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Kicking the can down the road outside the Roach Motel

My friend Marshall Auerback has described the EMU has the Roach Motel – a very North American term but one which resonates everywhere. The full article – is recommended reading. Very amusing and perspicacious. He says – “The Germans might occupy the penthouse suite, but it’s the penthouse suite of a roach motel” which is apposite. The latest decisions of the EU finance ministers after an emergency meeting in Brussels over the weekend will just hold the ultimate crisis at bay for a little while longer. The EMU is currently surviving because the ECB has stepped in as the “missing” fiscal agent and keeping the bond markets at bay. While the ECB is the only entity in the EMU which has currency sovereignty and can “fiscally fund” member state deficits permanently, the underlying logic of the monetary system will continue to ensure these on-going crises will spread across the union. The EU bosses are just buying time and “kicking the can down the road a bit” at the moment. Ultimately, to survive the system has to add a unified fiscal authority and abandon the fiscal (Maastricht) rules (not politically possible) or accept the experiment has failed and dissolve the union. The latter option is clearly preferred and while the can is being kicked down the road apiece the EU leaders should be dismantling the Roach Motel and setting the captives free.

As an aside, I first associated the slang term – Roach Motel – with the way the Java Memory Model orders accesses to synchronised blocks. The US company that developed the cockroach bait used an advertising tag – “Roaches check in, but they don’t check out” – in the JMM memory accesses can be moved into synchronised blocks but you cannot move them out – hence the association.

In the context of the EMU it isn’t clear what the Roach Motel association refers to – a cheap lodging in the seedy part of town – or the asymmetrical access! The inference in Marshall’s New Deal 2.0 article is the latter. It was easy for the politicians to dupe their populations into joining the EMU but it is now a major political problem trying to exit. Recall that the original plan was for a country-by-country ratification process (by referendum) which would have, at least, rendered the decisions to join the union democratically based. But as the early votes demonstrated the people were largely against joining up and so the politicians abandoned that approach and forced through the arrangement via the Lisbon Treaty.

I also borrowed the term – kicking the can down the road – from this Bloomberg article (November 29, 2010) – Ireland Wins $113 Billion Aid; Germany Drops Threat on Bonds – which reported on the agreement worked out at the emergency meeting of European Union (EU) finance ministers in Brussels over the weekend.

The Euro bosses decided to give in to the “bond markets” by giving the Irish government “an 85 billion-euro … aid package” and have diluted the German demands that would have forced “bondholders to cover a share of future bailouts”. The meeting also extended the horizon for Greece to pay back the emergency loans (110 billion euros) which brings both bailouts so far into line – seven-year terms.

Ireland has to impose further anti-growth/anti-people measures on its population courtesy of the IMF to get the cash!

Of-course, Ireland had done everything that was asked of them by the austerity monsters – and as I predicted (here) the situation deteriorated. Now they are having to make further cuts which will further worsen their outcomes. They are racing to a very deep bottom and it is only a matter of time before major civil unrest brings their corrupt and inept government down.

It is clear that the bond markets will pick off EMU countries one by one with Portugal lining up next – then Spain – then Belgium and then …. No EMU member-nation is immune from this crisis as a result of the flawed design of the monetary union.

The Germans demanded that the the EMU extended its austerity rules to allow for orderly defaults that would impose costs on the holders of public debt. I just laughed when I read their policy proposals. What the hell do they think would have happened?

They create a situation where the bond markets rule – totally unnecessarily – then tell the “investors” that if they lend too much they will take losses.

Apparently the “compromise” is that the IMF will determine who takes the losses on a “case-by-case” basis. Handing any discretion to the IMF is a mistake at the best of times. But it will just worsen this crisis and encourage more destructive targetting by the bond traders.

The other point is that the crisis is starting to threaten the penthouse occupants! In this UK Telegraph article (November 26, 2010) – EU rescue costs start to threaten Germany itself – we learn that the “escalating debt crisis on the Eurozone periphery is starting to contaminate the creditworthiness of Germany and the core states of monetary union”, which was always going to happen. All these nations are dependent on the “fiscal capacity” of the European Central Bank as a result of the flawed design of the monetary union.

Apparently, fear is spreading in Germany. The article reports that:

Germany cannot keep paying for bail-outs without going bankrupt itself … This is frightening people. You cannot find a bank safe deposit box in Germany because every single one has already been taken and stuffed with gold and silver. It is like an underground Switzerland within our borders. People have terrible memories of 1948 and 1923 when they lost their savings.

The Germans have been trying to force the pending public debt losses on the bond markets – so-called “creditor haircuts” which has clearly made matters worse. The bond markets have decided (those amorphous decision-makers) that Greece is not the limit of the problem. They soon set out to ruin Ireland and now Portugal and Belgium are being targetted.

The bond markets know that the EMU nations have ceded their currency sovereignty and acted over the last decade in a way that was in denial of that loss of sovereignty. So these governments, which gave up their capacity to “save” or guarantee their own banking systems, then allowed these systems to go berserk and effectively bankrupt their nations. All these governments should resign en masse.

But the point is that the Euro bosses are waging a losing battle – they are just “kicking the can down the road apiece”.

I am not a fan of the “bond markets” and I view public debt as corporate welfare. But I also recognise the logic of their motivation. Given the governments agree to a system where the individual member states are without sovereignty and are thus “financially constrained” they have to rely on the bond markets for funding of their deficits.

To then say to the “investors” that you lose if we overextend is not only a corrupt concept but also foolish. Overextend in this context has to be defined within the ridiculous context of the Maastricht Stability and Growth Pact (SGP) rules which provide no real capacity for any government to adequately address a major demand shock.

In this environment, there is a growing call for Germany to exit the EMU and leave the Euro to the weaker trading nations. For example, in this article – German exit from euro ‘realistic prospect in 2011’ – the author says:

Germany’s presence in the euro is a problem for the PIIGS, since the export powerhouse keeps the value of the single currency high, making it difficult for the likes of Greece and Ireland to escape their crises by increasing their own exports. Without Germany, the euro would fall in value, giving a much-needed boost to the competitiveness of weaker members.

Which as far as so-called informed commentary goes just demonstrates how skewed the debate has become. The fundamental problem facing the EMU is not that the member nations have differential trading capacities.

Certainly, net exports contribute to aggregate demand which drives income and employment growth. So Germany has always relied heavily on its export sector to maintain real output growth, while some of the other EMU nations have not. But it is perfectly reasonable (and desirable) to have strong domestic spending growth brought about by various mixes of consumption, investment and public spending.

The problem for the weaker EMU nations is that the nonsensical rules that have been developed by the monetary union prevent the member governments from using fiscal policy to fill spending gaps that have arisen from a collapse in private domestic spending – net exports status notwithstanding.

It is true, that one of the problems for each EMU nation is the fact they no longer can vary their individual nominal exchange rates and have to try to engineer changes in their real exchange rates via domestic deflation, which savages pay and working conditions for the domestic population. Clearly, a sovereign nation has to not only issue its own currency but also has to float that currency to free up the capacity of domestic policy to pursue public purpose.

But while Germany’s exit from the Eurozone would allow the weaker nations to “devalue” as a block, it still doesn’t restore sovereignty to the individual governments in the “block”. It could work if the remaining members agreed to cede fiscal authority to a unified “fiscal agency” which also was aligned with the currency issuing authority (it could be the same entity).

But without that overall fiscal capacity to meet asymmetric aggregate demand shocks, merely losing the “strongest” nation in the union will not achieve anything constructive for the remaining nations.

Some might say what is the difference between a nominal exchange rate change that generates a real depreciation and the same result achieved by domestic deflation (cuts in nominal wages and inflation). The difference is that workers have nominal contractual commitments which are aligned (more or less) with their nominal pay levels. A depreciation in the nominal exchange rate squeezes these workers somewhat to the extent that they purchase imports or products with significant import components. But they still (within reason) can then prorate the “real income losses” across their overall budget and prioritise their nominal contractual obligations.

But directly cutting nominal pay attacks their capacity to meet their nominal commitments. Yes, the real income losses might be the same but if they do not have enough nominal pay to meet their obligations then default follows.

This is one of the reasons why Keynes and others argued that workers are prepared to take real wage cuts that arise from a rise in the price level but will resist an equivalent real wage cut that might follow a nominal wage cut. The second option exposes the workers to nominal contract default. The argument generalises to why cutting pay is a very poor way to solve unemployment. Please read my blog – What causes mass unemployment? – for more discussion on this point.

