House of Lords - The euro area crisis - European Union Committee

The euro area crisis - European Union Committee Contents

CHAPTER 4: OTHER POLICY RESPONSES

An expanded role for the ECB

54. Member States that enter the European Monetary Union relinquish the capacity to issue debt in a currency they control and the ability to supply liquidity in times of financial distress through their national central banks. The existence of the European Central Bank (ECB) prevents national policymakers from using monetary policy in times of strain on public finances. Outside the monetary union (as in the UK), national central banks have the ability to provide liquidity to banks and governments.

55. The ECB does not consider financial stability as part of its core mandate. As its then President, Jean-Claude Trichet, put it in a press conference in August 2011, the ECB has "only one needle on [its] compass", namely control of inflation.[49] Frequent reference has been made by the ECB to Article 123 TFEU, which prohibits the direct purchase of debt from euro area states.[50]

56. The ECB's reluctance to take on a more interventionist role prompted EU leaders to come up with alternatives. As we have seen, they created the European Financial Stability Facility (EFSF) and the smaller European Financial Stability Mechanism (EFSM) as temporary mechanisms, with a permanent European Stabilisation Mechanism (ESM) now to come into effect in July 2012.

57. Despite these limitations, the ECB has for some months been purchasing from the secondary market government bonds of those euro area countries in financial distress, while making it clear that it sees such a role as limited, temporary and aimed at ensuring functioning markets.

58. On 30 November 2011, the ECB took part in the announcement of co-ordinated actions with the US Federal Reserve, the Bank of Canada, the Bank of England, the Bank of Japan and the Swiss National Bank, to enhance central banks' capacity to provide liquidity support to the global financial system, aiming to ease strains in financial markets and thereby to mitigate the effects on the supply of credit to households and business and so help foster economic activity.[51]

59. Then, in December 2011, the ECB announced a set of "additional enhanced credit support measures to support bank lending and liquidity in the euro area money market", including unlimited loans lasting three years to euro area banks. ECB President Mario Draghi stated that "these measures should ensure enhanced access of the banking sector to liquidity and facilitate the functioning of the euro area money market. They are expected to support the provision of credit to households and non-financial corporations."[52] This 'Long Term Refinancing Operation' (LTRO) provided 500 European banks with a total of €489 billion in three-year loans at very low interest rates.[53] A second round is to follow at the end of February 2012: on 30 January it was reported that take-up for this operation might be twice as high as for the one in December.[54] The aim was to provide liquidity to the banking sector, thereby increasing the banks' ability and willingness to resume lending to the private sector and euro area states.

60. The escalation of the euro area crisis has led to intensified calls for the ECB to take more decisive action in the sovereign bond markets, notably through the widespread purchase of new sovereign bonds.

61. We discussed the role of the ECB with our witnesses. Sharon Bowles pointed out that the ECB was the only institution that had the ability to respond swiftly to the markets, and stressed that it had been more "market savvy" and had more foresight than other key players. In her view, the ECB had already by its actions "saved the euro".[55] Professor Buiter made the point that "central banks are lucky institutions: they do not need equity"; that is, the ECB is not subject to capital requirements and its capacity to absorb losses is infinite if constraints on inflation are not considered.[56]

62. The fear of inflationary pressure is, in fact, a common argument against the ECB taking a more active role. This is in part a reflection of German fear of hyperinflation in light of the experience of the Weimar Republic during the 1920s. The reluctance of German leaders to countenance an enhanced role for the ECB was apparent in the evidence provided to us by the German Ambassador, who stated that "you have to keep in mind that the instruments of the Eurosystem are not designed and not intended to solve the structural problems of some [euro area] Member States. By buying certain government bonds the Eurosystem gave the [euro area] Member States enough time to address the problems where they should be addressed: at the fiscal level."[57] Mr Amato also sounded a note of caution, arguing that the ECB could not act in the same ways as the Federal Reserve in the United States, because "you cannot be the federal reserve without a federal state".[58]

63. Welcome and necessary as they have been, a note of caution should be sounded regarding the steps taken by the ECB. It has been argued that there is little evidence as yet that the ECB's lending is encouraging banks to inject much-needed credit into the economy. Furthermore, there is nervousness that such large-scale lending could spread the disease of over-indebtedness to the ECB itself, thus "undermining the global economy's last bastion of strength", and further prolong the distortion of normally functioning markets.[59]

64. The ECB has already taken unprecedented steps in relation to the euro area crisis through the purchase of sovereign bonds in the secondary debt markets, and more recently through a massive operation to refinance European banks. There has been pressure for the ECB to play an even greater role, which the ECB has thus far resisted, in particular citing the need to respect the Treaty provisions that bar the direct monetary financing of governments. In our view, although the ECB should not be regarded as a panacea, additional ECB intervention is likely to prove essential, at least to preserve the functioning of credit markets and thus to support economic growth, if progress is to be made in resolving the euro area crisis.

