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"Give me the power to print a nation's money and I care not who writes the laws."

-Nathan Rothschild

An interesting idea, and the ECB threats could very well work for a small country like Greece. But for larger countries, once the ECB intervenes, are not the ECB's hands tied by now owning hundreds of billions of dollars of the country's bonds? For instance, if the ECB intervenes forcefully and buys $500 billion of Italian bonds, can the ECB credibly threaten to trash Italy's bonds? Won't that cause a precipitous drop in the value of the ECB's portfolio?

Taking it to the next level, what happens if the ECB intervenes and a country, even a small country like Greece, now threatens to default and leave the Euro? The ECB will own say $100 billion in that country's bonds, and looking to lose 70-80% on that default. The ECB does not look like it holds a lot of power in this situation, and the country, to some extent, will be able to dictate terms. Indeed, that old adage about if you owe enough money to a bank that you own it comes to mind.

Kosta, I don't understand your point. It may not like it, but why would a "precipitous drop in the value of the ECB's portfolio" be a danger to the ECB?
-Farid Elwailly

Gregor; very apt!

Kosta: good point. It all depends on who moves first in the game of chicken. The country, the ECB, or the bond market. But remember, the ECB could make life very nasty for a country that left the Euro, if it wanted. Even nastier than it would be anyway. "Any bank that does any dealings with the New Drachma or Greek government will be a pariah to us, unless the Greek government does what we say".

The question is whether or not this is a credible threat. I'm not convinced it could ever be. Can you throw a member's financial system into the abyss without pulling the rest of the eurozone's banking system into it as well? Perhaps you could do it for smaller countries, but certainly not for Italy.

I guess you could make life miserable for a country that left the euro, but too what end? The dreadful experience of leaving the eurozone probably implies a dramatic restructuring of your country's financial system, taking it off the eurobanking grid would be like cutting off cable for someone without electricity. And it would be an eminently political move: how could you justify treating a democratic European nation like a pariah state?

Guillame: I'm not sure either. But I see three potential ways to make a credible threat: 17 governments meet around a table and hash out a plan (status quo); the ECB makes the threat (this post); tanks (the UK would have said "gunships" in the olden days of empire, when it wanted to bring debtor nations in line).

The 17 governments around the table isn't working. Tanks are probably off the table. So it's either ECB, or the end of the Euro. Probably the end of the Euro, which is what I've been predicting the last couple of years. But I wanted to cover my ass by thinking about one way my prediction could be wrong.

"if they know you are going to help them get out of trouble, they are not going to stay out of trouble"


"If you don't do what we say, we will loudly announce that we will no longer act as your lender of last resort, and the bond markets will make mincemeat of your bonds"

That's right! We'll trash those bonds, $1Tn of which will be on our own balance sheet [/sarcasm]. Clearly an empty threat. If they make that promise the Italians will happily agree to hand over all of their first borns, knowing full well they now own the ECB. It's already happening as the ECB is loading up on Italian bonds all the while protesting that it's all temporary. But they've already taken the bait and slowly, but surely they're swallowing the whole thing, hook, line and sinker. The game now is to carefully play them as long as possible, making sure the line doesn't break before you can gaff them.

"Any bank that does dealings with..."

Never going to happen. We are talking about Italy, not North Korea. If BNP and DB can't do business, Goldman will. The European banks will never let that happen. Anybody stop doing business with Argentina? More empty threats.

If you see it as poking holes in your own theory that sounds pretty good. I do agree that the ECB is the only institution capable of preventing a disorderly collapse and that it should be willing to break rules to do so.

I'm unconvinced that it can be the basis for a fiscal government if things ever go back to "normal". The eurobanks are not really national anymore. The "grim trigger" strategy sounds very brutal in practice. Let's say your country misses its deficit target by half a percent. Is it a reasonable basis to "gunship" a country? I'm not sure if there are any intermediate threats available to the ECB, perhaps a ceiling on interest rates that it could modulate according to compliance? Not sure if it's feasible to manipulate markets this way, but it does sound very European.