Further, Germany’s export strength relies heavily on the import spending of the other EMU nations. This is the myopic aspect of the German position. They want to maintain strong exports but they also want to impose fiscal austerity on the “importing” nations, which will not only significantly reduce public spending but will also reduce private spending (as incomes drop). I am reminded of the Aesops FableThe Goose with the Golden Eggs:

One day a countryman going to the nest of his Goose found there an egg all yellow and glittering. When he took it up it was as heavy as lead and he was going to throw it away, because he thought a trick had been played upon him. But he took it home on second thoughts, and soon found to his delight that it was an egg of pure gold. Every morning the same thing occurred, and he soon became rich by selling his eggs. As he grew rich he grew greedy; and thinking to get at once all the gold the Goose could give, he killed it and opened it only to find nothing.

Which might be re-written as:

One day Germany realised that the poor saps down south would buy whatever products they offered for sale – in particular, military equipment allegedly to ward of enemy neighbours. Germany couldn’t believe how stupid these southern nations were going into a monetary union with them but realised that they could grow wealthy from exporting to them. As Germany grew rich they also became greedy; they also wanted to take the islands that belonged to the southern nations and so imposed ridiculously harsh austerity programs on those nations to force them to hand over the islands. Soon after, the southern nations went broke and couldn’t buy as much stuff from Germany any more.

Please read my blogs – Export-led growth strategies will fail and Fiscal austerity – the newest fallacy of composition – for more discussion on this point.

There is also some argument about whether the Irish situation is a Euro crisis or a specific country banking crisis. The root cause is definitely the Euro membership and the banking crisis has exposed the lack of fiscal capacity that the EMU member states have as a result of ceding their monetary and fiscal capacity to the ECB.

While the banking crisis is symptomatic and has been instrumental in causing the Irish government’s budget deficit to increase the underlying cause of the problem now is Ireland’s membership of the Eurozone.

It is clear that the pro-free market Irish government lost oversight of its nation and allowed its banking system to run riot as they privatised the profits in the property bubble period. Certainly, the low interest rates coming from the ECB made borrowing cheap and helped fuel the property speculation. The low corporate tax environment also promoted economic allocations that were not in the long-term interests of the Irish population.

All of these developments have clearly combined to make the Irish crisis worse than most and reflect the lack of adequate government oversight.

But even with this appalling record of corrupt and incompetent governance, the Irish government could have reduced the costs of the meltdown had it been sovereign in its own currency and not been held hostage to the SGP fiscal rules.

It is true that the free-market bias of the Irish government which led it into trouble as above has also made it easier for them to impose the harsh fiscal austerity on its people. But that just means the Irish people should ensure they kick the government out of office as soon as possible. But even the most progressive government with all the insights in the world about how to promote domestic employment growth etc will not be able to do anything constructive while they remain in the Eurozone.

An aside also relates to the concept of governance that is lost in the current debate. The private markets are devoid of any “values”. They are amoral in that sense. To think that the decisions that private market participants make will somehow advance public purpose is naive in the extreme.

One of the roles that we seek in government is to mediate the private markets to reflect the “social values” of the nation. The neo-liberal era has successfully eroded the concept of collective will and has actively promoted the idea that nations do not exist beyond being a “collection of self-seeking individuals”. That is the myth that introductory economics textbooks seek to propagate – that optimal outcomes emerge when individuals pursue their self interest.

The current crisis should inform us of the folly of that “religious” belief. And it has also exposed the folly of governments that renege on their responsibilities to adequately regulate the private markets to ensure they work to advance social outcomes and welfare. The Irish government clearly abandoned that responsibility not only in allowing the markets to rip but also in shoe-horning their citizens into the monetary union which was always destined to come unstuck as soon as the first sizeable demand shock emerged.

The following blogs cover my recent commentary on the EMU:

Caption contest

We know that the ECB boss is blinded by neo-liberal ideology and now he seems to be noticing it. I am announcing a new contest which will offer very generous prizes and finish at some unspecified time for the best caption to this photo of Trichet adjusting his glasses while speaking at a press conference after the emergency meeting of European Union finance ministers in Brussels over the weekend just past.

I will announce a winner sometime and no correspondence will be entered into :-)

When I saw the photo, I started singing – I can see clearly now:

I can see clearly now, the Euro is gone
I couldn’t see all obstacles in my way
Gone are the dark clouds that had me blind
The Euro is dead (dead), gone (gone)
and I am having a very bad day

Clunky, sorry!


Anyway, now the EMU has decided to “kick the can down the road a while” but the monetary system will remain flawed and those flaws will ultimately bring it down unless the ECB keep providing “fiscal support” via their secondary bond market purchases.

The next EU finance ministers’ emergency meeting should have only one agenda item: how the hell can we dissolve the monetary union and restore currency sovereignty to the individual nations and minimise the (huge) adjustment costs that would follow?

While those adjustment costs would be large I guess they would be lower than the accumulating economic and social costs that will accompany their pig-headed attempt to maintain the system.

That is enough for today!

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    This Post Has 170 Comments
    1. RSJ ,

      If the ECB wants to drain the reserves and only sells Greek bonds then if the default risk premium is eliminated (it can be eliminated by the ECB), the markets will have to accept Greek bonds because it is better to hold them at 2% then cash at 0%. Obviously if ECB wants to sell German and Greek bonds at the same price, the markets will prefer German bonds because of the residual risk associated with the Greek bonds.

      Again this is all a matter of making certain arbitrary decisions.

    2. RSJ,

      “For the case of the Fed, it is only allowed to purchase assets guaranteed by the U.S. government in the first place”

      Ive read this a while back though, from the Fed’s Purposes and Functions Manual (Pg 36):

      “Open Market Operations
      In theory, the Federal Reserve could conduct open market operations by purchasing or selling any type of asset. In practice, however, most assets cannot be traded readily enough to accommodate open market operations. For open market operations to work effectively, the Federal Reserve must be able to buy and sell quickly, at its own convenience, in whatever volume may be needed to keep the federal funds rate at the target level. These conditions require that the instrument it buys or sells be traded in a broad, highly active market that can accommodate the transactions without distortions or disruptions to the market itself.
      The market for U.S. Treasury securities satisfies these conditions.”

      So to me, the near-exclusive use of Treasury securities in omo sounds like another self-imposed (not a ‘legal” per se)constraint. This reads like they could buy used cars if they wanted to, adding/subtracting reserves thru the bank accounts of the used car dealers. Resp,

    3. Matt,

      From the Federal Reserve Act, section 14, Open Market Operations, the Fed is allowed to:

      1. Buy and sell short term bills (in maturities not exceeding 6 months) that are obligations of counties, governments, and foreign governments.
      2. Buy and sell gold
      3. To purchase from member banks bills of exchange, and to sell bills of exchange ( to anyone).
      4. “To buy and sell in the open market, under the direction and regulations of the Federal Open Market Committee, any obligation which is a direct obligation of, or fully guaranteed as to principal and interest by, any agency of the United States.”


    4. Ramanan,

      “Combine the Treasury and the central bank balance sheets and you have an entity with a negative net worth. ”

      No, because on the asset side of Treasury is the power to tax. That, as a balance sheet item, is what ensures that the Treasury’s balance sheet pretty much always balances.

      By your logic, every non-financial business has negative net worth, as it’s assets are primarily real assets as well as things like “market power”. Really the assets are earnings power, and these are held against financial liabilities.

    5. RSJ,

      Yes you may want to add tax receivables in the assets. However, its simple if not added. That way financial assets sum to zero and it incredibly simplifies things!

      If you add tax receivables in the Federal Government’s assets, you have to include tax liabilities of the future in households and corporations’ balance sheets.

      Neither Z.1 nor Blue Book (UK) add the item in assets.

    6. Adam,

      “If the ECB wants to drain the reserves and only sells Greek bonds then if the default risk premium is eliminated (it can be eliminated by the ECB)

      This is where you assume your conclusion. Yes, if default risk could be eliminated, then the CB could buy the bonds in unlimited amounts. But how would the risk be eliminated? Only by buying the bonds in unlimited amounts. So you are not proving anything, you are assuming the conclusion.

      The whole point is that you have two modes in which the CB + fiscal arm can operate. In one state, the fiscal arm has taxing power and guarantees capital for the CB, while the CB guarantees liquidity to the fiscal arm. This allows the CB to expand its balance sheet however it wants, and it allows the fiscal arm to enjoy risk-free rates.

      In the other mode of operation, the fiscal arm does not guarantee capital for the CB, and therefore the CB cannot guarantee liquidity to the fiscal arm. In that mode of operation, the fiscal arm does not enjoy risk-free rates, and the CB cannot expand its balance sheet however much it wants.

      The U.S. operates in the first mode, whereas the E.U. operates in the second.

    7. RSJ:

      “FDIC insurance.”

      is irrelevant because it is funded by the member banks.

      “On the other hand, congress did agree to guarantee the agencies prior to the Fed’s intervention, so to the degree that you believe that this congressional guarantee is sufficient, the Fed is OK”
      “Guarantee” is a very vague word. Specific amounts should be allocated through a appropriation bill.

      “And that means that there won’t be any losses for MBS purchases. ”
      Do you mean to say that the losses will be absorbed by taxpayers or by additional debt issuance, or you have some other mechanism in mind ?

