Central bank independence combined with tough written rules is no guarantee against taxpayers being taken hostage.

Hans-Werner Sinn

The International Economy, Spring 2019, pp. 21-22.

Nearly thirty years ago, when the euro was designed, central bank independence was a dominant issue. France and southern Europe wanted the euro to share in Germany’s low interest rates, but Germany insisted on central bank independence combined with rules that would prevent the European Central Bank from financing governments as conditions for giving up the deutschmark. Germany firmly believed that the ECB could not act like the central bank of a state, which would guarantee the state’s creditworthiness, and it seemingly got its way. Central bank independence was assured at the expense of providing each national central bank—whether for a large economy such as that of France, Italy, and Germany, or a tiny one such as Malta and Cyprus—with an equal vote in the ECB Council. And Articles 123 and 125 of the TFEU even contained assurances that the ECB would not finance or bail out governments.

Reality, however, could not have been more removed from these assurances. In fact, the ECB has since allowed the national central banks to print about €2 trillion—nearly two-thirds of the euro monetary base—to buy government bonds from local governments, thus turning itself into Europe’s most active bail-out institution. To help struggling banking systems and states, the ECB council took a myriad of separate decisions, ranging from the full-allotment policy and a persistent lowering of collateral standards for refinancing credit, to tolerating asymmetric and arbitrary money printing by the local central banks under the emergency liquidity assistance and rules established by the Agreement on Net Financial Assets, as well as special credit programs such as the Public Sector Purchase Programme, longer-term refinancing operations (LTROs), and targeted longer-term refinancing operations (TLTROs). With these decisions, it effectively rescued over-indebted banks and states by undercutting the capital market through extremely favorable credit conditions. Target 2 balances of about €1 trillion are only the tip of the iceberg.

Arguably, an even more important bail-out decision was the Outright Monetary Transactions program of 2012—ECB President Mario Draghi’s famous “Whatever it takes”—promising buyers of local government bonds unlimited warranties at the expense of European taxpayers. This program has rescued over-indebted governments, but in doing so it has undermined the functioning of the European capital market by separating a country’s creditworthiness from its own financial behavior, making it possible for the European states to borrow nearly unlimited funds without ever facing the risk of being punished by markets with significantly rising risk spreads. Even Italy nowadays is able to borrow at lower rates than the United States.Small wonder that the governments of southern Europe and France have disregarded all those debt constraints they once accepted in exchange for the safety that the common currency in general and ECB’s rescue programs in particular provided for investors.

Vítor Constâncio, who was ECB vice president during the crucial years of the euro crisis and formerly served as secretary of Portugal’s Socialist Party, has triumphantly remarked that the ECB ultimately won the right to act like other central banks—despite Germany’s fierce opposition. He overlooked, however, that even the U.S. Federal Reserve would not buy the government bonds of sub-federal states. What a treat it would have been for California, Illinois, or Minnesota if the Fed were to buy their government bonds. They could issue more and more of such bonds without ever having to make the effort to convince their creditors that they would be able to repay.

All of this shows that central bank independence combined with tough written rules limiting the scope of bail-out policies is no guarantee against taxpayers being taken hostage by central banks to serve the needs of immoderate governments and their greedy creditors. The access to the money printing press is so tempting and lucrative that it cannot easily be limited by contractual rules.

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