Could the ECB acts rationnally in its own and Europe best loong-term interests?
Could the South avoid the Civil War by abolishing slavery?
Could Hitler avoid losing WWII by not invading Russia?

Some memes are so ingrained that you will sink with the ship rather than avoid the iceberg.

Mario Draghi can't do anything because he is Italian. Only Merkel and Schaüble can do something. And neither have the state(man)(men)(person)(?) quality of Richard Nixon going to China( or breaking Bretton Woods).
We are now to the point where we praise Tricky Dick...

K: your argument was convincing me. Then I saw that C.O. of the Economist is basically on board, only with a twist: the ECB does not buy the bonds now. It says it will buy the bonds in future iff the country gets its act together. Too late in some cases though, since it has already bought lots of bonds. Hmmmm.


Guillame and Jacques: As with K, I sort of agree. I'm really not sure if this could work. It was off the top of my head (as sometimes my posts are). If not, I'm back to my old prediction.

^ That's really quite brilliant. Italy can still try to play chicken by dragging its feet as the deadline approaches (much as Greece has done), hoping for an extension on the deadline or bond purchases despite failure to quite meet their requirements. At least when it does come crashing down, the ECB won't be holding the bag. But it's not clear who would be lending money to Italy after the ECB pledge to buy bonds if they meet conditions and before the deadline. Euro banks are already overleveraged. Who could buy those bonds, if not ECB?

I think the party is over. I wonder how so many people has followed the wrong way of monetary union. I wonder why, in spite of the great mistake, the euro has lived so little time. But the great question is how there is so many people wich think that without the euro things would be worse.
Politics is no rational.

Andrew: "Who could buy those bonds, if not ECB?"

Either the public buys the bonds. Or else the ECB buys the bonds, and the public holds the cash the ECB prints to buy the bonds. It's the same either way.

Nick: Yeah, I saw that piece too after my comment. There is a great deal of beauty in the idea. First, like O.C. says, it places responsibility squarely on the Italians. Second, it makes the ECB put its money where its mouth is: Follow our austerity prescriptions and we guarantee success. Either we're right and all will be well, or the Keynesians are right and we'll end up following an inflationary bond buying policy and all will be well anyways. This is one of those great ideas in negotiation where you find a way explicitly link each party's favourite outcome to their particular belief ultimately being true.

Whether it can work fast enough is a real test of the power of central bank commitments and of the ability of Italy to convince the market that it is capable of reform. But I don't see how it is possible, earnestly, to refuse to try. The real question is, do the Germans believe their own bluster. Great stuff!

One thing to keep in mind in the Italy is not Greece vein, Italy's annual deficit is not that bad. The focus tends to be on the debt/GDP ratio, but having a fairly small deficit gives the Italian government a great deal more leverage than Greece. Their need for current funding is less, and could probably be covered after a default and modest new lira devaluation with no more need for current funding.

Too many comments about what "Italy" is doing, which looks like representative agentism run amok, the problem is that "Italy" as an entity has a very hard time coming to agreement on what they want to do in terms of reform.

Lastly, I think the moral hazard arguments are being significantly overplayed, especially since they never seem to applied to banks in the home country. It would be better if Nick Rowe was writing that Italian officials should refuse to reform unless the ECB adopts NGDP level targeting. As of now, they are asking peripheral European workers to bail the ECB out of being such a lousy central bank.

Luis: you are probably right. It would be better in the long run if the Euro were wound up.

K. One other thought. OK, so the ECB has already bought a trillion euros worth of bonds. But at this point, that's a sunk cost.

OGT. Oh, agreed. Central banks should be doing 2 things: getting normal monetary policy right; acting as lender of last resort. This post is just about the latter.

But Italy is worried because, even even if it had no deficit at all, it needs to roll over its bonds. If governments (or banks) had long term liabilities, that they paid off at maturity, they wouldn't need a lender of last resort (but then if banks did that, they wouldn't really be banks).

Solution: The ECB acts as an independent central bank, with no more obligation to lend to Greece than the Federal Reserve has to lend to California.


