As I have been saying at Credit Writedowns, the ECB’s opposition to monetising sovereign debt is not about immediate inflation concerns but rather its resistance to moving into a politicised quasi-fiscal role. Arguing in defence of the ECB last week, I wrote the following:
Conclusion: central bankers always prefer to force elected officials to make the tough political choices that are the essence of fiscal policy. The fiscal agent adds and subtracts net financial assets in the private sector by deficit spending, or cutting spending and raising taxes. Central bankers want the fiscal agent to use these tools as the driver of macroeconomic policy while the monetary agent is tasked with more narrow aims.
In the US, the monetary agent, the Federal Reserve, has a dual mandate for price stability and full employment, and therefore has some political legitimacy as a quasi-fiscal agent. Even in the US, you hear Fed Chair Ben Bernanke stating very clearly that he does not want to do more and that he wants the fiscal agent to take on the principal policy burdens for maintaining full employment. The European Central bank has one mandate, price stability. And that means it is much more reluctant to step into a quasi-fiscal role.
So when Mervyn King talks about the ECB “buying sovereign debt of national countries, which is used and seen as a mechanism for financing the current-account deficit of those countries”, he is talking about a policy choice that helps the national governments achieve their fiscal aims, a quasi-fiscal role.
The ECB has balked at doing this – rightly so, I might add (in a brief role as policy advocate). Their position is that the fiscal agent is elected by a democratic process and must solely take on the responsibility of achieving macroeconomic objectives outside of price stability. [emphasis in original]
In an interview with the Frankfurter Allgemeine Zeitung, a leading German broadsheet, the ECB chief economist explained his resignation and that of Bundesbank head Axel Weber in terms very similar to these. The argument is clear. Whether the ECB eventually is forced to take on this quasi-fiscal role by the escalating sovereign debt crisis is another matter. I have said the ECB will be forced into this role because of Italy, though I do have my doubts.
Below is my translation of the Stark interview. Note his commentary on commodity and asset-price inflation and the distortionary asset-based economic model based on cheap money that is practiced in the US. His is a framing of the problem with which I agree due to the altered private portfolio preferences this Greenspan/Bernanke put engenders. However, I do not agree with Stark’s framing of deficits as the “root causes” of the crisis. Spain and Ireland had no deficits pre-crisis. The problem was the incomplete institutional arrangement of the euro zone currency union. Any solution that does not address this will fail.
Also notice his framing of the Eurobond/fiscal union issue. He doesn’t rule out Eurobonds. Rather, he says it must be fiscal/political union first and only then Eurobonds.
“The political pressure on the ECB is huge”
Chef economist Juergen Stark is leaving the European Central Bank. He sees its independence at risk and warns in a farewell interview of the threat of inflation.
Mr. Stark, at year’s end you are resigning your post as chief economist of the European Central Bank after five and a half years. How do you feel?
I feel that I’ve tried to do my part, that the euro remains a stable currency. And it has been throughout my tenure.
You are leaving like former Bundesbank president Axel Weber in protest against the ECB’s buying the government bonds of crisis states. Are you a martyr for a stable euro?
Not at all. And how would that be? I have decided to resign by the end of this year for personal reasons. But I will remain linked to the common European currency project. After all, I have worked for this for nearly a quarter century. And I will continue to accompany and support this project, just from another position.
What will you do in the future?
I have no comment on that at this time.
Why was the purchase of government bonds by the ECB such an unforgivable taboo break for you and Axel Weber?
The majority decision of the Governing Council to buy government bonds in this particular historical situation is to be respected.
But where’s the danger?
It is not so much that bond purchases will lead to inflation at this particular moment. The ECB regularly draws down the liquidity again; it later soaks up the money spent. What is important and problematic is that the interest rate on government bonds is affected by the purchase of bonds and thus has a fiscal effect.
We influence the conditions under which governments can borrow. This is absolutely not our job.
Why is it bad if the central bank helps governments?
There must be a clear separation of functions between central banks and governments. The central bank has to deliver price stability. And it is the responsibility of governments to ensure adequate conditions for the financing of government expenditures. That markets have been more sensitive to the high indebtedness of states for some time and therefore require higher interest rate is not a situation for the central bank to correct.
What is the problem in that?
