DW: What are the current strategies the European Central Bank (ECB) is using to try and reach their inflation target of 2 percent, and why aren't they working?
John Muellbauer: The current strategy the ECB is using has two main strands. One is to extend very cheap loans to the banking system on the condition that they lend it on to small businesses. And the second strand, which they have started on but haven't yet got very far on, is to buy assets.
These methods have worked well in the US, but are less effective in the eurozone. In the US, the central bank's buying of bonds and asset backed securities has a big effect on the mortgage market by keeping mortgage interest rates low. With cheaper mortgages, house prices go up, and higher house prices in the US means that people can borrow much more. A lot of that borrowing gets spent, which boosts the economy.
In Germany, France and Italy, it doesn't work that way. In these countries, when you want to get a mortgage, you have to pay a very large deposit. In Germany, it's very hard to get a mortgage with less than a 20 percent down payment. When house prices rise in Germany, people have to save more for that deposit. So instead of increasing consumer spending and boosting the economy, it has the opposite effect.
The other important thing about Germany, France and Italy is that households as a whole have much more in-bank deposits and savings deposits than they have in debt. When you add up all the deposits the households have in Germany, its much bigger than the total amount of debt households have. So when interest rates fall or are very low, it actually means that all these savers have less money to spend.
So in Germany, low interest rates do help borrowers, but the borrowers are a small part of the economy, whereas the savers are a much bigger part.
What solution you are proposing?
My suggestion is that the ECB sends every adult citizen in the eurozone with a social security number a cheque for 500 euros ($627). For many households, this would result in extra spending. Of course some households will just add it to their savings account, some households will use it to pay back debt, but if we look at studies for how people have used similar cash handouts, they show that many households will spend a lot of that money in the first year. This would have a really big impact on economic activity.
If it followed your suggestion, the ECB would give people money, they would spend it, and their governments would get revenue from tax, which would be used to reduce deficits. Are there any examples of this kind of a scheme working in the past?
The sad thing is that many examples of where this has happened have been in situations where there were already inflationary problems. So in many cases it has not had a beneficial effect. But of course in the eurozone, we're facing exactly the opposite problem: we're on the cusp of deflation.
My suspicion is that in January, when the annual inflation figures are announced, the eurozone could well be at zero inflation or slightly below zero inflation. In those circumstances, the question is, how is the ECB going to meet its inflation target?
If the conventional policies don't work very well, they will have to do something, and this idea would be a surefire way of actually stimulating activity and preventing deflation from getting worse.
Is it just as important to give 500 euros to people in wealthier countries as in countries where people are struggling?
One of the big internal debates that the ECB Council always faces is concerns about policies having differential effects on different countries. For example, if the ECB buys corporate bonds, then France, which has a very large corporate bond market, would benefit disproportionately from its purchase, whereas countries which have a very small corporate bond market would not benefit so much. So there is always this worry that policy is seen as unfair, and I think the simplest thing to do is to have the same payment going to every citizen in the eurozone. Politically, it makes a lot of sense for it to be completely equal.
Does the ECB have the money to do this?
Yes, it certainly has the money! The president of the European Central Bank, Mario Draghi, has been talking about a one-trillion-euro expansion of the ECB balance sheet. My proposal would cost only around one-sixth of that total amount. So its relatively small compared to what the ECB has been talking about, but it's much more likely to have a very strong effect .
But isn't it just a short term solution?
Absolutely. In the long term, the reform process has to continue. This is only a temporary measure to prevent deflation and prevent the eurozone from falling into a really deep, Japanese-style crisis.
But having effective tools is also really critical to the ECB's long term success. The ECB has an inflation target and it needs an effective policy to meet this. If the target isn't reached within a certain length of time, people will lose faith in the ability of the ECB to actually manage the business cycle in the eurozone and to prevent deflation.
At the moment, particularly in the peripheral economies, the impression is that these tough eurozone task masters are holding them to account. All the talk is about austerity, and there's a feeling that the eurozone policy makers are taking very little notice of the little people. This is part of the reason why all these nationalist parties are rising so strongly, for example in Finland, France, Greece and Spain.
Having something that ordinary people will see as immediately beneficial to them and also improve their employment prospects and improve growth would provide a great vote of confidence for the eurozone system.
What are the arguments against this idea?
I think the arguments against it lack foundation. But there are a couple of typical arguments. For example, German commentators say it will undermine the incentive to work. This is a silly argument, because I don't think the high unemployment in the eurozone is the result of people simply being work shy or not wanting to work, I think it's a result of the jobs not being there.
Another argument against it is that it could undermine 'faith in the currency,' meaning that the proposal is seen as inflationary and that it will somehow lead to high inflation in the long run. But of course, when you're on the cusp of deflation, maybe that's actually not the most immediate thing to worry about.
The third argument is the argument of the right, which is that handouts to poor people who 'don't deserve it' are somehow unethical. They forget that conventional monetary policy involves raising the prices of assets, which benefits the people who own the wealth. The right wing sees this as a natural benefit, but sees offering the same benefit to the poor as somehow unjust. I think that argument is immoral.
Ideally, when would this happen?
I think the earliest it could conceivably happen would be in the first quarter of 2015, because if I'm right about deflation, the actual experience of deflation will be a wake-up call, and the ECB Council will really have to look for options that work.
Professor John Muellbauer is an applied macroeconomist with Oxford University's Nuffield College and a fellow of INET (Institute for New Economic Thinking) at the Oxford Martin School. His 1980 paper with Angus Deaton, "An Almost Ideal Demand System" in the American Economic Review was selected as one of the top-twenty papers published in the first one hundred years of that journal. One important aim of his current research is to achieve a better understanding of interactions between the financial sector and the real economy.