ECB as LOLR unlikely
November 17, 2011 15 Comments
There are only two real game-changers left in the euro crisis: fiscal union and the ECB stepping in as a lender of last resort (LOLR). The former for now is resolutely off the table, particularly in the time period necessary for it to keep the eurozone together. Very bright people have fallen on both sides of the debate whether the ECB will step in as LOLR. For a number of reasons, even when push comes to shove, I don’t think it will.
I reject the notion that the ECB going all in and firing up the printing presses would solve the euro crisis. The ECB becoming a LOLR would not unwind all the imbalances within the eurozone, nor would it restructure the weaker countries’ economies so that they could regain competitiveness. It would certainly help countries in the eye of the storm issue debt at sustainable rates, but there are a few problems with the ECB serving this role.
First, it would be illegal. According to the treaties, the ECB cannot monetize debt. If it were to take on the role of LOLR, someone would take the ECB to court (there is already a court case in the ECJ against the ECB for its securities markets programme, the SMP, which is sterilized and technically legal) and would win that case. Of course, legislation can be changed, but that would require a treaty change. Even if all EU countries agreed to revise the mandate of the ECB—a big if—it would take about a year to hold the requisite referendums and to ratify the changes in parliaments. The chances of this treaty change are small, but the chances of it happening in the time frame necessary are even smaller.
Aside from the legal issues, there are ideological barriers as well. In his first press conference following the November governing council meeting, new ECB president Mario Draghi said over and over again that the ECB did not have a mandate to be a LOLR and that its measures to mitigate the crisis are limited and temporary. He was very clear that the ECB is not considering monetizing sovereign debt. This is to some degree a result of devout German opposition to the ECB providing quantitative easing. The president of the Bundesbank, Jens Weidmann, underscored this in an interview with the Financial Times on Sunday. The fear in Germany is that quantitative easing by the ECB would create a moral hazard for weaker countries and would stoke inflation. On the latter point, the memory of hyperinflation that culminated in war is by now a social memory in Germany, but it is a powerful one. In the lobby of the Bundesbank is a framed trillion Reichsmark note. Even if the ECB could print some money without driving up inflation, Germany is dead set against it.
Megan Greene is the Chief Economist at Maverick Intelligence, with a particular focus on Europe. She is also a senior fellow at the Atlantic Council, a columnist with Bloomberg and a senior research fellow at Trinity College Dublin. The opinions expressed here are her own and do not reflect those of any employers. Ms Greene offers a strictly independent voice without a political or investment agenda.
Thanks Megan
That all makes good sense. Assuming it is correct, then what’s next? How is this all going to end?
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Thanks Megan. Whilst everything you say above is correct, I think markets will force either the ECB to become LOLR or a breakup of the eurozone.
Whether the Bundesbank likes it or not, the costs of an Italian default, the bankrupt banking system, and the subsequent breakup of the Union would far out weigh a bit of inflation.
They’ll be forced to bring the ECB to the table eventually, and the market senses this.
I think the eurozone cannot survive for now without a higher inflation rate.
When push comes to shove? The ECB already does buy when Spain’s and Italy’s rates are getting uncomfortably high. Is it at all possible for them to stop buying if investors really start pulling out? Even the Germans would recognize an emergency when it hits them. Not?
I’m sorry but this is just wrong. The treaty bans primary purchases but gives the ECB power to make any purchases it wishes as long as they do not contradict the price stability mandate. Given a choice between a collapse of Europe’s financial markets and banking system and of its sovereign debt market on the one hand and the ECB buying some bonds for cash which then sits on account at central banks, it is obvious which is the greater threat to stability.
I think Germany is right to be concerned about inflation if the ECB monetizes Eurozone debt. Every piece of research I have read on the phenomenon of hyperinflation concludes that it is primarily caused by monetization of public debt, usually following a severe economic shock. There has unquestionably been a severe economic shock….If ECB monetization did cause inflation, therefore, I don’t think it would be a “bit” of inflation. It would be a lot – potentially an AWFUL lot.
Break up also is a possibility
Italy is losing market access as well as Spain. ECB cant backstop, so either the Germans come up with the money or they allow a break up of EZ.
Greece and Portugal moving out will be more manageable even if with some banking casualties.
If the ECB doesn’t print then there is no other alternative. Contagion has spread to the central core now. The EFSF wouldn’t be large enough. The IMF can’t be used to bail out the eurozone. China doesn’t want to invest. So faced with a collapse of the banking system and a massive default of sovereign debt, the ECB must be given the authority to print. Hyperinflation maybe the outcome, but that is preferable to the breakup iof the eurozone, which would be catastrophic.
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Yeah, the damages of a break up would be much bigger than those of a hyperinflation for some years. Germans have to realize this. On the other hand I agree that the technical times are big. They should use some “emergency-routine” in order to have the ECB printing money ASAP. But I am not very optimistic about this, though.
And all the lies the people in Finland, Germany, Holland etc. were told when they they were fooled in to this megalomaniac project by their corrupted politicians doesn´t count at all?
First I sell you a house. Then I burn it down. Then you will pay for a great deal of the construction of a similar house, othervise I threaten to burn the whole village down..
Nice Europe to be a ordinary citizen in.
I’m swedish and we are not in the EMU, but I have a couple of finnish friends and they(and ALL of there families, friends etc) would rather go back to barter trading instead of staying with this ponzi-currency.
So good look all hustlers in Brussel with the ECb-monetizing scam.
The finns are already out.They havent just told the Ponzi-people in Brussels yet. Remenber who told you first…
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