      “Congressional guarantees of Agencies ”
      Again, congressional guarantees is a promise. Were/wiil specific amounts of money be allocated to absorb losses, and where will the amounts come from ?

      Let’s say for the argument sake that the toxic asset losses on the Fed balance sheet are $500B. Who will pay ? The treasury ?

      Understanding the Fed recapitalization mechanism may also shed some light, hopefully, on the Eurozone situation.

    8. Ramanan,

      No, you would need to do more than add tax-receivables, you would need to add all future tax receivables. So no one bothers to add these in. In other words, it’s not really the case that the balance sheet of the government is allowed to “not balance”. It just means that the taxation powers of government are sufficiently powerful that we allow negative financial net worth, because the government has large non-financial assets (e.g. the ability to tax, and to increase taxes, etc.)

      And you can view a sovereign debt crisis — for example, in a pegged regime — as one in which the market begins to doubt the strength of the taxing power as being sufficient to cover the negative financial net worth.

      So in all cases, the balance sheet balances. Both for firms or for governments. When the assets are too small, the liabilities must also shrink — e.g. default of some kind. Government balance sheets must balance as with everyone else.

      But this highlights the fundamentally subjective nature of calculating balance sheets. In order to calculate balance sheets, you need some asset valuation method, and there is objective or expectations-free algorithm. There are only series of commonly accepted customs to try to enforce consistency.

    9. “But without a fiscal agent, the ECB cannot buy high and sell low. It doesn’t matter whether it buys directly from the member states or on the secondary market. As long as it keeps buying high and selling low, it needs someone else to supply additional capital.”

      Are you sure about that. The bonds are priced in Euros and the ECB creates those. Only regulation stops a bank creating an infinite amount of money.

      So surely the ECB can just create the money like any other bank does. The ‘hole’ in the balance sheet is then just ‘Euros outstanding’.

    10. “Only regulation stops a bank creating an infinite amount of money.”

      No, the capital providers stop the bank from creating an infinite amount of money, because the hole comes out their capital. That is why you have Bill Black arguing “the best way to rob a bank is to own one”.

      For the ECB, the ones that constrain activity are the ones that supply the capital subscriptions. They are Germany, France, etc. Should the ECB buy Greek debt high in the primary market and sell low in the secondary market, then money is being transferred from Germany to Greece, and Germany will veto that operation. Germany will be the one that needs to supply more capital to the ECB to make its balance sheet balance in the event that the ECB incurs losses. And therefore Germany will constrain the ECB to operate in such a way as to minimize losses. It doesn’t matter whether the debt is denominated in euros. What matters is who pays the debt.

      And the capital providers — the member states — will be the ones that constrain what the ECB does and how much its balance sheet expands. If their balance sheets were unified, so that there was no German debt or Greek debt, but only “EU” government debt, it would be one branch of government lending to another, with no noticeable effect on the consolidated balance sheet of the unified government entity.

      Then you would be in the better mode of operation in which ECB capital was unlimited and EU debt was riskless. But as long as the governments are pitted against each other, with a separate group supplying ECB capital and a different group wanting to borrow from the ECB, then the group wanting to borrow from the ECB will not find a sympathetic ear, and they will be told to make a separate arrangement with the group supplying the capital. The ECB cant do anything for them.

    11. RSJ:

      Somehow my message did not make through, so I’ll make a short one ;)

      For the argument sake, let’s assume that the Fed incurred $500B asset loss on its balance sheet. Who specifically will remit money to cover the loss regardless of specific operational arrangements (RTC, Maiden Lane, whatever) ?

      Is it the Treasury ?

      If it is the Treasury, under the current operational and *legal* arrangements, the money can come either from taxes or debt issuance, correct ?

      I think it’s a fairly straightforward question the answer to which that may help shed light on the Eurozone situation.

    12. VJK,

      Yes, the treasury will most likely issue more debt to cover the losses. And you are right, this sheds light on the EU constraints.

    13. Btw, there is a chapter in Complexity, Endogenous Money And Macroeconomic Theory: Essays In Honour Of Basil J. Moore which seems to worry about the ECB’s capital. Its written by a person called Otto Steiger.

    14. Ramanan,

      How do you find all these references? I’m amazed. You should post a bibliography one day.

      But I’m not going to pay $180 for that book :)

    15. RSJ,

      I do a massive massive research without being an economist. I buy those books!

      You can preview most of that chapter on Google Books btw.

      I recently managed to get Moore’s book Horizontalists and Verticalists after a mega search online. Ended up buying a used copy from a seller at Amazon France. It was not straightforward, the seller was not Amazon itself and would deliver only in selected countries. So I had to ship it to a friend in the US to get it via him. Plus I had to dodge some French at the Amazon France website! Google Chrome’s auto-translate was handy. (Anyway you can preview many pages of the book at Amazon)

    16. “For the ECB, the ones that constrain activity are the ones that supply the capital subscriptions”

      More ‘pay off the overdraft’. ECB could still do it on a cashflow basis because it creates the Euros. It’s not restricted because of capital. It’s restricted because of politics – the Germans won’t sanction the transfer payments nor a ‘negative equity’ central bank.

    17. Food for Thought.

      It is not enough to have your sovereign currency with flexible exchange rates and an integrated Treasury with the monetary authority but also must have policy rules that take advantage of these powers and not restrained by ideology. For exmple you might have Trichet as Governor of the joint authority! Policy makers matter………

    18. Neil,

      Euros are a liability of the ECB.

      Not an asset.

      The ECB cannot create net financial assets for itself.

      Write the ECB balance sheet as A = assets. E = euro liabilities. C = capital.

      So we have A = E + C.

      And C = A-E

      Now suppose that the ECB creates more euros, dE, and buys assets with them, dA. Then we have

      A + dA = E + dE + C

      C_new = A-E + (dA – dE) = C_old + (dA-dE)

      Now suppose the ECB overpays, or that some assets do not perform (remember, most of the assets that the ECB holds are private sector debt). Say dE = 2dA.

      Therefore C_new = C_old – dA

      So the capital providers take a hit of dA = the amount by which the ECB overpaid.

      Given this hit, it doesn’t matter if the ECB recovers the loss by keeping interest income (that would have gone to Germany), or by asking Germany for dA more capital.

      In either case, it is Germany and not the ECB, that is overpaying for the asset.

      The ECB is just the conduit for the subsidy, but the source of the subsidy is the capital provider.

      Therefore you can understand why the capital providers may want to constrain the ECB, to prevent it from engaging in fiscal policy. If they wanted to subsidize Greece, then they would have done so — and they are doing so via the ESF.

      On the other hand, suppose that we have a unified EU, and that the ECB only buys government debt.

      Now, on the one hand, the government loses dA of capital. But on the other hand, the ECB shuttles dA of funds to the government.

      In the unified scenario, the unified government does not incur a loss (or gain) when the ECB overpays for a government asset.

      Therefore in the unified scenario, attempts to boost asset prices are politically palatable, since no one suffers (in the government). Non-asset holders in the private sector may suffer (and asset holders in the private sector may benefit), but the government does not suffer or benefit.

      This is why unified central banks can expand their balance sheets and attempt to boost asset prices whereas the ECB cannot. This is why Germany and the other core nations impose constraints on the ECB. Those constraints would go away in a unified government scenario.

    19. Neil, RSJ

      It is the NCBs that create the Euros not the ECB. I just searched for Otto Steigers paper that Ramanan quoted to RSJ above. The European Central Bank and the Eurosystem: An Analysis of the issing Central Monetary Institution in European Monetary Union

      The ECB has very little power, it only gives the outward appearance of independence when in fact the power resides with the Council of Governors of the Eurosystem who meet once a month and determine the interest rate and then instruct the ECB who are just the newsreaders for the media. It doesn\’t even have a lender of last resort facility, everything is still decentralised to the NCBs.

      This is done by the Council of Governors of the Eurosytem which, however,
      is not the “Council of the ECB” as its official name suggests. The Executive
      Board of the ECB does not form a council of its own but is a minority group in
      the Council. As Board it functions only as an intermediary, a vicarious agent,
      between the 18 member Council, in which the six directors of the Board sit
      together with the twelve NCB Presidents, and the NCBs which implements the
      Council’s policy. Other than the Board of the Federal Reserve System or the
      Directorate of the former Bundesbank the ECB’s Executive Board cannot take
      any independent decision. In every respect it is controlled by the Council which
      until now has only assigned the ECB some 1,200 employees out of over 60,000
      in the Eurosystem.

    20. BFG,

      Then it may not be technically 100% accurate to say “the ECB buys X”, etc. (could be splitting hairs but its best to know the details first) I guess on a macro level the “ECB” does these kinds of things. But to me it’s like Trichet in reality just acts as an “honest broker” (I know loose language!) sort of between the NCBs.