There are two separate issues – central fiscal authority, and lender of last resort.

Both are problematic in this environment.

Both can be combined within the ECB, as you suggest, but not necessarily.

The ECB could be lender of last resort by operating under guidelines set by an overseeing central fiscal authority. The ECB doesn’t have to be that authority in order to execute policy under guidelines.

LLR limits would be defined by the central authority according to the circumstances of different nations.

E.g. suppose, for whatever reason, policy guidelines triggered ECB LLR for Italy, but not for Greece. Then Greece would presumably default, while Italy would be stabilized by LLR.

The ECB would execute LLR policy for Italy – by purchasing bonds until market bond rates stabilized. But it would ignore Greece under the assumed scenario.

LLR is selective by country. The fiscal authority sets the parameters for qualification. The ECB just executes under country specific limits for LLR.

My point is that the ECB doesn’t have to be the policy making body for setting the conditions that qualify countries for LLR rescue.

You have to distinguish between the operational capacity of the ECB (which is unlimited for purposes under discussion), versus the policy power of the ECB (which may be usurped by a higher fiscal authority in the case of LLR limits.)

My analogy would be with a bank, where policy limits/trading limits are passed down from a higher authority to trading desks. LLR country limits (sometimes zero) would be delegated by the fiscal authority to the ECB for execution.

That leaves the ECB with the most important role – which is the operational capability to buy the bonds with newly created Euros – whatever the policy to do so.

There is no operational framework for ECB LLR now.

There needs to be both an operational framework and a policy setting body to delegate the limits. These are two distinct functions. They don't both have to be in the ECB.

Mike: But California State government is only one level of government. The feds can do all the important stuff. Rogoff(?) had a good post on this a few days back.

JKH: OK, but if the 17 governments could get their acts together to agree to do something like that....the Euro would not be in this mess right now. The ECB will ask Henry Kissinger's question "If I want to call my boss, to get permission to do this, who do I call?" Then, like an army in a banana republic with no functioning government, it will take power itself. To preserve its own existence. Because if the Euro implodes, there won't be an ECB anyway.

I meant Rodrik, not Rogoff. Memory going.



The 17 never planned for the ECB to be a government(s) LLR.

That has to be changed.

There's the problem of LLR as a principle, and the problem of the 17 (as opposed to 1, as in the case of the US) resolving it together and distributing it as policy.

Where does the ECB get its existing authority from? It didn't create itself.

So, ECB is the lender of last resort to the European banks, but refuses to be the lender of last resort to the European governments. Why? And in any case, without a corresponding EU wide treasury, operationally ECB can not be the lender of last resort in any meaningful size that will placate the Market. Ultimately, if EU is to stay together they need to sort out the fiscal transfers issues - ECB " printing" QE style is only a temporary solution. You need to give the power back to individual governments to fund themselves through deficit spending without borrowing.

This is crazy talk. You're talking about a continent-wide subversion of European democracy by a bank, whose only power consists in the fact that it happens to manufacture the money used by common consent in a currency union.

No free people should or would ever submit to this kind of usurpation and thralldom. Perhaps Greece, Spain and Italy should just say that they are going to default on their loans, nationalize every EU asset inside their countries and go back to manufacturing their own currencies. Let's see where all the brave talk about a central bank takeover goes when the financial pros in the core start jumping out of windows.

"the ECB could make life very nasty for a country that left the Euro"

How so? Its like saying the Fed could make life nasty for Argentina when it abandoned convertibility. Argentina defaulted on its debt and staged a maxi-deval. What could the Fed do about that if it had held Argentine sovereign debt? I suppose become party to the ineffective law suits against the sovereign state. Other than that, I can't think of anything.

The fact is, Italy holds the cards. The ECB knows this, which is why they are reluctant to step into the swamp of financing their budget deficits. Once a CB enters that swamp, they are unlikely to exit.

Dan/Anton: Google "ECB buying Italian/Spanish/Greek/whatever bonds". It's already happening. They just aren't talking about it. They haven't (yet) gone Chuck Norris, which a true LOLR does. I wonder if the ECB is quietly making conditions? Read the Brad DeLong link. Read Bagehot.

