 6%. And the list of mispriced assets is quite long.

  8. Robert Frances

    VAT (sales tax) is a highly regressive tax. If the goal is to get more money into the pockets of households with the highest propensity to spend, then targeting a large reduction in VAT rates seem a much better approach since lower and middle income households spend a far higher percent of their income on VAT. Also, I’d question the assumption that using a non-elected body like the ECB to bloat their balance sheet on the (unproven) theory that the increased money sloshing around the system will actually create more “productive” economic activity. Instead, the increased debt will need to be paid off by future generations, reducing their production and consumption of goods and services.

    At least in the US – and likely Europe as well – putting more money in the pockets of consumers usually means higher rent payments and higher housing purchase costs. It’s a great idea if you’re a landlord or property speculator, but for those of us who are tenants it’s a worse system since after rents go up and the short-term stimulus ends, rents often don’t decline to previous levels. Thus, tenants are left with higher rent costs and lower or flat income levels.

    The developed world economies all suffer the same problems – very high housing costs and governments that rely primarily on regressive taxes to fund their operations. Rather than try to prop up this neo-feudal system with even more debt (with more interest payments and more control acceded to the economic elites), it’s time to focus on slashing taxes on lower and middle income families (repealing regressive payroll and sales taxes) and increasing the taxes on landlords and asset speculators (capital gain tax rates at least double the tax rate on wages and salaries, and much higher taxes on the highest earners of gross rents, interest and dividend income). If these polices are currently non-starters in the halls of government, then letting the status quo fester for a few more years is a better strategy since eventually the house of cards (excessive debt) will crumble and better fiscal and housing systems may come out of the rubble.

    1. not_me

      Instead, the increased debt will need to be paid off by future generations,

      Pure baloney since public debt need never be paid off.

  9. Steven

    This could be titled “Let’s give the people a share of the swag”. The West – with the US far out in front of course – has been increasingly paying its way by just printing money. To date a good portion of the ex nihilo money so created has been used to buy up the rest of the world – and to silence any critics of this arrangement. The money of the imperial power du jour has always been ‘backed’ more by guns than gold. (Mechanization and automation have indeed created a ‘services’ industry.) Not content, however, simply replacing their laboring cattle with machines, the Lords of Finance decided to move the machines beyond their borders where they could hire machine tenders at a fraction of the cost they would have to pay within them. (And the Lords of Finance called this ‘wealth creation’).

    So… no longer able to offer their laboring cattle jobs, the Lords of Finance appear to be on the verge of offering them at least enough of the ex nihilo money they are creating to keep them from rioting. That way when the real wealth creators of the world start asking “Why shouldn’t WE receive a larger share?”, the West’s ‘reserve armies’ (forget ‘of labor’!) will be motivated to give them their answer.


    I agree with all the recomendations made by Prof. John Muelbauer, in the paper here posted by Yves Smith, however I think that just improving the European QE probably will not be enough.
    I would like to suggest here an additional and totally diferent approach, the summary of this proposal would be “let´s produce inflation increasing taxes”.
    Just a few quotations of a larger text, in order to explain my idea:

    FIGHTING DEFLATION (a heterodox approach)
    …..To reverse these deflationary processes, governments have done next to nothing, having left the problem almost exclusively in the hands of central banks, with the obvious limitations that they have and the enormous risks of their more aggressive measures. Although there are measures that governments could have taken, on the fiscal side and others.
    ….. The three major sources of deflation are the growth of risk aversion, the reduction of propensity to spend, and the spread of the feeling that prices will continue to decrease. Aging and inequality are important factors for the decrease of the propensity to spend and the increase in risk aversion, these factos, among others, should be addressed with specific measures which are not the aim of this text. The spread of the feeling that prices will go on decreasing is the most dangerous source of deflation because it makes it a self-powered process, this document is about how to try to deal with that.
    To address this problem in order to stop that self-powered deflationary mechanism, an unconventional approach is necessary to be taken by the governments, even a radical one. That approach can be summarized in one sentence, if there is no inflation “let’s produce inflation”. Governments can create inflation by several ways, as nowadays it is not possible to do it through spending because of the need to control budget deficits, so, the best alternative is to do it through taxation.
    Usually taxation has been used to fight inflation, not to increase it, but in this case the objective of the new taxes would not be to take money out of the economy, neither to reduce public deficits. These additional taxes would have two purposes, to transmit the idea that no matter what happens prices will go up, and simultaneously to give back to the economy the collected money, mainly to those economic agents with lower risk aversion. This return of the money to the economy should be done as quickly as possible, if possible starting to do it even before collection.
    In this context governments should make it clear to everybody that, when inflation is significantly below the target, they will generate inflation through taxation until it returns to the target. The set of rules to implement this solution would be the kind of the oversimplified example below, those rules should be publicized to all the public:
    1. Whenever the annual inflation rate is equal or less than half of the target set, the following measures will be taken:
    a) An extra and temporary tax will be added on VAT (and on other taxes which may be deemed appropriate – on the transaction of real estate, cars, etc.) to compensate for the price decline in the last quarter
    b) If in the following quarters, quarterly inflation remains negative the government will repeat the above in a), setting new extras to the taxes
    c) Those extras will start to be phased out as soon as inflation returns to a level about 0.75 to 0.9 of the annual inflation target.
    2. All funds raised through these additional taxes should be immediately returned to the economy, preferably for quick deployment of labor-intensive investments.
    It is important to notice that this proposal has nothing similar with the increase in VAT that the Japanese government had intended to do in two steps, and later on has cancelled the second increase. This situation is totally different because of two reasons, first the intention of the Japanese government was not to give back to the economy the collected money but to keep it to reduce the budget deficit, and secondly, because the objective with this kind of solution is to create a public perception of a constant and linear inflation, and not, like the Japanese did, the perception of a risk of a sudden tax increase that would induce people to save more, like it happened in Japan,
    This “solution” does not pretend to be a Columbus ‘egg, however it can be a starting point to a deeper discussion on how to tackle deflation at a different perspective.
    This problem is so important, difficult and crucial, that all clues must be pursued…..


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