In: Blog25 May 2012
By Warren Mosler and Andrea Terzi
Technically, any central bank can spend or lend any amount of its currency with any of its member banks by simply crediting their accounts. This is the basis and the source of any currency, which is nothing more than an account at the central bank—an ECB liability in the case of the euro area.
This power of “issuing” currency is exercised by simply changing the numbers on the account balance of commercial banks as a result of a loan being extended or of a payment being made. The ECB does this routinely when it makes loans to banks and when it credits banks to settle government payments to the private sector. This power of crediting reserves is held by the Governing Council of the ECB (Article 12.1 of the ECB Statute).
The process can work inversely, of course: the central bank can debit reserves (i.e., “un-print” euros) when banks pay off their loans or when banks pay taxes for their own or their clients’ accounts.
The political rules of the euro area, however, limit what the ECB can do. Governments are forced by those rules to get funding without ECB support. The ECB is prohibited from buying government bonds or distributing a balance of euros to each government (on a per capita basis) to prevent local states from running out of money. So, euro area governments can run out of money, although their common central bank clearly cannot!
One would suspect that if the euro area were to undergo an emergency such as a major natural disaster or a war, European governments would request that the ECB put its absolute power at their disposal. Thus, one wonders why European politicians do not believe this is an emergency that justifies the exception.
An often heard argument is that if the ECB were to assist governments by buying their securities or by distributing reserves, inflation would ensue. Yet, with today’s institutional structure, this argument lacks any logical foundation: neither buying securities nor distributing reserves to national governments adds, by and of itself, to aggregate demand.
Thus, the remaining logical objection, known as moral hazard, is the following: if the ECB were to guarantee all national debts, governments would have one further incentive not to comply with common fiscal rules. This may be true. Yet, this simply points to the need for a political solution that includes the possibility that the ECB can fund government debt. If the euro area has now reached a point where governments have run out of euros, while the ECB (obviously) has not, then the ECB must write the check.