Abstract
Since the onset of financial turmoil in August 2007, the main central banks worldwide have implemented extraordinary standard and non-standard monetary measures. Accommodative fiscal measures were also implemented on a large scale. These measures have questioned the sustainability of public finances in various euro area countries, which led to the current sovereign debt crisis. The current sovereign debt crisis is even more challenging as it affects the value of banks’ assets and their collateral, and therefore increases risks to the economic outlook. Against this background, this chapter describes the actions of the European Central Bank (and their rationale) while discussing the necessary separation between the responsibilities of central banks and government. Finally, some lessons about the possible adjustment of the roles of central banks and fiscal authorities in the euro area are also addressed.
This chapter was prepared for the international conference of joint research groups “EU Economy” of the EU Studies Institute on “Who will provide the next Financial Model? Asia’s Financial Muscle and Europe’s Financial Maturity” held in Tokyo on 10 December 2011. It reflects information and data up to mid-November 2011. Special thanks go to Piet Philip Christiansen, Adriana Lojschova and Giovanna De Salvo for their research assistance. The views expressed in this book chapter are solely those of the authors and do not necessarily reflect the views of the ECB or the Eurosystem.
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Notes
- 1.
This evolution in the thinking on central banking came from growing criticisms by academics in the 1970s and 1980s about political control over central banks (and exploited at large the associated central bank quasi-fiscal powers), which usually led to high inflation and an inefficient allocation of credit to favoured economic sectors. In particular, works initiated by Kydland and Prescott (1977) and Barro and Gordon (1983), and empirically supported by Alesina and Summers (1993), point to possible benefits in terms of macroeconomic performance (notably as regards the level and variability of inflation rate) in case of more independent central banks.
- 2.
This first strand of literature refers to models of seignoriage as initially discussed by Cagan (1956).
- 3.
- 4.
On the basis of a New Keynesian DSGE type of model, Durré and Pill (2010) find that a third equilibrium regime (besides a regime of pure monetary dominance and a regime of fiscal dominance) may exist under strict conditions. However, (implicit or explicit) pressures from fiscal authorities may be such that these conditions appear difficult to respect in practice. For a discussion on the risks of financial dominance see BIS (2011) and Borio (2011).
- 5.
Under Article 123(1) of the TFEU (which prohibits monetary financing), the ECB and the national central banks (NCBs) are prohibited from purchasing debt instruments directly from public sector’s institutions or bodies, i.e., debt instruments issued in the primary market. The acquisition by NCBs or the ECB of debt instruments issued by all public sector institutions or bodies in the secondary market is, in principle, allowed. However, in accordance with Recital 7 of Council Regulation (EC) 3603/93, 13 December 1993, specifying definitions for the application of the prohibitions referred to in Articles 104 and 104b (1) of the Treaty (now labeled Articles 123 and 124 of the TFEU), such purchases must not be used to circumvent the objective of Article 123. This qualification also applies to marketable debt instruments issued by all community institutions or bodies.
- 6.
- 7.
Between 2003 and 2007, the volume of US sub-primes mortgages increased by almost 300%, from $332 billion to $1.3 trillion. Most financial institutions continued believing that US house prices would continue to rise, interests would remain low, and households would continue servicing their mortgages.
- 8.
Note that this reference interest rate for the unsecured segment of the euro area money market is called the EURo InterBank Offered Rate (EURIBOR) and that of the US and UK money market is called the London InterBank Offered Rate (LIBOR).
- 9.
The net recourse to the standing facilities (i.e., the difference between the amounts on the marginal lending and on the deposit facility) during this first phase was rather low, i.e., a daily average of approximately EUR 0.25 billion during most of the reserve maintenance period with a peak of EUR 1.5 billion during the final week.
- 10.
As recalled in Cassola et al. (2008), by reducing the probability of banks’ recourse to borrowing at elevated interest rates in the unsecured money market and by increasing the probability of being “locked-in”, this procedure contained the upward pressures on the short-term interest rates in the money market. At the same time, liquidity draining fine-tuning operations (FTOs) were conducted during and at the end of the reserve maintenance period to mop up the remaining liquidity surplus and to support the expectations of the overnight interest rate being close to the minimum bid rate, i.e., the main ECB policy rate. Thus, the majority of the FTOs conducted during that period were liquidity-absorbing operations as reported in Cassola et al. (2011).
- 11.
- 12.
These tensions were due to the difficulties experienced by some credit institutions, and played an important role in the banks’ debt instruments market in the euro area. They materialized through increasing covered bond spreads against the swap rate, reaching a peak in April/May 2009 (see Fig. 2).
- 13.
The previously underestimated Greek public deficit was made possible by off-balance sheet operations and a lack of transparency in budget data. The desire for clarity by the newly elected government led to a revision of the public deficit from 8.2% to 12.5% of Greece’s gross domestic product released on 1 November 2009.
- 14.
At that time, the agreement was that the IMF would provide under a 3-year program EUR 30 billion through the stand-by arrangement while the EU would provide EUR 80 billion over the same period. This program was subject to strong conditions to restore fiscal sustainability and improve the country’s competitiveness.
See further details at http://www.imf.org/external/pubs/ft/survey/so/2010/car050210a.htm.
- 15.
See the decision of the ECB of 6 May 2010 on temporary measures relating to the eligibility of marketable debt instruments issued or guaranteed by the Greek Government (ECB/2010/3), available at http://www.ecb.europa.eu/ecb/legal/date/2010/html/index.en.html.
- 16.
In particular, it was decided to conduct fixed-term (i.e., with a maturity of 7 days) liquidity-absorbing FTOs to create incentives among credit institutions to have more active liquidity management. Moreover, it was decided to apply the fixed rate with full allotment procedure to the regular 3-month LTROs to be allotted on 26 May and 30 June (which will be further prolonged until at least the end of January 2011) and to conduct one single 6-month LTRO with full allotment and a fixed rate indexed to the average of the minimum bid rate at the main refinancing operations over the life of the LTRO.
- 17.
On 10 May the EU announced that the IMF was ready to provide up to EUR 250 billion to supplement its own EUR 500 billion stabilisation fund to support the euro area’s weaker Member States.
- 18.
On 29 September 2011 the German Parliament approved the strengthened EFSF and a few weeks later the Slovakian Parliament ratified it as well.
- 19.
In this regard, it is worth recalling the importance of banks in the external funding of non-financial corporations in the euro area (80% of total funding) in comparison with the US (40%). Consequently, most of the instruments used by the ECB took the form of direct financing to banks whereas the US Federal Reserve implemented several asset purchase programmes in larger amounts.
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Appendix
Appendix
Activity and pricing in the EONIA market (daily averages). Source: ECB, Reuters
Activity and pricing in the overnight Repo market (daily averages). Source: ECB, Reuters
Money market spreads between EURIBOR and OIS rates in the euro area. Source: ECB, Reuters
Volatility in the term EURIBOR market (daily averages). Source: ECB, Reuters
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Drudi, F., Durré, A., Mongelli, F.P. (2013). The European Central Bank and Implications of the Sovereign Debt Crisis. In: Kaji, S., Ogawa, E. (eds) Who Will Provide the Next Financial Model?. Springer, Tokyo. https://doi.org/10.1007/978-4-431-54282-7_5
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