Debt crisis: The ECB has only to say the word
14 November 2011
There is a simple way to resolve the Eurozone crisis: the European Central Bank just has to state that it will be the lender of last resort for European states. But this solution, which has the support of many economists, is rejected by the ECB — a doctrinaire position, which a Le Monde columnist deplores.
According to many economists, a single sentence announced by the European Central Bank would be enough to quell the Eurozone crisis. The ECB simply has to make it clear that it will act as a lender of last resort for the most indebted members of the monetary union. If it did, the euro would be off the ropes.
Not only that but the markets would be obliged to show some respect, and – oh, supreme joy! – we could stop worrying about the ratings agencies. We would be able to relax the vice-like grip of fiscal restraint and relax spending cuts to promote a resurgence of growth that would facilitate the clearing of debt.
And, without indulging in empty promises, we would be able to break out of the vicious circle that has turned the eurozone into a bowling alley where governments fall like skittles: first Athens, then Dublin, Lisbon, Madrid, Rome – en attendant Paris...
When an issuing institution mints coins – which is one of its functions – by definition, it benefits from unlimited resources. If the ECB said it would be the insurer of last resort, it would deter speculation, and the markets would be pacified to the point where they would no longer demand extraordinary interest rates to invest in loans to the most indebted states.
Hampered by a doctrine
Embattled governments would no longer have to contend with the snowballing costs required to service their debt, and thus would have an opportunity to exit the vicious circle whose various stages are now well known: having been excluded from sovereign bond markets where they are obliged to offer exorbitant rates of interest, ignoble indebted states are forced to hold out a begging bowl to external creditors who make their insistence conditional on draconian austerity conditions that suck the blood out ailing economies.
But if the European Central Bank were to announce in advance that it intended to invest in loans to a state that has difficulty settling its debts, the outcome would be radically different: with purchases by the issuing institution forcing down interest rates to a reasonable level in the event that the announcement of its intention to pursue such a policy was not sufficient in itself.
This is what happens outside the eurozone in such countries as the United States, Britain and Japan. For diverse reasons, these countries do not score better than the average state in the eurozone. But it is clear to everyone concerned that the Federal Reserve, the Bank of England and the Bank of Japan would not hesitate in such circumstances.
Why then has the ECB not taken the initiative? Because it is hampered by a doctrine that advocates the separation of powers. The bank is there to regulate monetary policy, while budgetary policy is left to governments. It is the bank’s role to ensure currency stability (no inflation), while it is up to governments to manage their debts. In other words, the issuing institution should not fly to the rescue of an embattled treasury, because that is not its mandate.
Memory of spiralling devaluation
"It’s ideology,” exclaims Jean-Paul Fitoussi, research director at the French Economic Observatory (OFCE). "Having ruled out the possibility of calling on a lender of last resort, in the event of financial difficulties we are left with the following choice: bankruptcy or assistance, but assistance that is conditional on stringent austerity that will not prevent bankruptcy."
Fitoussi’s incomprehension is shared many of his American colleagues, including Jeffrey Sachs, Kenneth Rogoff and Nobel Prize laureate Paul Krugman who points out: "If the European Central Bank were to similarly stand behind European debts, the crisis would ease dramatically." (Paul Krugman, New York Times, 23 October).
But what about the obvious risk of inflation? Proponents of the separation of powers insist that the direct purchase of sovereign debt by a central bank is equivalent to cranking up the printing press to produce more money.
The very thought of this process sets alarm bells ringing in Germany where collective consciousness continues to be marked by the memory of the spiralling devaluation in the 1920s which ushered in Hitler. And this is why Germany’s condition for giving up its very solid Deutschmark for the euro was that only one task should be assigned to the ECB: combating inflation.
And that is not the only reason, there is also the credibility of the issuing institution, which we are told, should be protected, and that means keeping its books free of dodgy loans.
The rigidities of the gold standard
This may not square with the ECB’s discreet purchase of large quantities of weak EU member state debt on the secondary market, but as the partisans of the "separation of powers" will tell you, if it announced in advance that it was prepared to guarantee the debts of irresponsible member states, the ECB would be encouraging poor budgetary management.
In response, Jean-Paul Fitoussi and Paul Krugman argue that money creation does not lead to inflation in depressed economies like ours. They also point out that a softening of the ECB’s monetary doctrine would not act as an invitation to succumb to the temptation of taking on more debt, if it was accompanied by initiatives to ensure strict budgetary discipline. In short, it is a fair exchange: doctrinal flexibility in exchange for budgetary rigour.
In concluding his New York Times article, Paul Krugman writes: "Out of the ruins of war, Europeans built a system of peace and democracy, constructing along the way societies that, while imperfect – what society isn’t? – are arguably the most decent in human history.
"Yet that achievement is under threat because the European elite, in its arrogance, locked the Continent into a monetary system that recreated the rigidities of the gold standard, and – like the gold standard in the 1930s – has turned into a deadly trap.” Translated from the French by Mark McGovern