      I often wonder in these sort of convoluted arrangements if there is something that operationally prevents for instance the Irish NCB from buying Ireland Govt debt at much lower rates for the citizens of Ireland… like due to the external deficit the system in Ireland ends up actually short of balances that prevents this operationally, and they have to go ‘hat in hand’ to the surplus countries via Trichet … anyway good point.


    21. BFG,

      Yes of course the NCBs do “the work” but the ECB is the ultimate authority. For example, if some government bonds have to be purchased, its the ECB giving the orders. My understanding is based on the following rules:

      From GUIDELINE OF THE EUROPEAN CENTRAL BANK of 26 April 2001 on a Trans-European Automated Real-time Gross Settlement Express Transfer system (Target)

      Article 4 Interlinking Provisions (b) 1 says:

      The ECB and each of the NCBs shall open an inter-NCB account on their books for each of the other NCBs and for the ECB. In support of entries made on any inter-NCB account, each NCB and the ECB shall grant one another an unlimited and uncollateralised credit facility

      2 says:

      To effect a cross-border payment, the sending NCB/ECB shall credit the inter-NCB account of the receiving NCB/ECB held at the sending NCB/ECB; the receiving NCB/ECB shall debit the inter-NCB account of the sending NCB/ECB held at the receiving NCB/ECB.

      The ECB Annual Report says:

      Intra-ESCB balances/intra-Eurosystem balances

      Intra-ESCB transactions are cross-border transactions that occur between two EU central banks. These transactions are processed primarily via TARGET2 – the Trans-European Automated Real-time Gross settlement Express Transfer system – and give rise to bilateral balances in accounts held between those EU central banks connected to TARGET2. These bilateral balances are then assigned to the ECB on a daily basis, leaving each NCB with a single net bilateral position vis-à-vis the ECB only. This position in the books of the ECB represents the net claim or liability of each NCB against the rest of the ESCB.

      So … just like banks hold settlement balances at the central bank, the NCBs hold balances at the ECB.

      On the other hand, banks will clear the overdrafts by borrowing from other banks but the NCBs do not do that. This is because NCBs are passive. If a nations banks are short of reserves, its NCB’s indebtedness to the ECB also would have increased. However when the banks borrow funds from foreign banks/cross border, the NCB’s indebtedness decreases. There is no inter-NCB market.

      Have to read the paper you quoted in detail. My understanding is that the authors think that since the ECB’s balance sheet is “small”, its small. The way the article has been written makes it difficult to debate the other way :). Have to come up with something. For example they seem to argue that the ECB argues less currency and hence has less power. But the real reason is banks ask NCBs for currency notes not the ECB!

      I found a nice thing BFG btw in that article – “mousetrap currency” – something I have been looking for though didn’t know the jargon – thanks.

      On a different note, you must have read Wynne Godley Maastricht And All That rt ?

    22. Matt,

      In the ECB’s legal framework I have found some articles where the ECB has instructed NCBs to stay away from government debt by moral suasion. That was before the crisis. Will search it out.

    23. Now when you say that Greek bonds are “worth” 2%, even though no one in the private sector is willing to buy them at 2%, then what you are really saying is that the Greek bonds have no price. All the Greek bonds will be held by the ECB.

      That is not a problem.

      OK, fine. That means that the ECB cannot conduct monetary policy.

      Of course it can. You do not need open market operations to conduct interest rate policy.

      Set reserve requirements high enough to ensure that there are negative excess reserves in the system (yes, that can be higher than 100 % – that’s not a problem), and conduct monetary policy at the discount window instead of the secondary bond market.

      then blaming the ECB for “holding governments hostage” because, in your wet-dream version of reality, the ECB already has these policy options.

      Nothing in the treaties requires the ECB to conduct monetary policy through open market operations rather than the discount window, and nothing in the treaties prevents it from using open market operations to support the prices of government bonds in the secondary markets. So it is, in fact, correct to chastise the ECB for not using the powers it already has to reduce the disruption to orderly economic planning that these interest rate spikes represent.

      For the ECB, the ones that constrain activity are the ones that supply the capital subscriptions.

      You have yet to show me where in the treaties it says that the capital subscribers can do any such thing. The ECB has ridiculously great independence, precisely because the crazy German inflation hawks wanted it to be immune from democratic accountability. Such immunity cuts both ways. Of course if they make sure that only ultra-orthodox neoliberals like Trichet, Stark and Weber are appointed, then they can be sure that they will use their lack of democratic accountability in their favour. But that is a policy decision, and as such open to political criticism.

      – Jake

    24. RSJ, Ramanan, Matt

      RSJ, you could of wrote the following paper: Which Lender of Last Resort for the Eurosystem? LINK_

      Ramanan, if you get the time read the above paper, the writers imply that it is the Governing Council which is the main decision-making body of the ECB. It consists of
      ■the six members of the Executive Board, plus
      ■the governors of the national central banks of the 16 euro area countries.

      The ECB cannot make independent decisions without the say-so of the Governing Council.

      There is some reflection of the alarming lack of power of the ECB which the Maastricht Treaty reveals in its Article 73f –unchanged as Article 59 in the Amsterdam Treaty. This Article states that in the case of a currency crisis the Council of the European Community (ECOFIN, i.e. the ministers of finance of the fifteen member states of the EU) can suspend capital flight out of the euro, a decision concerning which the ECB is only consulted.

    25. Ramanan, RSJ and others book readers

      I suggest to buy books not on Amazon but here_

      This shop has free global shipping and prices are typically 20-30% lower than on Amazon. For instance, that book that costs $180 on amazon, costs $150 from this shop. I’ve been using them for quite a while (already bought 10+ books) and never had any problem.

      This is not advertising and I make nothing from it :) Just wanted to share but if Bill says no, then no.

    26. RSJ,

      I think you’ve got stuck in a rut.

      There is nothing stopping the notional capital of the ECB being negative – that’s just equity plus the profit&loss account. Since it creates Euros (via the NCBs if that’s the sleight of hand) it can still settle its debts or provide loans in the currency of issue – because that’s its job. Nobody is going to put the ECB into administration or bounce its cheques.

      It is entirely possible for the ECB to run negative equity for as long as it wants operationally although it is likely that bond sales losses would be offset by increase reserve repayments from Germany’s NCB since the Euros have to end up somewhere within the currency area. It could sit with that on its balance sheet until the arguments over who ‘funds’ the difference are settled.

      After all they’ve run the whole of Europe with dodgy accounts for decades.

    27. 1. For those confused, the ECB has no credit risk if it acts as a “buyer of last resort” in secondary public bond markets (assuring investors to purchase new public issues of Eurozone countries without risk of default) and does not sterilize the liquidity reserves from its purchases (QE) and its euro reserves are not a “liability” as it is fiat and not convertible.

    28. RSJ,

      Okay here is what you are trying to say (my interpretation). You may actually empathize with Steiger’s points.

      The central bank is finally backed by the Federal Government. The Federal Government’s liabilities are backed by its power to tax. In the Euro Zone, there is no single entity and its a confused set of several governments. The acceptance of the central bank money is on the faith that it will keep its capital positive. Else people may refuse to accept the central bank money. (And there have been cases in the past such as 17/18th century where – when banks were issuing notes – people refused to accept bank notes.

      For the case of the US, even if the Fed lands up with zero capital – maybe due to rise in long term interest rates, its functioning is backed by the US Federal Government. In the case of the Euro Zone, there is no such authority and there is no lender of the last resort for the Eurosystem (the ECB/NCBs). Etc.

    29. In most €-zone countries, it is not legal for a tradesman to refuse to accept legal tender. You are sometimes (though far from always) allowed to quote a price in both legal tender and foreign currency – at whatever exchange rate you want – but you have to quote a price in legal tender if you wish to legally transact with the general public.

      So printing money in the €-zone can, at worst, lead to inflation. But since inflation is not a realistic risk at the moment, that is not a problem.

      – Jake

    30. JakeS,

      Thanks for the info.

      However going by your comments, I am a bit surprised by your usage of “printing money” and that leading to inflation. Nothing wrong with the usage of “printing money” but the phrase is used as if issuing currency notes is a supply-led process. Also, it doesn’t cause any inflation. That is because money is printed on demand, not supply. If households (who mostly need them) need more currency notes, they ask their banks and the bank reduces the household’s deposit and hands over the notes. The banking system may then demand more notes from the central bank either by selling government bonds to the central bank or increasing its indebtedness through a repurchase agreement (the MROs).

      The household has just exchanged deposits for currency notes and currency notes by themselves cannot cause inflation.

    31. @Ramanan

      I know that “printing money” is a somewhat sloppy vernacular, and I don’t believe that accommodating government fiscal policy causes inflation either (although the fiscal policy thus accommodated can obviously cause inflation, which would have been prevented by holding fiscal policy hostage to an inflation target – but that’s a somewhat different issue).

