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Combatting Eurozone deflation: QE for the people

Muellbauer, J. (2014) “Combatting Eurozone deflation: QE for the people“, VoxEU Organisation, 23 December.


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.


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