Dan: Then let's talk about "crazy talk".

And welcome to the Euroskeptics club!

JKH: Dunno. But maybe sometimes authority grows out of the barrel of a printing press?

Nick: "OK, so the ECB has already bought a trillion euros worth of bonds. But at this point, that's a sunk cost."

Sorry. I meant that by the time they would get around to making good on your proposed threat they'd be owning $1Tn of Italian bonds. Not that they have that much now. What we know is that the Eurosystem balance sheet is around EURO2.3Tn. Wouldn't be surprised if there's at least EURO500Bn of Italian sovereign and bank liabilities in there already, maybe much more. But they don't tell us.

As far as it being a sunk cost, the average Italian bond is only down maybe 20%. So it's only a sunk cost in case they have already decided that Italy is going to default and the bonds are really only worth 40 cents per Euro. But they are definitely not there yet. For one, even if they were convinced that a default were inevitable, consider the incentives of senior ECB bureaucrats. Making the decision to cut Italy loose might be a career ending move for a lot of them. Paulson would never have let Lehman default either if he'd had a backup plan, but he didn't. The ECB does have a backup plan (procrastinate: every day buy just a few more Italian bonds) so the decision doesn't become critical.

Have the ECB publicly guarantee EFSF bonds, then turn the EFSF into a European Treasury offering credit lines to member states with a pre-negotiated yearly limit of X% of their GDP, at the rate it pays on its bonds. Beyond that limit, it's between them and the markets.

No ?

Why does it matter if the value of the ECB's portfolio takes a hit? Wouldn't that only matter if the ECB was trying to reverse the moves later on? And if they're doing that, then you'd have to assume the strategy was working, in which case the assets would almost certainly have retained (or recaptured) their value.

And if not, then there is probably more to worry about than the ECB's balance sheet.

"I meant Rodrik, not Rogoff. Memory going. "
They say that's the second thing to go. I can't remember what the first thing was.

Rodrik's two most pertinent points:
"# Californian borrowers do not get shut out of credit markets and those with healthy balance sheets can borrow from the rest of the nation."
Solvent private Greek banks can borrow from the rest of the world.

# The Federal Reserve stands ready to act as a lender of last resort to any Californian bank."
The ECB can still lend to private Greek banks, even if the Greek government has gone bust.

kirkegaard, has been writing/testifying (pg 6,10) along this vein.

This talk about independent central banks is arrant nonsense. The Coyne Affair should remind Canadian economists otherwise.

There is a fundamental difference between the UK suspending the gold standard and the ECB threatening governments: sovereignty.

Brad Delong was mistaken and hyperbolic in his article. When a Minister of the Crown asked the Bank of England to do something, it is the same as the Queen herself asking it. The Crown takes all its direction from the Prime Minister and Cabinet who have a working majority in the House of Commons. They have a democratic right to rule.

So when a sovereign, democratic government asks the central bank to do something, it shall be done. The law can be changed to suit the government's agenda. That is, after all, democracy.

The ECB threatening sovereign governments is the entire opposite. It is a subject of the government, a creature of law and tool of administration giving orders and threats to democratically elected governments. That cannot be tolerated. It is a coup.

To quote Cate Blanchett in the movie "The word 'must' is not used with princes".

The Euro crisis is not an economic crisis. It is a political one. Economists are not going to solve this problem, politicians are. Economists can describe the nature of problem to clarify things to politicians, but central bankers and economists are not going to do much. There isn't much they can do.

Why do macro-economists have such problems with democratic, responsible (to the people) government?

edeast: VERY good find. Must update this post.

David: Hmm. You may be right. Dunno.

Mike: think about the Argentina episode. When Argentina left the USD, it also said that any debts to banks in Argentina were now payable in Pesos. So the banks, even foreign-owned banks, decided to treat their liabilities as peso liabilities too. I don't see that happening in california.