We know from economic history that when a central bank has financed states in grand style, it has always led to disaster. It ends in inflation – not always in the short term, but in the medium to long term. And it ultimately leads to economic and social instability.
You say there is no threat of inflation in the short term, because the central bank is able to sterilise the increase in money supply. What changes over the long run?
Right now the central bank lendsas much money as is needed to banks because the banks are lending very little to each other. Worldwide there is an extremely expansionary monetary policy. This is currently not inflationary, as banks pass the money as extra credit on to households and businesses very haltingly during the crisis. That will change when the economy is doing better again someday. Then the central banks will have to respond very quickly.
In America, under Alan Greenspan, low interest rates led to a real estate price bubble. Will this happen in Europe too?
Liquidity can always find its way, we central bankers say. Either consumer prices increase – or asset prices. We are already seeing that the abundant liquidity available in global markets has led to higher inflation in emerging countries and to price increases of over five per cent in Britain and more than three per cent in the United States. At the same time, global commodity prices have risen, especially the price of oil.
People in Germany fear not only inflation. They are afraid that the crisis has grown beyond Europeans’ control. Last Wednesday, even Germany had trouble finding buyers for its bonds.
There is no reason to dramatise the difficulties in the auction of 10-year government bonds. Remember: the interest rates offered are below inflation. No wonder investors are reluctant.
Nevertheless aren’t the signs that the crisis has arrived in the states performing the rescue? Even France has been anxious about its rating.
I would not make that distinction between rescuers and rescued States. When large economies such as France have a budget deficit of more than five per cent, and the debt continues to rise and policy makers act only with reluctance, it cannot be surprising that markets react and interest rates rise. Then it will also be harder for the large countries to finance themselves.
But how does this process end? Can Europe only choose between plague and cholera: accept Eurobonds, the joint liability of all countries for all debts, or turn on the printing press?
No. “Money printing” as you call it, is in no way used for the reduction of public debt. We are fulfilling our mandate to ensure price stability now and into the future.
Don’t different rules apply for extreme situations than in calmer times? More and more economists and politicians are calling for the ECB to be “lender of last resort” for countries too.
Rules are there to give one direction, especially in times of crisis. If the central bank starts to finance governments, it decreases the incentive for governments to address the root causes of the crisis.
Then Eurobonds are truly all that is left in the end?
Eurobonds do the least to solve the structural budget problems that some member States in the euro zone have. Rather, they can lead to a liability or debt union that no one wants. Only when important steps toward political union are made can we have common bonds.
How do you want to solve Europe’s problem then?
Rising public sector debt must be stopped. This must go hand in hand with the implementation of structural reforms carried out in order to improve the competitiveness of the problem countries and to strengthen growth potential.This is a matter for governments, not the central bank.
You are particularly strict on this issue. Many Anglo-Saxon economists say the Germans should not be so unyielding. Doesn’t the crisis require one to sacrifice noble principles?
Principles apply, especially in critical times. The concept of solving all the world’s problem with additional liquidity is wrong-headed. It may help in the short term; medium term, however, it leads to market distortions and higher inflation. But it is precisely American think tanks which encourage the public and policy makers to higher inflation rates. This viewpoint is slowly penetrating Europe as well. The recommendation that the ECB should allow instead two per cent inflation, four or five per cent, I think is fundamentally wrong. Such a price development can be very difficult to reel in.
In America, the argument is that the Germans, with their unyielding policy framework, are unnecessarily prolonging the euro crisis. Are we too obstinate?
I will be in the United States next week and will be confronted with this question again and again. We Europeans should have the courage to point out the consequences of a continual policy of cheap money. Many of the dislocations of the financial crisis with which the whole world has had to fight are due to this policy.
Why is it so important for central bankers to be principled?
The current political pressure on the ECB is enormous. There is an open discussion about extending our mission. This not only affects our independence, it threatens it.
What will you tell your successor Joerg Asmussen from the heart when you leave the ECB?
The ECB must remain an anchor of confidence and stability. Board members must, as the President has recently stressed again publicly, pay attention to the continuity of this institution for consistency in its actions and credibility. And they must defend the independence of the ECB by all means.
Do you think the euro will exist in 10 years?
Yes, without a doubt. But probably with more member countries than today. However, we must heed the lessons and assess compliance with the convergence criteria by potential candidates intensely and critically.
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