MARTIN WOLF: Here's Why The ECB Will Always Disappoint

Martin Wolf

Late last month at the Israeli Presidential Conference, we sat down with influential economic commentator and Financial Times columnist Martin Wolf to discuss the failure of the European Central Bank to take big enough steps to calm concerns about banking and sovereign debt crises in Europe.

In the wake of yesterday’s central bank action from around the world—including a rate cut from the ECB—we’ve published a full transcript of our conversation.

Simone Foxman: Why can’t central banks save the world? 

Martin Wolf: Central banks really have a role in two respects. They have to provide liquidity to solvent banks. When there are runs on banks which we’ve been having. So an LTRO is an operation to fund banks and it’s a lender of last resort operation and it’s very extreme, but I think we’re in extreme circumstances so I think that’s a classical central bank [move]. That’s not new; it’s just the scale is so new because of the pressure is so big. 

Second, central banks have to conduct monetary policy, and they have to decide what is an appropriate monetary policy for a situation in which we have, in my view, a clear set of balance sheet deflation. In a balance sheet deflation, people are trying to get rid of debt. The interest rate has to be very low. When the nominal interest rate short end goes to zero they have to change the long rate, so that gets you into quantitative easing. All this is an indirect way of trying to get negative interest rates, which is what we really need.

So that’s classic. Of course, to the extent that there’s any solvency problems in the financial sector or in the household sector or even the financial sector, the central banks can’t solve them. The only way they can try to do that is to do so much monetary easing they generate inflation. Inflation could erode debt, that improves the balance sheet, and that creates solvency. On the whole I think central banks are not doing that. I think probably, rightly, but that’s a very big question.

But it’s clear, central banks have a very big role on their own there’s a limit to what they can do. In conjunction with monetary authorities they can do a lot more, but they’re not trying that yet. [Like] direct monetary financing of the government spending…

 SF: You’ve mentioned that true federal union really won’t happening in Europe.

To be fair, I’m not talking about a big one. A minimal federal union, it’s conceivable. But it seems at the moment unlikely.

 SF: But there’s no way the ECB can hijack the process, and decide to step into a larger role?

MW: No. The ECB can create money. The ECB can raise inflation. The ECB can finance governments and banks, though it takes a big solvency risk. The ECB is not a legitimate political authority. It can’t create fiscal union and it can’t conduct fiscal policy beyond a certain amount. 

It’s very complicated to define actually what the ECB is because it’s a central bank without a government. It’s different from most central banks which have a government–one government. But the constitutional issue of writing a fiscal union, creating fiscal solidarity among member states, is not one the ECB can execute. It doesn’t have that power. It can’t sign treaties; it’s the product of a treaty.

The ECB is, however, an entity that has stepped in the breach..It is a financier but it cannot create a common fiscal constitution for Europe.

 SF: Some investors have complained that the scarcity of safe haven assets could expose financial firms to more risk than they can handle (i.e. investments in riskier assets could produce a downward spiral should the economy deteriorate). Should we be worried about this?

MW: It’s true that a very large part of the recent issuance has been purchased by the central banks. But because the deficits are so large–in the U.S. and U.K.–the supply of bonds, and thus the market, is really still very large. So I don’t see any huge problems for most of the private sector. 

But it is true that in the US today certainly and in the UK the net supply of bonds to the private market probably hasn’t increased very much, and the demand really has increased. You can see that in the prices. The demand is for safe haven.

But the aim of the central bank is to drive people towards riskier assets. It has worked in the sense that the prices of riskier assets have risen. So they’re reasonably comfortable with what they’ve done.


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