Determinant. Of course it's a coup by the ECB. But who exactly is the Euro sovereign? Read the (first) link from edeast. Maybe the ECB is itself the sovereign? And the question isn't whether this *ought* happen, it's whether it *will* happen, or *is* already happening. Think of this post as asking whether the worst fears of the Little Englander (and their counterparts in other countries) euroskeptics might be right.

"Why do macro-economists have such problems with democratic, responsible (to the people) government?"


There's a name for that rhetorical tactic, but I've forgotten it. Let me use it on you: "Why do you hate lenders of last resort so much? Why do you have such problems with Europeans?"

It's a variant of "have you stopped beating your wife?" The rhetorical technique is called a loaded question. Always jarring!

It's not at all a loaded question when you see the behaviour regularly repeated with hardly an acknowledgement.

Mandos: "when"? Not "if"? Loaded.


I suppose the Greeks could declare their debts payable in drachmas. For that matter, Californians could declare their debts payable in reales. That's why the Fed would be unwise to lend money to the government of California, just as the ECB would be unwise to lend to the government of Greece. The central bank (if it exists) should not be forced to lend to particular parties, since those parties might not be good for their debts.

Mandos: "when"? Not "if"? Loaded.

But if so, not a fallacy. It's not fallacious for a lawyer to ask a witness---to use the canonical example mentioned above---"Have you stopped beating your wife?" if it is true and known that there was an event with a witness and his wife, and the witness was beating his wife.

(Macro-?)economists as a group have had a long history of not only idly second-guessing democracy, but actively participating in subverting or preventing democratic governance from taking place, and prescribing policies for which it is absolutely necessary to subvert the public will in order to implement. Consider pretty much any post on consumption taxes in Canada on this very blog. Almost all evade that very issue, except for Frances' one discussion on the value of hiding the sales tax in order to mitigate its unpopularity, if I remember correctly. Um.

I would say that this might well be endemic to the very practice of economics, particularly macro. Unlike, say, physics or chemistry, the desired science in economics has entities with incontrovertible volition and moral status as its ultimate object. Therefore, for economics to have any policy-making value, one must approach the subject from the implicit perspective of a sovereign. Again, consider the European crisis, and what is being proposed for it. This is not an isolated incident: consider the resistance to the idea of e.g. the Fed being governed directly. In an even nominally representative democracy, shouldn't the members of its board be elected from the people? How could anyone even consider delivering so much power to the ECB?

Asimovian psycho-history is fun to imagine, but deeply creepy and almost certainly impossible, possibly more so than the Enterprise's warp drive. That doesn't stop an entire field from accreting around the concept.

"Is this democratic? Of course not."
Wouldn't it be easier to become real, honest to goodness democratic nations if we actually got the monetary histories and economic theory we need to be realistic voters while we are still young. The fact that hasn't been deemed necessary goes a long way to exlain the current crop of Republican presidential candidates in the U.S.

The idea that the ECB must save the euro is a myth peddled by worried euro government bond holders, British politicians whose main concern is Britain's exports to the euro zone, and American academic economists who seem to prescribe easy money for any macroeconomic weakness these days. The GIIPS have two only loosely related problems. One problem is excessive debt, which they could tackle by a straighforward default/haircut, which need have no bearing on their membership of the eurozone, no more than GM's Ch11 bankruptcy meant that it could no longer use the US dollar. The other problem is uncompetitiveness, which the GIIPS might find easier to fix by leaving the eurozone and reintroducing a devaluable currency. However, I get the impression that the citizens of the peripheral countries are overwhelmingly in favour of the euro - even in Greece, a recent poll indicated that 7 out of 10 people wanted to remain in the euro. Even if it means that they may have to make sacrifices, they want to be seen as serious countries with serious money. The ECB should tell their critics to get stuffed.

I have no problems with Europeans Nick. I also have no problems with lenders of last resort generally. I have problems with institutions that forget who has the mandate of the people, who writes the laws, who controls the police and armed forces and who has the authority to exercise executive power.

I have a deep problem when theories appear that disregard how authority is lawfully exercised and with how government actually works.