      But the question was what would happen if people didn’t want to accept ECB money in an economy where the legal tender laws force them to do so at some price. The natural response to such laws, if I were a tradesman who found the € disagreeable, would be to quote a price in dollar and another price in €, at some ridiculous exchange rate that would ensure that people would prefer to pay in dollars. So in principle, enforcing such a law could result in inflation, if people lose faith in the € as a store of value. I just don’t believe that’s a realistic risk at the moment; hence the “at worst” ;-)

      But more to the point, I just don’t believe that the solvency of the central bank is important to the question of whether its currency is a viable store of value, when the currency is not redeemable. Obviously, the solvency of the central bank in hard currency terms is important, but I don’t see any mechanism for how soft currency insolvency can transmit itself out of the central bank.

      – Jake

    32. JakeS,

      No disagreement. I haven’t made up my mind one way or the other about the ECB’s capital.

      So you are saying that as long at inflation is low and people don’t care about ECB’s capital, what’s the worry. Sellers don’t even know what such things mean, they are interested in obtaining products and selling it for a bit higher and making a profit.

      Its true that the ECB is liable to pay in its own liabilities and cannot go bankrupt in that sense. What Steiger (whose articles are discussed above) are saying is that its true but it comes with the assumption that this trick is acceptable by citizens.

      Also at present, in my opinion is that the only way out is to keep rescuing governments and resorting to direct monetization if needed and Article 122 of the Lisbon Treaty allows that. But while this keeps happening, convergence to some kind of solution is required and its via the creation of a supranational fiscal authority and a blueprint for nations to exit the Euro Zone when they wish, without causing any damage to anyone. At present nobody dares doing that.

    33. And while I’d be absolutely delighted to see a unified fiscal and industrial policy, I fail to see how that’s going to happen in the current political climate. So that’s why I persist in pushing the idea of a less than fully federal mechanism that will still balance out the internal current accounts. That could be a higher inflation target, based on each member’s need to either increase or decrease their real terms of trade; it could be a direct transfer equal to the output gap or the CA imbalance; or it could be something as simple as forcing the ECB to grant the member states unlimited overdrafts on terms no worse than the Frankfurt overnight rate, and then let the ECB issue €-bonds.

      The point is that I don’t want to lock us into a double-or-nothing mentality where we either go full-on federation or break up the union. Because then it’ll be breakup, given current political sentiments on the subcontinent.

      What Steiger (whose articles are discussed above) are saying is that its true but it comes with the assumption that this trick is acceptable by citizens.

      But all money comes with that assumption. In fact, all institutions come with that assumption. And with the possible exception of the crazy professors, I don’t think anybody is going to even notice that the ECB’s notional capital goes negative.

      I can think of a lot of things that would make people lose faith in the €. The sign of the ECB’s equity is not one of them.

      – Jake

    34. JakeS,

      Good points and I think I fully agree with you. JMK said

      The problem of maintaining equilibrium in the balance of payments between countries has never been solved since methods of barter gave way to the use of money and bills of exchange. During most of the period in which the modern world has been evolved … the failure to solve this problem has been a major cause of impoverishment and social discontent and even of wars and revolutions

      Maybe barter never existed but Keynes was right about problems arising out of international trade.

      The balance of payments problems is the root of the crisis in the Euro Zone. However I think there is no way to solve this without resorting to explicit ban on imports within the Euro Zone. At least for some time. The external debt of Spain is around 90% and there is no mechanism from stopping this process from continuing forever. I also think that it won’t lead to inflation because the Euro Zone is a developed world and such things are more likely to happen in the less developed nations where there is less competition and local producers may hike prices in response to the featherbedding the get. Some amount of inflation is good for the government anyway.

      At any rate, I agree with you and am completely anti-empathetic to any plan such as breaking up. That will throw zillions of people homeless and individual nations’ fiscal policy will become a slave to the currency markets.

    35. Hi Ramanan,

      Related to the Euro, Prof. Wray made a point wrt the Euro back in April at a conference that as long as taxes were implemented and payable in Euros (and enforced) that the Euro would always have significant value…

      Also, I’d like to get your opinion as to whether you agree with the idea that the problems in the Eurozone are not with the Soveriegn Credits (For instance Greece and Ireland (so far)) but rather with their domestic financial institutions ? (I believe BFG & RSJ made this point and I agree with this).

      When the juggernaut of the negative media focus seemingly in succession on these periphery countries total debt (first Greece, now Ireland, next ?), how the markets are trashing the govt credits seems like ‘guilt by association” to me.


      PS wrt the external balance: Our 50B/mo external deficit here in the US is what is really killing us currently imo…

    36. For any concerned noneconomists, let me assure them that the ECB faces no”capital risk”; see my comment December 3, 22:24. Private investors will buy “roll over”issues of Eurozone public debt as long as they know that the ECB stands ready to off load this debt from their balance sheets and not sterilize the extra reserves generated. Furthermore, let me assure them that the euro is legal tender in the Eurozone and that all taxes levied by Eurozone states are payed in euros.

    37. Matt,

      Re your PS, yes, for a given fiscal stance, imports are not benefits. So questions on whether its a benefit is for different scenario. In the real world, governments tighten fiscal policy if external trade is not doing well and imports are far from beneficial. The US government cannot relax fiscal policy sufficiently to bring unemployment back to lower levels without both the public debt and the external debt hurtling toward unchartered territory.

      The “twin deficits” hypothesis first advocated by IMF’s Jacques J Polak says that any fiscal expansion with lead to a leakage to the external sector, mainly due to the identity relation net private saving, budget deficit and current account balance. (Though not sure he knew the identity) In the simplest form the hypothesis is incorrect because it seems to give a behavioral hypothesis to the accounting identity. The relation of the various flows of the identity is through output both domestically and in the rest of the world. So there is a leakage due to fiscal expansion.

      So lack of political will on one hand means that fiscal policy alone cannot do the trick. However, even looking at the matter from a non-political perspective, there is a genuine constraint – if the external debt is restricted to 100%, a differential between a growth rate and interest paid to foreigners of 2% restricts trade balance to not go beyond 2%. Of course there is no sharp cut-off as the US does not have to settle international debt in Gold, but the limit is decided by foreigners – and can change from time to time. One way or the other fiscal policy is dependent on the exchange rate.

      The balance of payments problems are severe in the case of the Euro Zone. Also since governments do not have their own central bank, the lenders can ruin them anytime. This is because as the governments spend, income and wealth increases but there is a leakage too. Hence the domestic private sector is unable to satisfy the supply of government bonds in the market. Due to substitutability effects, other Euro Zone investors won’t continue financing the government deficits and this leads to pressure in auction of government securities.

      Before the crisis, investors will indifferent to the government securities and one saw all governments bond yields are nearly the same levels.

      The problem with the Euro zone is with everyone. For the United States, the US Treasury has the power to finance its deficit even if overdraft and direct monetization are not allowed – via changing the law through voting and the power to create its own coins. Plus foreigners have higher preference for US Treasuries and the leakage due to imports causes no issue in financing the deficit. Thats the story now – automatic stabilizers do not work in the case of an open economy. The story is different if the public debt keeps increasing – foreigners liking the story is an implausibility.

      If the Euro Zone nations somehow manage to keep trade balances and indebtedness to each other at ultra low levels, the Euro Zone can continue indefinitely. (Of course some amount of guarantee needs to be given so that governments don’t default).

      However imagine if a supranational fiscal authority is made. Now whatever mainstream economists say and however capitalist any nation is – there is a big institution which behaves in a socialist way – the government. Its the reality as opposed to alternative. Even in the present scenario, the institution is already in place in the Euro Zone – the confused group of leaders is a mini supranational fiscal authority. The job of this institution is to help “weak” regions. I use weak in quotes because Germany is stronger than Greece due to historic and sociological reasons. So this authority has to make substantial equalization payments. It cannot provide stimulus by performance because that will make the weak nations even weaker.

      So in some sense it is like one government. However the alternative is dreadful. There is no way single nations can go back.

      I would say “problems” are due to governments. They cannot help but be indebted to their citizens simply due to the sectoral balance identity. However, the blueprint of the monetary union doesn’t help them behave that way without troubles.

    38. @Matt: There really aren’t any €-zone countries with a sovereign debt problem. If what we are seeing right now were sovereign debt problems, then France and Belgium would also be under attack (since they have larger debts and deficits than Portugal, which is the current target).

      In the case of Greece, what you are seeing is a balance of trade problem (and a corruption problem, and a military pork barrel problem). In the case of Ireland, what you’re seeing is a case of economic suicide by the ruling party, who are willing to scuttle the Irish economy to protect their bankster friends. In Portugal and Spain, you’re looking at a balance of trade problem (and a structural import dependency on petroleum). Italy is, well, Italy.

