Winner of the New Statesman SPERI Prize in Political Economy 2016

Friday, 10 July 2015

The non-independent ECB

Imagine that the Scottish National Party (SNP) had won the independence referendum. The SNP starts negotiating with the remaining UK (rUK) government over issues like how to split up national debt. On some issue the negotiations get bogged down. Rumours start circulating that this might mean that rUK will not form a monetary union with Scotland, and that Scotland might have to create its own currency. People in Scotland start withdrawing money from Scottish banks.

Now it is almost the definition of a private bank that if everyone who has an account at the bank wants to withdraw their money, the bank will run out of cash and go bust. That is why bank runs are so dangerous. It is also why one of the key roles of a central bank is to supply an otherwise solvent private bank with all the cash they need, so they will never deny depositors their money. (To be a lender of last resort.) If they did not do this, anyone could start a rumour that a bank was insolvent, and as people withdrew their cash just in case the rumour was true, the bank would run out of money and go bust anyway.

So in my hypothetical story, as people started withdrawing cash from Scottish banks, the Bank of England should supply these banks with all the cash they need. Except suppose it did not. Suppose it put a limit to the amount of cash it would supply. The Scottish banks would protest - you agreed we were solvent before independence, they would say, so why are you rationing our liquidity? The Bank of England replies that although they might have been solvent before independence, if there is no agreement solvency is less clear. The Bank of England says that the limit on cash will remain until the Scottish and rUK government come to an agreement.

This announcement of course leads everyone in Scotland to try and get their money out, and the Scottish Banks have to close. The Scottish economy begins to grind to a halt. The English media report that Scotland is running out of money because the Bank of England will not ‘lend’ any more to the Scottish banks. The Scottish government is forced to agree to the rUK’s terms. The English media say look what happens when you elect a radical government. In Scotland they call it blackmail. What would you call it?

If it sounds to you like the Bank of England is taking sides and putting impossible pressure on Scotland, then you will know what it feels like in Greece right now. When, on 28th June, the ECB stopped providing emergency funding to Greek banks, it took sides. Part of the ECB’s logic is that Greek banks may be insolvent if there is no agreement between the Troika and Greece (even though it is the Central Bank of Greece, and therefore the Greek people, which stands to suffer losses from defaults by commercial banks).

Why should the failure to reach an agreement influence the solvency of the Greek banks? Is it because without an agreement there would be a Greek exit? But Greece does not want to abandon the Euro, and the other Eurozone countries have no formal grounds to expel Greece. Greece will only leave the Eurozone if the ECB stops supplying Euros. We reach exactly the same self-fulfilling logic of a bank run. Is it because without an agreement the Greek government would default on some of its debts, and that might adversely influence the solvency of Greek banks? But the fact that the Greek government will not get money from the Troika to pay back the Troika seems to have no implications for the underlying solvency or either the Greek state or its banks. (Paul De Grauwe discusses this further.) If the Troika can make Greece insolvent by itself withholding money we have another self-fulfilling justification.   

The real explanation for the ECB’s actions is much simpler. Limiting funding on 28th June was the Greek government’s punishment for failing to agree to the Troika's terms and calling a referendum the day before. The ECB was not, and never has been, a neutral actor just following the rules of a good central bank. It has always been part of the Troika, and right now it is the Troika’s enforcer.

As Charles Wyplosz recounts, this is not the first time the ECB has chosen to bow to political pressure. There will be some on the left who will say of course - what else do you expect of a central bank? In response, let me go back to my hypothetical example involving Scotland and the Bank of England. I may be wrong, but I think in that case the Bank of England would have supplied unlimited cash to the Scottish banks. I may be naive, but I believe it would have realised that to do anything else was an overtly partisan political act, and recoiled from doing that. Just as I do not think it was inevitable that the Eurozone committed itself to austerity, I also think it was possible that the ECB could have been a more independent central bank. The really interesting question is why it has turned out not to be such a bank.  


88 comments:

  1. "That is why bank runs are so dangerous. It is also why one of the key roles of a central bank is to supply an otherwise solvent private bank with all the cash they need, so they will never deny depositors their money. (To be a lender of last resort.)"

    That's correct, Simon. And I think that's why the ECB initially did purchase Greek debt during the crisis. However, it is my understanding that it is illegal for the ECB to purchase debt that it will knowingly take a loss on. And at present, it seems that monetizing Greek debt is not a LOLR action -- it is a fiscal transfer for which the ECB presently has no mandate.

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    1. 1) OMT and QE are pari passu with private bondholders yet they are monetary operations of the same nature as SMP. You cannot have double standards.

      2) The ECB is a member of the troika. It should accept responsibility and the losses that its recommendations might lead to.