When you yourself say that the tactic is a coup, Nick, then this whole debate is a loaded question.

Determinant: you don't seem to understand how the EU works. The point of the exercise is to subvert democratic accountability at the EU level. Nick's suggestion is just "going with the flow".

Also, on your critique of DeLong's legal understanding: ask yourself whether it would be legal for a Minister of the Crown to ask someone to murder some citizen. Laws are understand to bind the Crown, including its agents.

When the Minister of Finance asks the Central Bank Chairman to to something, there is a democratic mandate behind the Minister. A properly advised Minister will change the law first if it is an impediment, but at least the Finance Minister's actions are backed by the Cabinet. The Finance Minister has a colour of legitimacy while the Central Bank making threats does not.

I know how the EU works. I contend that the current problem with the Euro is a political problem with economic aspects; the solution is primarily political.

A central bank issuing orders to governments is not a viable political solution.

Enjoyed reading Lorenzo's post again.

Determinant: you are saying that the EU has a democratic deficit? And that the ECB taking over fiscal authority from democratically elected governments will only worsen that democratic deficit? I'm *shocked* (in the Casablanca sense)!

"A central bank issuing orders to governments is not a viable political solution."

Well, yes. Duh. But it seems that maybe that is the "solution" that is ordained by the internal logic of the Euro.

Look, let me spell it out for you: I do NOT think this is a GOOD THING. And the fact that the internal logic of the Euro seems to lead to this "solution" only confirms and strengthens my anti-Euro perspective.

Here, read Mr Bean's brother.
I used to think he was a bit out on left/right field. Now I'm not quite so sure.

(Hmmm. I see he has favourable comments ranging from PJ O'Rourke and Lord Tebbit (Mrs Thatcher's tame skinhead) to the Morning Star (UK communist party newspaper)!)

Look, I blog here about my views on economics, because I'm an economist and this is an economics blog. My views about politics are worth about as much as those of the guy next door. And I'm not going to do some ritual genuflection about politics on every post just because you and Mandos might have your noses out of joint. You are big boys, and can decide for yourselves whether it's a good thing if the ECB takes over fiscal authority for the Eurozone. So can I. So can every other reader of this post.

Well, as the poster in Mandos' link put it, Politics Matters.

Politics would not matter if the debate were whether to have a 3% inflation target instead of a 2% target. Or whether to switch to an NGDP target for the Eurozone. It might be a tad political if the debate was whether to have an varying inflation target by country for the Eurozone, but economists would still play a central role in explaining the costs and benefits to politicians and the public.

But the central bank actions contemplated in the OP are a subject for the Political Science department rather than the Econ department. With the greatest of respect there aren't any economics decisions to be made in the posited problem, but there are lots of political ones.

The question of the OP has departed from the field of economics and is now in the field of political science.

Determinant: well, yes, the Treasurer/Chancellor of Exchequer/Minister for Finance telling the central bank what to do has much more democratic legitimacy than the other way around. (I am sure Brad DeLong would also agree.) That is a rather different claim, however.

On a ECB diktat being politically unacceptable, if a situation of looming disaster does not have a politically viable solution, then disaster follows. The American Civil War could likely have been avoided if the US Government had just bought out all the slaves and freed them. But taxing northern workers to pay off the richest people in the US to create competing free labour suppliers while devaluing white Southern votes (by adding in all those black ones) was not politically viable. 600,000 dead Americans later ...

The eurozone countries created a common currency while failing to follow the rules required to make it work and without the effective political apparatus to deal with the consequences of not doing so. Alas, this was not some temporary madness but a natural consequence of the underlying logic of the EU.

The euro is a looming disaster because it is both economically and politically not feasible. The politics cannot cope with the economic difficulties and the economic difficulties arise because it lacks the political institutions which allow the US to be a single currency zone and failed to adhere to the rules set up to try and get around that. Which is back to why folk such as Milton Friedman were so sceptical in the first place. As is normal in these things, there was no clear timing for failure, nor was the specific way failure would occur well understood, but the underlying scepticism was well placed.