      Bottom line: Greece is not Ireland, Ireland is not Iberia and Iberia is not Italy. The symptoms are the same, but that’s only because the way the €-zone works ensures that a bond run is one of only a few possible expressions of underlying policy conflicts.

      – Jake

    39. Barry Eichengreen, Ireland’s rescue package: Disaster for Ireland, bad omen for the Eurozone

      According to the deal, not just interest but also principal is supposed to begin to be repaid after a couple of years. At that point, Ireland will be transferring nearly 10% of its national income as “reparations” to the bondholders, year after painful year.

      The inevitable populist backlash

      This is not politically sustainable, as anyone who remembers Germany’s own experience with World War I reparations should know. A populist backlash is inevitable. The Commission, the ECB, and the German Government have set the stage for a situation where Ireland’s new government, once formed early next year, rejects the budget negotiated by its predecessor.

      Do Mr Trichet and Mrs Merkel have a contingency plan for this?

    40. Ramanan,

      for a given fiscal stance, imports are not benefits.” This is perhaps a good way to put it…ie: ‘for a given fiscal stance’. Here in the US we are spending ‘political capital’ at the rate of 110B/mo (current deficit), but its like our people (and mostly at the top end) are only reaping 60B/mo of it due to the 50B/mo CAD. Without a federally implemented JG or other strict full employment policy, I dont see how our people get out of this gracefully.

      PS I noticed that Iceland has swung around to a CA surplus in the last reported qtr., does this follow your script? This from the Iceland central bank website:

      “The current account balance was positive by 23.8 in the third quarter, as opposed to a negative balance of over 44 in the preceding quarter. The goods account showed a surplus of 21.8, and the services account was positive by 35.3 The balance on income, however, was negative by 33.3

      As before, the deficit in the balance on income during the quarter can be attributed to financial institutions in winding-up proceedings. Calculated expenditures due to these institutions totalled 38.8, while revenues were 1 Therefore, the balance on income excluding deposit institutions undergoing winding-up proceedings was positive by 4.5, and the current account balance was positive in the amount of 61.7”


      I dont have access to professional data, but are not the 10-yr govt bonds of Greece and Ireland at about a 10% yield?

      Based on the last three comments from Ramanan, Panayotis, & yourself, it looks like the Greece and Ireland Govt Bonds may be a “buy of a lifetime”… especially for someone in the Euro area.


    41. JakeS,

      Net external debt is a good proxy.

      Portugal 88.6%, Ireland 75.1%, Greece 82.5%, Spain 80.6%, Italy 37.3%. These are end of 2009 IIP figures.

      Germany on the other hand is minus 21.7%

      Will find Q3 2010 figures.

    42. Here is some stat at the end of Q2 2010. Data from central banks and statistical institutes.

      International Investment Position at the end of Q2 2010: Spain €916b, Ireland €189b, Greece €218b, Portugal €180b, Italy €260b
      (4 times Q2 2010 GDP) : Spain €1,086b, Ireland €156b, Greece €235b, Portugal €171b, Italy €1,514b

      Hence (-IIP/GDP) ratio is Spain 84%, Ireland 120%, Greece 93%, Portugal 105%, Italy 17%

      As JakeS explains, government debt is not the problem. Its the indebtedness to the rest of the world due to trade imbalance which is the problem.

    43. Here in the US we are spending ‘political capital’ at the rate of 110B/mo (current deficit), but its like our people (and mostly at the top end) are only reaping 60B/mo of it due to the 50B/mo CAD. Without a federally implemented JG or other strict full employment policy, I dont see how our people get out of this gracefully.

      You won’t get out gracefully, if your political class is any indication. You’ll keep offshoring your industry to China until you run out of civilian industry to offshore. At which point China will revalue the Yuan on their time table, and start dealing bilaterally with your (then former) colonies (the genius of the post-Bretton Woods American empire has been to saddle your colonies with unpayable dollar debts rather than garrison them to the extent of the old-fashioned empires… but in a dollar collapse, that cuts both ways).

      Then the US will have to start living within its means, in terms of foreign trade. That will be painful.

      PS I noticed that Iceland has swung around to a CA surplus in the last reported qtr., does this follow your script?

      I don’t think there’s a “script” for countries as seriously FUBAR as Iceland. But it’s not excessively surprising. Their currency collapsed pretty hard when the banksters fled with their loot. That destroys their ability to import luxury goods, while their exports remain priced in hard currency. So a medium-term improvement in the foreign trade is not surprising. Sort of a painful way to go about it, though.

      I dont have access to professional data, but are not the 10-yr govt bonds of Greece and Ireland at about a 10% yield?

      Based on the last three comments from Ramanan, Panayotis, & yourself, it looks like the Greece and Ireland Govt Bonds may be a “buy of a lifetime”… especially for someone in the Euro area.

      Ireland is going to default. It is mathematically impossible for them to adhere to the conditions imposed on them as part of the bondholder bailout, and they have a foreign trade surplus, so there is no real downside to defaulting. For Greece, I don’t know. It depends on whether the cost of having to rebalance their foreign trade overnight is worth the gain from defaulting, and on when the federal EU institutions come to their senses. I’d give it about 50/50 that you’re never going to see those € again if you buy a Greek bond right now.

      Net external debt is a good proxy.

      Yep, but external debt != sovereign debt.

      Besides, if you have a large foreign trade surplus (like Ireland but unlike Club Med), you can always tell your foreign creditors to go away and perform reproductive acts with farm animals. Because that means that the rest of the world thinks it needs you more than you think you need ROW.

      – Jake

    44. Here is the opening of a paper A simple model of three economies with two currencies: the eurozone and the USA by Wynne Godley and Marc Lavoie, 2006

      This paper presents a model which describes three countries trading merchandise and financial assets with one another. It is initially assumed that all three countries have independent fiscal policies but that two of the countries share a currency—hence the model can be used to make a preliminary analysis of the conduct of economic policy in ‘the eurozone’ vis-a` -vis the rest of the world—‘the USA’. It is assumed, as seems most realistic nowadays, that the exchange rate between the eurozone and the USA is freely floating. The main conclusion will be that, if all three countries do indeed operate independent fiscal policies, the system will work under a flexible rate regime, but only so long as the European Central Bank (ECB) is prepared to modify the structure of its assets by accumulating an ever rising proportion of bills issued by any ‘weak’ euro country. For instance, if one of the ‘euro’ countries starts importing too much and makes no modification to fiscal policy, the ex ante effect will be to raise the proportion of bills issued by that country and held by the ECB—in successive stages and without limit. If this becomes unacceptable, at least within the confines of the model (and always given the assumption about three independent fiscal policies), the interest rate of the deficit country must give way and become endogenous. But this would bring about an exploding situation, as the interest rate of the weak country would need to increase for ever. There is, in the end, only one lasting solution to this problem within the existing structure—to endogenise the fiscal policy of the deficit country. Faced with rising imports, unable to devalue and trapped by an unaccommodating central bank, the ‘weak’ country would have, in the end, no alternative but to operate a restrictive fiscal policy that would have strong negative effects on output and employment. The only alternative is to modify the structure of the eurozone arrangements, either by forcing euro countries enjoying surpluses to pursue expansionary fiscal policies or by expanding the spending power of the European Union government, so it can engage in induced equalisation payments that transfer fiscal resources from surplus to deficit countries.

      Of course doesn’t take into consideration the possibility of breaking up – which is difficult to model – but insightful.

    45. Ireland has a trade surplus. Seems to have lost heavily in other items on BOP/IIP.

      It’s not (just) losses in other parts of the current accounts. Ireland had lots and lots of foreign direct investment in the last few decades. That will make your balance sheet look like that. I’d expect the Chinese data to look much the same. With the obvious difference that those companies that off-shored to China will probably not be allowed to off-shore to Viet Nam when China decides to revalue their currency. Whereas Ireland has no effective tools to prevent their transnats from offshoring to Slovenia or the Czech Republic, since they’re all in the EU.

      – Jake

    46. Jake,

      “There really aren’t any €-zone countries with a sovereign debt problem.” vs “Ireland is going to default.”

      Jake these two dont seem congruent. I’m sure I’m missing something. Resp,

    47. The Irish debt problem isn’t the government’s. The Irish debt problem is that their banks gambled with other people’s money and lost. And then they had their friends in Fianna Fail bail them out. A default would simply be a way to not socialise private losses.

      The Greek debt problem isn’t the government‘s debt, it’s the country’s foreign debt. The fact that it is held by the government is neither here nor there (there are reasons for that, of course, but they’re not pertinent to the present discussion).

      In both cases, describing it as a government debt crisis – that is, a crisis resulting from past fiscal policy – implies a wrong cause-and-effect story. And it’s the cause-and-effect story that’s interesting if you want to treat the problem rather than the symptoms. After all, the symptoms are easy to treat – just default on the damn bonds, already. In Ireland’s case, that would also treat the problem – which was a socialisation of private losses – but in Greece it would not, because it would not address the underlying trade imbalance.

