The euro area is not running out of euros. Yet, it pretends it is.

In: Blog

25 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.

4 Responses to The euro area is not running out of euros. Yet, it pretends it is.

Avatar

Hugo Heden

May 27th, 2012 at 11:36

>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.

I don’t follow the logic.. About the moral hazard problem; are you saying that such a political solution would somehow *solve* that problem?

Avatar

maurizio poli

June 16th, 2012 at 16:40

I believe that this situation stems from the unhappy European monetary aggregate, which at that time did not think the necessary of a collegial fiscal vision policy. Today force a single tax system compares the different tax morality of various countries and will make entering the European community into a crisis with no way out.
However it is necessary to draw lines fiscal policies common to which all governments must abide with staggered times depending of the present difficulties of the individual states.
Tying the help of the ECB to achieve the objectives of each government in fiscal policy it could during time maybe overcome moral hazard.

Avatar

bruno

September 10th, 2012 at 14:25

I have the feeling that your position is yet another variant of the “free lunch” argument: money to fund governments would be somewhat “free”, which is nonsense.

Of course this is not an inflation problem (at least not immediately). It is rather a problem of allocation of capital: by loading its balance sheet with government debt, the ECB effectively channels a huge amount of available capital to the entities that make the worst use of it.

In the end, this can only destroy the potential growth of the economy, as capital and profits are spent on weakly efficient government spending instead of being used and invested by private entities.

Avatar

Warren Mosler

September 10th, 2012 at 18:13

@bruno
Current fiscal policy is restricting demand from full employment levels as it puts a severe drag on the economy. The idea is to remove the drag and allow aggregate demand to revert to it’s ‘neutral’ full employment level.

The ECB policy does not alter spending and budgets but in fact is conditional on fiscal restraint. Therefore, while it will solve the solvency issue, it will not address the output gap issues. ECB policy does not support increased aggregate demand in either the private or public sector.

Comment Form