'Eurobonds'

65. We explored the idea of 'eurobonds'—bonds which are in some way mutually guaranteed by all of the euro area Member States—in our previous report.[60] Since then there have been increased calls for their adoption as a means of calming the markets by providing liquidity to the euro area.

66. Professor Begg argued that the proposal for a 'eurobond' was attractive in the eyes of many because, by mutualising the debt, "you would have a highly rated bond ... on a par with a US Treasury bond, with a coupon that is much lower, on average. It will not be the average of the German and Italian rates; it will be very close to the German rate." He referred to the case of the United States where, despite their poor deficit and debt figures, which are higher than those for the euro area as a whole, the market was still liquid even after their credit rating was downgraded. He asserted that the Chinese would welcome European bonds as an alternative to investing in Treasury bonds in the US, and argued that other major creditors, such as the Gulf States, would see a 'eurobond' as a safe haven, especially with a strong commitment on inflation. In his view, "fully fledged eurobonds ... will almost certainly come."[61]

67. Germany has been highly reluctant to countenance 'eurobonds'. Ambassador Boomgaarden argued that they "are not a solution for the existing crisis. If there is any debate about eurobonds, this is not the time to have it. This is something that could be the crown of an existing full fiscal union, but it would have very great moral hazard in an incomplete monetary union."[62] Mr Amato stated that, even with the fiscal compact treaty in place, it was unrealistic to expect that Germany would accept fully fledged 'eurobonds'; and that attention should be focused on mutually guaranteed 'project bonds' for specific pan-EU projects such as the development of a European power grid.[63]

68. On 23 November 2011, the European Commission published a Green Paper for consultation which suggested that 'stability bonds' could be established to help all euro area members to meet their financing needs and to compete with US Treasury bonds as a global benchmark. The Green Paper assessed three potential options: (1) the full substitution of Stability Bond issuance for national issuance, with joint and several guarantees; (2) the partial substitution of Stability Bond issuance for national issuance, with joint and several guarantees; and (3) the partial substitution of Stability Bond issuance for national issuance, with several but not joint guarantees. It also raised the possibility of these approaches being combined.[64]

69. In spite of President Barroso's appeal for these discussions to be approached "with an open mind", Chancellor Merkel quickly denounced the Commission's proposals as "extraordinarily inappropriate".[65] And while in the December summit statement the euro area states undertook to "examine swiftly the new rules proposed by the Commission on 23 November" relating to budgetary surveillance in the euro area, there was no reference at all in the document to 'eurobonds'.

70. It remains to be seen whether a 'eurobond' could be designed in such a way as to meet the concerns of nations such as Germany, so that it will not lead to a risk of moral hazard nor lower the cost of servicing the public debt for some countries in the euro area at the expense of a considerable increase for others. The Commission's proposals are at an early stage of development, and, though 'eurobonds' could relieve pressure in the bond market, they are only likely to become a mechanism available for use in the medium to long term. The lack of reference to 'eurobonds' in the 9 December statement might be taken to suggest that their introduction remains a distant prospect. Yet the question of whether they are a necessary step towards solving the euro area crisis needs to be addressed.

49 See http://blogs.reuters.com/macroscope/tag/bank-of-england/ and http://www.ecb.int/press/pressconf/2011/html/is110804.en.html. Back

50 See The future of economic governance in the EU, Box 10. TFEU refers to the Treaty on the Functioning of the European Union. Back

51 http://www.federalreserve.gov/newsevents/press/monetary/20111130a.htm. See 'Central banks' move lifts markets', Financial Times, 1 December 2011. Back

52 http://www.ecb.int/press/pressconf/2011/html/is111208.en.html. See also "European banks' shortfall hits €115bn as German system's weakness exposed", Financial Times, 9 December 2011. Back

53 European Central Bank, Monthly Bulletin for January 2012, p 30. Back

54 "Banks set to double crisis loans from ECB", Financial Times, 30 January 2012. Back

55 Q 28 (Sub-Committee). Back

56 Q 45 (Sub-Committee). Back

57 Ambassador Georg Boomgaarden, German Ambassador to the UK (Sub-Committee). Back

58 Q 99 (Select). Back

59 "Super Mario's bank funding scheme is no panacea", Financial Times, 31 January 2012. Back

60 The future of economic governance in the EU, paras 211-7. Back