      – Jake

    48. Jake,
      I agree with what you are writing in general, even if Ireland perhaps would repudiate this “screw deal” (US term) that their govt has foisted upon them, why would they default on their general obligation govt bonds that perhaps many of their own citizens own? Resp,

    49. They don’t have to default on all their bonds. Governments can make strategic defaults, such as defaulting on all bonds held by foreigners, or all bonds issued before or after a certain date (such as the date they overthrew the previous government, or the date they started socialising private bank losses).

      But in Ireland’s case well over three quarters of the government debt is, in fact, odious socialisation of private losses. The number of widows and orphans who’ll get shafted by a full default is not very large, and they can be made whole through other means. So it’s not a distinction that I usually bother to make in Ireland’s case.

      – Jake

    50. Ramanan @ 7:28,

      No, I’m not arguing about people refusing to accept euros. Actually, the whole argument that fiat money has value because of taxes is a bit weak. Money is accepted because others accept it, and taxes is one way (and not the only way) to kickstart this process.

      My argument is that all banks are capital constrained. What makes the central bank special, in a unified government scenario, is that the capital provider and the liquidity provider can support each other in a mutually beneficial way. When the central bank is always ready to buy the debt of the capital provider, the capital provider enjoys risk-free rates, and therefore has unlimited capital to supply to the central bank. The central bank therefore has unlimited liquidity. A allows B, given that B occurs. B allows A, given that A occurs. It’s a symbiotic relationship.

      In the EU, the central bank remains capital constrained. At the end of the day, the capital providers are on the hook for any CB losses. Sure, a CB can go through a period of having negative capital if the capital suppliers allow it. Negative capital is effectively a loan from the capital suppliers, as well as suspension of seignorage payments to these suppliers. Should a CB “earn back” capital by accumulating seignorage income, then this is no different than just receiving a capital injection up front, as the seignorage income should have gone to the capital provider. You are just converting the asset gift into a series of small gifts spread over a large period of time. Nevertheless the capital providers are the ones paying the for the capital loss, regardless of the nature of the loss recognition process.

      If, for some reason, the capital provider is not willing to supply the CB with unlimited capital to absorb losses on Greek debt, then the CB wont buy Greek debt in unlimited amounts. As a result, Greek debt will be risky. It’s simple.

      So what’s really going on here is that there are multiple government entities that supply the ECB with capital, and the ones supplying the bulk of the capital are not the ones needing the bulk of the funding.

      Therefore political constraints enter the picture in a way that doesn’t happen in a unified government framework. Those political constraints are realized as operational and economic constraints, and translate into more conservative CB behavior and a refusal to engage in large-scale asset purchases of the peripheral debt. Instead of criticizing the CB for this conservatism, or even worse, pretending that the ECB is supporting peripheral debt, understand that the ECB is constrained in a way that the U.S. Fed is not, just as the Euro governments are constrained in a way that the U.S. is not.

    51. If, for some reason, the capital provider is not willing to supply the CB with unlimited capital to absorb losses on Greek debt, then the CB wont buy Greek debt in unlimited amounts.

      Who is going to take the ECB through bankruptcy if its notional capital becomes negative?

      Given that our Dear Leaders are barely willing to take commercial banks into receivership when they become insolvent, for fear of triggering another round of panics, I really don’t see that happening (and I don’t believe anybody has the formal authority to do it anyway).

      For that matter, given that a run on the ECB is impossible, who decides what totally illiquid assets are worth? Further along the same line of reasoning, who decides what any of the ECB’s assets are worth? The fact that “the market” says they’re worth N doesn’t mean that particular value has anything to do with any applicable economic fundamentals, so “market prices” clearly cannot be used to value the ECB’s balance sheet.

      I understand perfectly well that buying Greek sovereign bonds would be a fiscal transfer from Germany to Greece. I also understand perfectly well that nobody in Germany believes that the ECB should be allowed to do that. What you have failed to persuade me is that it’s any of Germany’s business, according to the current treaties. The fact that it’s Germany’s money is neither here nor there – if they don’t have a legal way to prevent the ECB from doing it over their heads, then it’s the ECB’s decision whether to do it or not.

      – Jake

    52. JakeS,

      If you truly want to know the mechanisms, then the NCB of Germany can refuse to supply capital to the ECB. And the ECB does not have a provision that allows it to operate with negative capital. If you combine these two constraints, then you get a constraint on ECB behavior.

      But this is really missing the point. You are not going to get all of these realities just by looking at treaty obligations.

      This reminds me of the discussion in which (IIRC) Ramanan pointed out that the U.S. Treasury could issue a trillion dollar platinum “coin”, and so retire the federal debt with a few of these coins.

      But it’s not really the case that the Treasury has this latitude. In the same way, you might be able to find some rationale by which the ECB could go on a Greek debt buying orgy or follow Mosler’s “Plan” to provide fiscal support.

      The reality is that the ECB does not have this power, just as the Treasury does not have the power to issue a Trillion dollar coin. It doesn’t matter that the current law doesn’t specifically prohibit it. If the law doesn’t explicitly prohibit it, then this tells you more about what the author’s concerns were than it does about what Treasury’s power is.

      When you walk into a store and see a sign that says “no dogs allowed”, it tells you the store had a problem with dogs. The store doesn’t have a sign that says “do not vomit on attendant”, or “do not bring alligators”, because its understood that you wont. But there is doubt that you may bring a dog. Treaties are meant to clear up these doubts, and provide sufficient operational guidance in order to agree on how things will be done. But which things will be done will be constrained by many factors not specified in treaties.

      Poring through legal documents in order to find loopholes isn’t a good way of determining the real constraints on behavior. It may be fun to discover that Treasury “could” issue a trillion dollar coin, but you have to keep in mind that Treasury doesn’t have this power.

      Should the ECB attempt to deviate from its expected behavior, then the ECB will be forced to change its behavior, rather than forcing Germany to subsidize Greece. That’s what it means to lack a unified fiscal government — nothing can force Germany to subsidize Greece. Until that changes, Greek debt will remain risky.

    53. Should the ECB attempt to deviate from its expected behavior, then the ECB will be forced to change its behavior,

      By who?

      Germany can’t force the ECB to not operate with negative capital unless it is willing to either a) withdraw from the € system – at enormous cost to Germany, b) forcibly expel Greece from the €-system – something for which there is neither mechanism nor precedent or c) revise the treaties – fat chance of Greece going along with that. Herr Weber cannot put on his Deutche Bundesbank hat and go to the ECB and say “I want my money back” – because the ECB’s liabilities are not redeemable and there is no established institutional mechanism for putting the ECB through bankruptcy.

      nothing can force Germany to subsidize Greece.

      Except the fact that in the face of a determined ECB stance in favour of the deficit countries rather than the surplus countries, not subsidizing Greece would be more expensive in real terms than continuing the subsidies. It’s a game of chicken race to the cliff, and the ECB decides whose car starts closer to the cliff. Right now it is siding with the surplus countries, but there is no legal, institutional or economic reason for this to be its default behaviour. That is a purely political decision on part of Messrs Weber, Trichet and Stark. It may be the predictable decision, given their history and training, but that does not make it any less a political decision for which they should be held politically accountable.

      – Jake

    54. RSJ,

      This reminds me of the discussion in which (IIRC) Ramanan pointed out that the U.S. Treasury could issue a trillion dollar platinum “coin”, and so retire the federal debt with a few of these coins.

      Not that I advocate this. Its just a way of saying that the US Treasury has supreme powers. Also when I talk of setting the yield curve, I do not mean that I think governments should be doing that. When I give such examples, I just mean to talk of the power to do so.

      So back to coins, the US government earns revenue because of coins it issues as opposed to its usual spending – minor compared to other items but its there nonetheless. Its demand-led and endogenous however and the US Treasury doesn’t decide to exogenously do that.

    55. RSJ,

      The reality is that the ECB does not have this power, just as the Treasury does not have the power to issue a Trillion dollar coin. It doesn’t matter that the current law doesn’t specifically prohibit it. If the law doesn’t explicitly prohibit it, then this tells you more about what the author’s concerns were than it does about what Treasury’s power is.

      section (k) of Title 31 – Money And Finance § 5112 Denominations, specifications, and design of coins of the United States code:

      The Secretary may mint and issue platinum bullion coins and proof platinum coins in accordance with such specifications, designs, varieties, quantities, denominations, and inscriptions as the Secretary, in the Secretary’s discretion, may prescribe from time to time.

      I am sure the US Treasury secretary has the power to just write xyz on a piece of paper and declare it as money.

    56. “I am sure the US Treasury secretary has the power to just write xyz on a piece of paper and declare it as money.”

      The second that Treasury decides to mint a trillion dollar coin is the second that that the law is changed and this loophole is closed.