I am reminded somewhat of the economic calculation debate concerning socialism. Mises and Hayek wildly underestimated the capacity of people, even in very dysfunctional institutions, to "muddle through". Their basic point was sound, however, as was clear to anyone who actually visited the Soviet Union or immediately post-Soviet states.

The ECB is not telling the politicians what to do; it is telling the politicians what they told it to do the last time they checked with their electorate. And hopefully, the sound money ethos in the ECB is sufficiently entrenched that it will not, like the Bank of England, unilaterally choose to abandon its mandate - although I am not sure about Draghi: http://reservedplace.blogspot.com/2011/11/easing-in.html

Anyway, as I say in my comment above, I get the feeling that peripheral European electorates do not want to go back to joke money, even if they may feel justified in repudiating debt. It is not clear that politicians demanding that the ECB "print money" have any more democratic legitimacy than the ECB.

And by the way, what the ECB is being asked to do is very different and more risky than being a LoLR to a bank. When the ECB lends to a bank it takes collateral. It is not easy to see how the ECB could take collateral from a country.

RebelEconomist; a fascinating notion of "sound money" that it involves mass unemployment, dramatic drops in income and pushing countries to default/bankruptcy. The point of money is to facilitate transactions. Money should be managed so it does that: if one is "managing" the level of transactions (indeed, driving down the level of transactions) so as to "protect" money, that is putting things very much the wrong way around. (I will grant there can be an argument for tightening money when there is runaway spending, but we are so not in that situation: and even that is about moving to greater macroeconomic stability to facilitate a more stable and sustained trend level in transactions.)

The "excessive debt" problem did not come from nowhere. The sustainability of debt is not independent of income. The ECB's tight money policy has been driving down spending, which is to say driving down income, in the most vulnerable countries, making debt "unsustainable". (Greece admittedly is a somewhat different case, in that it lied to get in, went on a spending binge and is a deeply dysfunctional polity which should have not been let into the euro, nor probably the EU.)

The Fed and the ECB should have an explicit policy target like the Reserve Bank of Australia--keeping inflation within set range on average over the business cycle (or a NGDP target: not that there is a great deal of difference between such). Looking at the Oz$ exchange rate, and inflation rate, that is a pretty "sound" money policy. And it keeps the focus on facilitating stable growth in transactions.

So much of what it going on has been various reprises of 1929-32, including folk bleating about "sound money" as economic activity is way below trend.

Rebel: "When the ECB lends to a bank it takes collateral. It is not easy to see how the ECB could take collateral from a country."

Good point.

Lorenzo: that so reminds me of Cuba in the mid-1990's. They used the verb "resolvar" (IIRC the spelling) to mean "muddling through", "work-around", "fixing a problem by a clever but non-orthodox dodge", in the same way a smart shade-tree mechanic holds the old car together and keeps it running with bits of wire and string.


I agree that the ECB, or any central bank for that matter, should simply manage its currency to facilitate transactions. And to me, that means not distorting that currency to fix the problem when those transactions drive a country into bankruptcy. The euro did not drive any country into bankruptcy - even now, despite all the bleating about 7%, Italy's cost of debt service, for example, is much less than it was when EMU began, because of years of locking in financing at low yields. The problem has been that countries used this slack to borrow or spend more.

"Good central banks ignore all the rules in an emergency (as Brad DeLong tells us the Bank of England did for a century)."

That reminds me of a good quote:

"All Central Bank Governors like quiet lives, working behind the scenes and in the comfort of their tall buildings and plush offices, and only appearing in public once or twice a year.

"But the question to answer is 'Are we in a normal situation demanding normal policies and practices in Zimbabwe today?' Let’s pause and stop the blame game regarding who is responsible for our situation and simply say whatever the cause, are we in a normal environment today?

"Certainly not... Thus in the economic sphere, we are living in extra-ordinary times and as such, only extraordinary monetary policy and fiscal policy initiatives are needed to secure our survival as an economy let alone growth... These interventions are never meant to be permanent features of our economic lives but today, they are necessary just as some extra-ordinary measures were necessary for the survival of the economy during UDI days [when Zimbabwe was fighting for independence]."

