Monday, November 14, 2011

ECB remains involuntary fire brigade in euro crisis

Thread packing? The ECB continues its role of euro crisis fire brigade but only at half speed. According to its latest press statement, the ECB purchased government bonds for 4.5bn euro last week, down from 9.5bn euro one week earlier. This brings the total amount of purchased bonds since May 2010 to 187bn euro.

The ECB remains stuck in a catch-22 situation. As long as the official ECB stance gives the impression that the SMP is only implemented half-heartedly, the ECB might end up buying more bonds than if it would come out with a numerical target or fully-fledged commitment. However, an end to this catch-22 is not in sight. First of all, resistance from core Eurozone central banks, above all the Bundesbank, against the bond purchases is rather increasing than decreasing. Today, Bundesbank president Weidmann reiterated his criticism of the bond purchases and called the German public an ally of the Bundesbank. Moreover, even if theoretically, the ECB’s role as an unconditional lender of last resort for the Eurozone makes sense, it can only work if the economic governance is right. An unconditional lender of last resort would need a strong fiscal counterpart at the Eurozone level to ensure conditionality and to avoid moral hazard. The ECB is simply not a political institution that can enforce conditionality on member states.

Despite last week’s slowdown of bond purchases, the controversial debate on the ECB’s SMP will continue. The Eurozone is still in need of an unconditional lender of last resort. A possible short-term fix to take the burden off the ECB’s shoulders could be the European Stability Mechanism (ESM). With a credit line at the ECB, the ESM could impose conditionality on member states and would at the same time have the ECB’s fire power. However, any steps in this direction still need time. For the time being, the ECB remains the involuntary fire brigade of the Eurozone.

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