Getting out of the crisis: the responsibility of the ECB

In the world before the 2008 crisis, the role of the European Central Bank (ECB) was simple: adjust its key rates to keep inflation around 2%

The eurozone countries had given the ECB the independence to conduct this inflation-targeting monetary policy. Tax policy and debt management remained the responsibility of the Member States. The statutes of the ECB prohibited any financing of the financial obligations of the States by monetary creation, establishing a tight border between monetary policy and fiscal policy.

The restrictive mandate of the ECB turned its back on centuries of monetary history. Indeed, almost all the central banks created before 1900 were to finance states in war. States granted monetary power to central banks. These, in return, financed the states, especially in exceptionally dramatic situations. A time abandoned in the name of the control of inflationary risk, this practice was resumed and perfectly assumed during the crisis by the US Federal Reserve and the Bank of England. Between April 2009 and today, the US Federal Reserve bought and monetized $ 1.2 trillion worth of public debt. It is thanks to the massive intervention of their central bank that the United States and England, which nevertheless have very high ratios of public debt to GDP (respectively 100% and 95%), were able to avoid a crisis debt- read the article.

The ECB has hitherto been modest on the path of buying government bonds

Between May 2010, the date of the creation of the sovereign bond purchase program, and November 2011, the ECB bought for 180 billion euros bonds mainly Greek, Italian, and Spanish. Unlike the United States and England, purchases of government securities have not been monetized: a cash amount equal to the cost of buying the securities has been withdrawn by the ECB. This bond purchase program was successful, in its most active phase, in stabilizing the level of interest rates in Spain and Italy. This allowed stopping the famous self-fulfilling spiral by which investors speculating on the default risk of some countries sell massive bonds, causing a rapid rise in interest rates, thus increasing the risk of default and so on …

The two obstacles to the intensification of the securities purchase program by the European Central Bank are the situation in Greece and the issue of fiscal discipline. Greece, before restructuring, being fundamentally insolvent, whatever the behavior of the investors, to buy Greek securities meant to lodge future losses in the balance sheet of the ECB. The tax issue was initially tackled in a very undemocratic way by a secretive letter from Jean-Claude Trichet to Silvio Berlusconi asking Italy for immediate structural and fiscal reforms. A much better approach combines the adoption by parliaments of European countries of credible but realistic consolidation plans coupled with a possible recourse by the International Monetary Fund (IMF) in a role of monitoring and certification of the execution of these plans. The latest developments in Italy are, in this respect, promising.

At a time when the obstacles mentioned are being lifted, the government bond purchase program should be accelerated to prevent the default risk of Italy and Spain. However, it is precisely at this crucial moment for the future of the euro area that the ECB is preparing to transfer the responsibility for debt stabilization to the European Financial Stability Facility (EFSF). This is a major mistake of economic policy. The EFSF has neither the resources nor the flexibility of execution necessary to contain the public debt crisis.

On the other hand, the ECB already has an operational securities purchase program and its money creation power gives it resources that are in principle unlimited. This is not to say – and this is absolutely crucial – that it will have to use all its resources with all the attendant risks of massive monetization and inflation. This means that a resolute action like that of the central banks of the United States and England would have a deterrent power sufficient to contain, beyond Greece, the risk of sovereign default in Europe.