Combatting Eurozone deflation: QE for the people

John Muellbauer

23 December 2014



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.


Aron, J, J Duca, J Muellbauer, K Murata and A Murphy (2012)  “Credit, housing collateral and consumption in the UK, U.S., and Japan”,  Review of Income and Wealth 58 (3): 397–423. 

Bank of England and Procyclicality Working Group (2014), “Procyclicality and structural trends in investment allocation by insurance companies and pension funds”, Discussion Paper 310714  

Bernanke, B (2003), “Some Thoughts on Monetary Policy in Japan”, speech, Tokyo, May. 

Boone, L and N Girouard (2002), “The Stock Market, the Housing Market and Consumer Behaviour”, OECD Economic Studies No. 35, 2002/2, 175-200.

Buiter, W H (2014), "The Simple Analytics of Helicopter Money: Why It Works - Always"m in Economics, The Open-Access, Open-Assessment E-Journal, 8 (2014-28): 1-51.

Chauvin, V and J Muellbauer (2013), “Consumption, household portfolios and the housing market: a flow of funds approach for France”, presented at Banque de France, Dec.

Duca, J, J Muellbauer and A Murphy (2011) “Housing Markets and the Financial Crisis of 2007-2009: Lessons for the Future”, Journal of Financial Stability,6(4), 203-217, 2010. 

Duca, J and J Muellbauer (2012), “Tobin LIVES:  Integrating evolving credit market architecture into flow of funds based macro-models”, in A flow-of-funds perspective on the financial crisis, vol. 2, Palgrave-Macmillan, Ed.: Bernhard Winkler, Ad van Riet and Peter Bull, Palgrave-Macmillan. Also

Geiger, F, J Muellbauer and M Rupprecht (2014) “The Housing Market, Household Portfolios and the German Consumer”, Presented at the Bundesbank, DFG and IMF conference ‘Housing markets and the macroeconomy: challenges for monetary policy and financial stability’, Eltville, June 5-6.

Johnson, D S, J A Parker, and N S Souleles (2006), “Household Expenditure and the Income Tax Rebates of 2001”, American Economic Review 96: 1589-1610. 

Jordà, Ò and A M Taylor (2013), "The Time for Austerity: Estimating the Average Treatment Effect of Fiscal Policy," NBER Working Papers 19414.

Leigh, A (2012), “How Much Did the 2009 Australian Fiscal Stimulus Boost Demand? Evidence from Household-Reported Spending Effects”, B.E. Journal of Macroeconomics 12(1). 

Muellbauer, J (2008) “Time for unorthodox monetary policy”,, 27 November.

Muellbauer, J and K Murata (2011) “Mistaken monetary policy lessons from Japan”,, 21 August.

Parker, J A, N S Souleles, D S Johnson, R McClelland (2011), “Consumer Spending and the Economic Stimulus Payments of 2008”, NBER Working Paper 16684, January.

Reichlin, L, A Turner and M Woodford (2013), “Helicopter money as a policy option”,, 20 May 2013.

Turner, A (2013), “Debt, Money and Mephistopheles”, speech at Cass Business School, 6 February.

Wren-Lewis, S (2014), “Helicopter money”,, 22 October.


[1] Chauvin and Muellbauer (2013) for France and Geiger et al. (2014) for Germany. Earlier research by Boone and Girouard (2004) had pointed to the negative effect of higher house prices on aggregate consumer spending in Italy. Aron et al. (2012) confirm a similar effect in Japan. Japanese households are world champions in the ratio of bank and saving deposits held relative to income and to debt. As a result, lower real interest rates reduce total household spending, given income and equity prices. Applying US-style thinking to Japanese monetary policy led to erroneous lessons from Japan for the US, see Muellbauer and Murata (2011), and explains the failure of Abenomics so far to raise growth in Japan.

[2]  In the UK, where variable rate mortgages dominate, monetary policy was even more potent than in the US since cash flows of mortgage borrowers immediately improved.

[3] In November 2008, I was an early enthusiast for QE (Muellbauer 2008). In circumstances of market meltdown, mounting solvency, liquidity problems, as well as heavy disruption of credit flows, QE made complete sense. Indeed, as I argued would be the case, its use proved highly profitable for central banks. There is, therefore, no contradiction between my views then and now.

[4] Friedman, great communicator as he was, almost certainly had multiple reasons for the helicopter image. One was for dramatic effect of the visualisation. Second, for a central bank to resort to helicopters emphasises its independence from governments and the fact that this is not standard fiscal policy.

[5] This simplifies the argument slightly. The models imply that not all the impact is felt in the same quarter, so the full effect takes several quarters to come through. However, once the initial surprise impact is over, the unspent amounts are added to liquid assets, whose marginal propensity to spend we estimate at about 10%, which implies a longer lasting and slightly larger overall impact.

[6] The calculation is based on the following assumptions. Suppose in Spain, Portugal, and Greece, 60% of the €500 is spent in the first year. With annual GDP per adult of around €28,000, €20,000 and €15,000 respectively in Spain, Portugal, and Greece, this would imply a 1.1% of GDP boost in Spain, 1.5% in Portugal, and 2% in Greece. Assuming 40% is spent in Germany in the first year, and GDP per adult of around €42,000, the boost in Germany would be around 0.5% of GDP.

[7] Behind this are credit constraints, myopia of some households and fundamental uncertainty.

[8] Also see Bernanke (2003), the 2013 voxeu debate on helicopter money between Turner and Woodford, chaired by Reichlin, Turner (2013) and Wren-Lewis(2014).

[9] One might ask: why resort to the printing press when conventional fiscal expansion would work? see Jorda and Taylor (2013) for literature discussion and innovative new evidence on fiscal policy effectiveness.  However, ‘fiscal space’ is currently poor given the high government debt to GDP ratios of many EZ countries and political pressures for austerity are strong.



Topics:  Macroeconomic policy Monetary policy

Tags:  quantitative easing, inflation, deflation in EZ, helicopter money

Senior Research Fellow, Nuffield College; Professor of Economics, Oxford University; and Senior Fellow, Institute for New Economic Thinking, Oxford Martin School