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What might soothe Europe’s economic pain? Cash handouts

November 18, 2014, 2:45 PM UTC
ECB President Mario Draghi Rates Conference
Mario Draghi, president of the European Central Bank (ECB), pauses as he speaks during a news conference to announce the bank's interest rate decision in Frankfurt, Germany, on Thursday, Sept. 4, 2014. The European Central Bank unexpectedly cut interest rates at today's decision to spur economic growth and stave off the threat of deflation. Photographer: Martin Leissl/Bloomberg via Getty Images
Photograph by Martin Leissl — Bloomberg via Getty Images

In recent attempts to stimulate the European economy and fight deflation, the European Central Bank (ECB), led by President Mario Draghi, has cut its benchmark interest rate to 0.05%, and said it would buy €1 trillion (about $1.25 trillion) in asset-backed securities and bonds.

These changes in monetary policy sent the Euro below $1.24 in early November, its weakest in over two years, making European goods and tourism less expensive abroad. This did not lead to rejoicing on the streets of European cities, however.

“They ought to encourage consumption to reactivate the economy,” said Luis Carrasco, 42, as he stood in front of a Barcelona restaurant where he is a chef.

Many economists would argue that people like Carrasco do not understand that the ECB is doing just that, albeit indirectly; lowering rates and buying assets should get credit flowing, which in turn should increase house prices and household spending.

But another school is arguing that Carrasco is exactly right, and that what European households need is not contorted monetary policy changes but, rather, an influx of cold, hard cash. The ECB should send each European adult a check, they say, and let him spend it how he likes.

John Muellbauer, a professor of economics at the University of Oxford who recently published a piece titled, “Quantitative Easing for the People,” says that sending €500 euro checks to every EU citizen would cost a sixth of the €1 trillion Draghi talks about spending on asset purchases, and would increase EU consumer spending by €34 billion, or 1.4% of GDP.

London-based fund manager Eric Lonergan, along with Brown University professor Mark Blyth wrote the recent Foreign Affairs article “Print Less but Transfer More,” which argues that transfers of between €500 and €1,000 per capita would have a far greater effect on consumption than the ECB’s plans.

“It’s much more efficient and sensible to directly target household spending,” Lonergan says.

While stimulating the economy via society-wide handouts may seem silly or simplistic, it’s an idea with a long history. In the 1936 economics classic General Theory of Employment, Interest and Money, John Maynard Keynes suggested that the treasury could juice the economy by burying bottles of cash in coal mines and having people dig them up.

And on the other side of the political spectrum, Milton Friedman noted in his essay “The Optimum Quantity of Money” that dropping cash to people from a helicopter would have a similar effect.

“It’s funny that the left and the right are unified on this policy,” jokes Muellbauer.

But while Keynes and Friedman were speaking with tongue in cheek, governments have performed a kind of cash handouts in the recent past. During slow economic times in 2001 and 2008, the U.S. gave out tax rebates, giving economists a chance to study the effect handouts would have.

While much economic theory holds that people would not spend the money, the opposite happened. According to a study from the National Bureau of Economic Research (NBER), households spent between 20% and 40% of their rebates on non-durable goods, like food, during the three-month period in which they received their checks, and they spent another third of the rebate during the following quarter. The poor spent more than the rich.

And in 2008, another NBER report found that households spent between 50% and 90% during the quarter they received the rebate. The spending was on a mix of non-durable and durable goods (particularly cars).

Two of the beauties of the giveaway approach, says Lonergan, are that it would be applied equally to all EU citizens, no matter the country, and it would let people do what they want with their money instead of pushing them to buy assets, as cheap credit does.

“If I’m a Spanish or Italian household and I’m in a bad situation, I’ll use it to improve my situation,” he says. “If I have debt, I will use it to repay it. If I have more money, I may take a holiday or put it in a pension fund. Sometimes it’s good to let people to do what they want. They know what’s best for them.”

The idea that people would spend the money (instead of putting it under the mattress)—and in a variety of ways—was backed up on the streets of Barcelona.

“In Spain, the majority of us have debts, so we’d use it to pay debt,” said Juan Galera, 53, a self-employed mason working in the Tres Torres neighborhood. “I’d use it to pay one mortgage payment.”

Several blocks away, Pepi, who was cleaning the sidewalk outside of a dental clinic, said if she received a check, she would buy food and use it to pay her rent and electricity bills.

Of course, after years of pushing austerity policies, no one expects the EU’s greatest economic power, Germany, to embrace a handout scheme any time soon. And there is another problem with the plan: while the idea was well received, a €500 handout wasn’t exactly embraced as a panacea.

“Would it solve the crisis? That’s another question. €500 doesn’t go very far,” said Galera.

Pepi, who did not to give her last name, was more pointed.

“Just €500?” she asked. “More would be a little better, no?”