      So Treasury does not have this power.

      And that’s the point.

    57. RSJ,

      Back to your general points – the fact that the ECB creates money out of thin air gives it a supreme power compared to other institutions. Even banks do that but its a promise to convert the liabilities into central bank liabilities on demand or the promise to transfer it to another bank and also the power to use it to purchase foreign stuff if the relationship is such (such as usage of debit cards to purchase something in foreign currency).

      The ECB liabilities are promise to pay in its own liabilities unlike a bank. You quoted the ECB’s balance sheet and I do not think it is so straightforward to figure out how much government bond it holds – simply because of the language it uses in putting the balance sheet on the website.

      Now the only question then is whether there is any limit on doing so etc. It can be that the ECB capital goes negative due to some reason. Is that the end ? Not really. If the citizens accept that the negative capital is fine. the game goes on. If a financial institution’s capital goes negative, other financial institutions stop lending it and it has to be closed by a complicated process. The ECB on the other hand doesn’t need the support of others as far as Euros are concerned – because its a central bank.

      The ECB can continue to operate with a negative capital. There is no rule which says that people will stop accepting this game at point X. The man on the street doesn’t know these things and will pay and demand Euros. The man on the street can refuse it even if the capital is positive.

      Why am I saying this ? For the moment, there are powers within the system which allow prevention of defaults. Greek government may default by its volition or it may default because the ECB didn’t bail it out. There is no rule which says that the ECB can’t bail it out. The ECB can directly monetize the Greek government’s debt by appealing to Article 122. Any crib will simply be a moral attack.

      This Euro zone game is longer than previously thought

    58. “The ECB can continue to operate with a negative capital.”

      No, it can’t.

      It must pass losses onto the NCBs, who must pass losses onto the member governments. And the member governments are not required to accept losses or to fund them. They can say “no”.

      Therefore the member governments prevent the ECB from taking risks in the first place, provided that they are not willing to cover losses.

      Therefore the ECB is constrained by the member governments.

      This explanation of constraints is consistent with reality — with actual ECB behavior during this crisis.

      Aren’t you more interested in understanding actual behavior?

      The ability to create money isn’t a big deal. That an institution can create more liabilities for itself doesn’t make it powerful at all.

      Many institutions can create liabilities in large amounts.

      What makes an institution powerful is the ability to net financial assets, not liabilities.

      The supreme power is the ability to supply capital to whoever needs it. That’s power.

    59. RSJ, you keep simply assuming that funding comes with total discretionary power to withdraw said funding. That is not necessarily true, which is why I keep pushing for you to outline a concrete mechanism for how to prevent the ECB from continuing operation with negative capital.

      Germany is also a major source of funding for the European Court of Human Rights. That does not mean that Germany can simply close down the court should it find its rulings objectionable. Institutional relationships don’t work that way. So unless a specific mechanism already exists ahead of time for how to shut down an ECB governor who goes off the reservation, a conflict between a member state and an ECB governor will be a constitutional crisis, not a simple matter of pulling the plug on an unruly civil servant. My suspicion is that such a mechanism does not, in fact, exist, since the explicit desire when the treaties were framed was to make a central bank that was wholly insulated from democratic accountability.

      Now, if the ECB were all alone in that crisis, then it wouldn’t have much of a chance. They’d just change the treaties and be done with it. But the countries who stand to benefit from an accommodationist central bank have veto powers over any treaty change. And even if that were not the case Ireland would still be constitutionally obligated to hold a referendum, and there’s not a snowball’s chance in a blast furnace that a treaty that is widely believed to serve narrow German national interests is going to pass an Irish referendum for the next decade or two.

      Germany can always simply pick up their marbles and leave the €-zone, of course, so in that sense the ECB cannot force Germany to bail out anybody. But the ECB can make sure that Germany’s choice is between bailing out PIGS and leaving the €-zone, just as it can make sure that Greece’s choice is between Austerity(TM) and leaving the €-zone.

      – Jake

    60. JakeS,

      I would look at things differently. That the peripheral nations need to approve the treaties means that the real constraints placed on the ECB will not be accurately represented in the treaties. Because the core nations do not want to supply the ECB with unlimited capital, the ECB will be more averse to expanding its balance sheet and will refuse to provide fiscal support in the first place.

      The ECB will continue to represent the interests of the core nations until there is a constitutional crisis. That’s how the institutions work. The ECB does not have wide latitude to go against the interest of its main capital suppliers, which is why it hasn’t been supplying fiscal support.

      So what is your mechanism for the ECB to go off the reservation? Why would they? Why is Ireland agreeing to IMF covenants instead of rolling over ECB funding? Why was Trichet appointed?

      In other words, you can take the point of view that Treasury can mint the trillion dollar coin, and for some unknown reason it hasn’t elected to do so, or you can argue that Treasury cannot mint the trillion dollar coin, regardless of what the law says, and that only a crisis would allow Treasury to mint the coin.

      I’m arguing that only after a real confrontation between the periphery and the core — possibly a constitutional crisis — will the ECB change its behavior. That would require Ireland standing up to its banking sector, for example, and credibly threatening to leave the euro. Then there would be a fight involving the banks, Germany and Ireland and the result of that fight will either be a unified EU in which the ECB has real power, or it will be a dissolved EU, in which the ECB disappears.

      But the actual latitude is not there yet, and wont be there if all the deficit nations keep rolling over and agreeing to the austerity demands coming from the core.

    61. I would look at things differently. That the peripheral nations need to approve the treaties means that the real constraints placed on the ECB will not be accurately represented in the treaties.

      The political constraints, you mean.

      Which I understand. I just happen to be of the opinion that political decisions should be subject to political criticism, not walled off as some sort of mechanical inevitability.

      So what is your mechanism for the ECB to go off the reservation?

      Open market operations.

      Why would they?

      To preserve the smooth functioning of the European financial system. That’s their day job when they’re not moonlighting as amateur macroeconomists.

      Why is Ireland agreeing to IMF covenants instead of rolling over ECB funding?

      Because Fianna Fail is a gang of corrupt criminals who like handing taxpayer money over to their cronies.

      Why was Trichet appointed?

      He was promoted to his level of incompetence, because nobody who matters in Europe understands elementary macroeconomics.

      But the actual latitude is not there yet, and wont be there if all the deficit nations keep rolling over and agreeing to the austerity demands coming from the core.

      That paints the ECB as a mostly passive entity here. I’m not buying that. To take one example, the ECB was even more insane in the Greek negotiations than the IMF. Taking a more extreme stance than the US State Department’s tribute collection agency is not consistent with the theory that the ECB is passively following the path of least resistance. It’s really only consistent with their negotiators being hard-core neoliberal ideologues.

      Which is their right, of course. I just happen to think that it should disqualify them from any position of responsibility more important than municipal dog catcher.

      – Jake

    62. JakeS,


      Okay FDIs it is.

      The numbers are amazing. The annual GDP is around €156b. The balance sheet size of the Central Bank of Ireland is €186b. External assets is €4.41 trillion and liabilities to foreigners is €4.60 trillion. Mind blowing.

    63. JakeS,

      The only constraints are political constraints and real resource constraints. We have an endowment of real resources and politics determines what we do with that endowment.

      That’s it.

      There are no operational constraints, ever.

      If you believe that you’ve obtained some insight as a result of studying operational constraints, then you may be right.

      People can obtain insight from many sources.

      But don’t confuse the source of your insight as being a constraint on outcomes.

      There are no operational constraints. As soon as Nixon didn’t want us to be on the gold standard, we left the standard. We were not constrained by the gold standard. Same for FDR.

      The only benefit from studying operations is that if you are misled as to the real constraints — e.g. the political and resource constraints — then studying the operations can be a source of theory-free feedback that can clear up your political and real resource misconceptions. But there are never any operational constraints.

    64. RSJ, not all political constraints are created equal. Operational constraints do in fact become political constraints when your organisation has been operating in the same way long enough, and tightening or expanding the operational constraints against a strong precedent requires more political capital than simply changing your policy stance within those operational constraints.

      But more to the point, there is a difference between saying “the ECB has no discretionary power to side with the deficit countries in this crisis,” saying “the ECB has some discretionary power, which it does not exercise because it does not believe that the deficit countries will win, and it wants to remain on the winning team” and saying “the ECB has some discretionary power, but does not exercise it because it is staffed by neoliberal quacks who do not believe in exercising discretionary power.”

      The first statement is quite clearly untrue. The ECB does have considerable discretionary power to pick sides in this crisis. The difference between the second and third statements is whether Trichet et al are cowards or traitors. For myself, I believe that they are ideologically neoliberal, making them traitors more than cowards, but now we’re in the realm of guessing about motivations. Either way, they need to go away and be replaced with people who have both a modicum of courage, a basic understanding of elementary macroeconomics and enough common honesty to serve the people rather than the banks.

      – Jake

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