It has been debated whether taxpayers would have to foot the bill from different ECB government bonds purchase programmes. This column argues that for the participants of such programmes that involve the mutualisation of interest revenues, there is no free lunch.
Would the taxpayers have to foot the bill?
It has repeatedly been attempted in the media to demonstrate that taxpayers would not have to foot the bill should losses occur from the purchases of government bonds by the ECB. The ECB balance sheet, it is asserted, is pure fiction. It can conjure up money out of thin air. German populists are stalking fear among the populace because they don’t understand this.
Is the German Constitutional Court then wrong to see a liability risk for the taxpayers in the unlimited purchases of government bonds of the crisis-afflicted countries under the SMP and OMT programmes? And did the opponents of the ECB’s QE programme fight in vain for leaving out of joint liability 80% of the purchases? Has the ECB given in to ‘German irrationality’?
Far from it. The Eurosystem is, save for the allocation of voting power (ECB 2015), arranged like a joint-stock company belonging to the Eurozone member countries. It is, of course, not really such a company, and its task is not to generate profits, but to carry out monetary policy. Nevertheless, as a by-product of its tasks, the system normally does generate profits, which are then distributed via the national central banks to the respective national treasuries. The profits result from the investment of the Eurosystem’s equity capital as well as from lending self-created money against interest, or from the acquisition of interest-bearing assets with such money. If central banks were traded in the stock exchange, they would have a market or present value that is derived, as it is for every other stock corporation, from their future dividend distributions.
Given the time path of the monetary base, any write-offs of defaulting government bonds lead to a permanent reduction in the dividends distributed to the member countries and to a decrease in the present value of these dividends in the exact amount of the write-offs. This is true regardless of whether or not accounting capital becomes negative in the process. The ‘shareholder countries’ must therefore either raise taxes or reduce expenditures. The assertion that this poses no problem since ‘merely’ the profits sink, as is sometimes maintained, is a euphemism. What would a real shareholder say if merely part of his dividends were taken away?
The loss of profit and taxpayers
It is correct, however, that the taxpayers are under no obligation to recapitalise the central bank in order to make up for the loss of profit (European Communities – Council 1992). But this holds for every real stock company as well, without this meaning that the shareholders would not perceive the drop in dividends as a loss; they will, of course, have to bear the profit drop fully.
But could we be talking about peanuts here? Unfortunately not. In static terms, that is, when the monetary base remains constant over time, the present value of the ECB system’s dividends amounts to the sum of the stock of central bank money and the central banks’ equity capital, irrespective of when and how quickly the currently very low interest rates return to normal levels. (After all, the present value of the interest revenue earned by a deposit is always equal to today’s cash value of the deposit if the actual time path of the deposit’s interest rate is used for the calculation of the present value.) By the end of 2014, the monetary base amounted to €1,317 billion, while the equity capital including valuation reserves added up to €425 billion. The assets to be distributed amounted thus to €1,742 billion. One can deduct from this sum the banks’ minimum reserves for which the ECB may, but doesn’t have to, pay interest. This would bring the sum to €1,636 billion. This is more or less equivalent to what German reunification has cost in terms of net transfers through the government budget. Assuming a continuous expansion in the monetary base on par with economic growth, one would even come to a present value of about €3.4 trillion, as Buiter and Rahbari (2012) have calculated. This sum can whet some appetites.
France, for example, is entitled to around one-fifth of this sum, i.e. almost €700 billion. It must also bear a fifth of the potential write-off losses resulting from government bond purchases already performed under the SMP programme or promised under the OMT programme, both programmes set up to prop up the Eurozone’s crisis countries. And it would also be liable for potential write off-losses of one-fifth of the 20% portion of the government bond purchases under the new QE programme which are to be pooled among the member countries.
Of course, in net terms, such losses would only result from other governments’ bonds purchased under these programmes. If, as is the case for 80% of the QE purchases of government bonds, a central bank buys its own government’s bonds, a default is not a net loss, since the disadvantage of the write-off loss is matched by the advantage of getting rid of a payment obligation of equal size (De Grauwe and Ji 2015).
Thus, much to the chagrin of those claiming otherwise, there is no such thing as a free lunch for the participants of government bond purchase programmes that involve the international mutualisation of interest revenues (see also Sinn 2014).
Buiter, W and E Rahbari (2012), “Looking into the Deep Pockets of the ECB”, Citi Economics, Global Economics View, 27 February.
De Grauwe P and Y Ji (2015), “Quantitative Easing in the Eurozone: It´s Possible without Fiscal Transfers”, VoxEU.org, 15 January.
ECB (2015), "Organisation, Decision-making, Governing Council", FAQ on the rotation of voting rights in the Governing Council, 1 January.
European Communities – Council (1992), “Treaty on European Union”, in particular protocols, chapter 5, article 33, paragraph 2.
Sinn, H-W (2014), The Euro Trap. On Bursting Bubbles, Budgets, and Beliefs, Oxford University Press, Oxford, chapter 8: "Stumbling Along – No Risk for Taxpayers?", pp. 265-267.
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