Anyways, that was Gideon Gono's paen to breaking the rules of the RBZ Act in an emergency. Two years later the Zimbabwe dollar had ceased to exist.

"But the ECB does have that power. It can say to each of the 17 governments: "We will act as your lender of last resort if and only if you do what we say. If you don't do what we say, we will loudly announce that we will no longer act as your lender of last resort, and the bond markets will make mincemeat of your bonds, and there will be runs on all your banks.""

I can't see why this wouldn't work in theory, it's how a private clearinghouse regulates its member banks. However, I'd be skeptical about the credibility of any no bail-out threat emanating from a European institution since the Eurosystem's initial no-bailout clause was dashed last year. Fool me once, shame on you, fool me twice...

Nick, I agree that various Eurozone countries used the low cost of borrowing to run up debt (as did the US, of course), but I also take the point of David Glasner and others that tight money policy by the ECB when a serious negative economic shock was sweeping through the global economy made things worse (as did the Fed, of course). Greece (and California) would have likely been in trouble anyway, but the other countries, not so much.

Tino Sanandaji provides evidence that joining the Euro cruelled Italy. Joining the Euro fundamentally changed the rules of political economy for the Mediterranean economies but it was seen as "hard currency" and "cheap borrowing": all upside, no consequences; no changes to the rules of the game.

Lorenzo, your point on the American Civil War is a straw man.

My point is that the Central Bank tail wagging the Ministry of Finance dog is just not going to happen. You can't subvert democracy and responsible government that way. Not event the ECB can do that.

There is a way to do things but this is not it.

"It's time, in the Eurozone, to reverse that question. Should the 17 fiscal authorities have independence from the one monetary authority?"

Any of the 17 fiscal authorities can literally show a middle finger to ECB and then ECB can evaporate into the void overnight. There is no central bank without fiscal authority and if even one chair falls out the whole house can collapse under fire.

This is what the first Papa tried to do bu failed. Well, somebody one day will get it right.

Lorenzo From Oz,

In an important sense, the Eastern Bloc countries weren't socialist. Hayek and Mises were right: they COULDN'T be socialists, in the old sense, even though they wanted to be so.

I suppose the parallel is with euro membership criteria: whatever their merits or flaws, Greeced proved that they don't exist, and they won't be enforced because the euro is a primarily political, rather than purely economic, project.

Determinant. You mean red herring: a straw man would be if I misrepresented your argument. My point was that political solutions are not always viable--disaster can happen.

You seem to be wavering back and forth between "that's outrageous!" and "it won't happen!". Plenty of outrageous things happen, so they are not the same claim. And the French President and German Chancellor effective organising to bring down uncooperative Mediterranean PM's doesn't seem all that hot from the democratic legitimacy perspective--but that seems to be what has been happening.

If the ECB cannot bring fiscal policy into line and, as W.Peden points out, the fiscal authorities are failing to bind themselves effectively, then the downhill spiral will continue. Then we are at my point about the antebellum US countdown to disaster and political solutions which are not viable.

One wonders if the ECB is not already playing a game of fiscal-monetary "chicken": until those fiscal policies are acceptable to us, we will continue our tight money policies.

Citing Australian experience again, the fact that fiscal policy has assiduously sought to give as much scope as possible for the Reserve Bank to stabilise the economy is not a small factor in Australia's continuing macroeconomic stability. But we have one federal fiscal authority, one monetary authority and they talk to each other: both privately and publicly. And that monetary policy is explicitly agreed between that one fiscal and one monetary authority allows for a very clear game to be played, one where the "democratic" fiscal policy clearly has one eye very firmly on likely responses by the "independent" central bank.

With a 17:1 arrangement, only very explicit rules could possibly have made the thing work, and it has been demonstrated that none of those 17 fiscal authorities will keep to the set rules. So, either the system acquires an enforcer or it will collapse. If the ECB is not the enforcer, and the fiscal authorities are demonstrably failing to fulfill the role, the next stage is collapse.

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