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    2. Wouldn't your argument depend completely on Greek bank exposure to Greek government debt because that's the only debt the ECB could "knowingly" believe to be at risk of loss? If that's the case, then why weren't Greek banks bailed out like those of Germany?

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    3. David. The problem for me is what changed on 28th June. The underlying solvency of the Greek government did not change on that date. Holding a referendum did not influence the solvency of the Greek government.

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  2. There is more than enough money in the world to ensure that a genuinely solvent bank does not run out cash.
    The problem is with insolvent banks.
    Maybe we need a mechanism to dissolve them, rather than keep them going with government funds.

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    1. Where were you in 2007/2008?

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    2. In 2007 I was in the US when Barclays withdrew all its finance from the US mortgage market and wondered why the news hardly produced a ripple of response.
      Through the year I pondered the relationship between money and value and how the debt situation could be resolved without some prolonged (relative) hardship. I couldn't think of a way.
      In 2008 I witnessed the folly of pouring government money into insolvent banks.

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  3. "When, on 28th June, the ECB stopped providing emergency funding to Greek banks, it took sides." The ECB never stopped ELA, it did not increase it beyond the 26 June level (€89bn) and increased the haircuts.

    To me this decision is not so strange. The ECB can only provide ELA with sufficient collateral (Greek bonds in this case), and there is/was a clear danger of a Grexit and/or default.

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    1. Up until 28th June the ECB had supplied all the cash that was required by the Bank of Greece. That is what being a lender of last resort means. The moment it put a limit to the amount of cash it would supply, it would provoke a bank run and capital controls. So the only possible excuse for its change of policy was a change in solvency, But again nothing happened just before 28th June to indicate a change in solvency.

      According to your logic, the ECB should work out how much collateral each EZ country's banks have, and announce its lending limits in each case. That would provoke a bank run is every EZ country.

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  4. SW-L; " I may be wrong, but I think in that case the Bank of England would have supplied unlimited cash to the Scottish banks."

    You are wrong; this government would have ensured that did not happen. Which is exactly the same political pressure that is being exerted on the ECB to ensure Greece is punished. I don't know whether it is naivety on your part or just a a personal flinching from acknowledging the inhumanity of the individuals involved.

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    1. I think this depends on how the Bank of England would have regarded the independence vote. If it regarded the vote as immediately transferring 'ownership' to rUK, then maybe you are right. I suspect instead it would have continued to regard itself as being jointly 'owned' by the prospective rUK and Scottish governments, until any negotiations ruled otherwise. In that case it could not have been told what to do by just one of its two owners. That is also the relevant analogy for Greece.

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  5. The Greek banking system has been insolvent for years. It's just convenient to pretend it's not... ELA has been expanded (and so far never contracted) for months now. No sign of reduction in the speed of withdrawals... At some point you have to face reality. If EU governments don't give the money to the Greek government, the Greek banks are bust.

    The ECB correctly reflects the majority opinion of the various EU governments. This is basic democracy. The Greeks cannot unilaterally issue Euro. There is no alternative to this arrangement.

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    1. On October 2014 the ECB disagreed:

      http://ftalphaville.ft.com/2015/07/02/2133491/greece-shows-ecbs-stress-tests-were-nonsense/

      So what changed its mind?

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    2. different anon - the fact that the Greek sovereign can no longer recapitalise its banks if needed (which would protect the ECB).

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  6. David, I guess, if profit/loss considerations would have priority, modern central banks would never be able to do QE in a severe recession.

    The Swiss Nationalbank (SNB) would have nothing to hold against the excessive appreciation of the CHF in the wake of euro zone crisis.

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    1. Profit/loss calculations *are* required by FRA in LOLR operations. These "crisis" events usually last only months at most -- they are liquidity events. Greece is not a liquidity event.

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  7. If your 'central bank' started out only as an inflation target, that seems to have reflected a lack of trust between the members under that 'central bank' at the very beginning of the Euro.

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  8. Looks like Syriza has folded now. Has any government been as incompetent? Capital controls, recession and 2 weeks bank holiday for agreeing the same deal that was on the table 2 weeks ago?
    Even if rejecting austerity was optimal, their negotiating skills are really terrible. For a government elected to negotiate a deal with the EU, this is a terrible outcome...

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    1. Looks like they might get some debt reduction. That's a better deal than previous governments had obtained if Germany goes for it.

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    2. Perhaps Syriza did not believe the ECB would act in such a political way. Perhaps the referendum was more about the survival of Syriza, because without it Syriza would have fallen apart if it agreed with these terms. But it is difficult to negotiate with an entity where your views are miles apart, and one part of that entity is only prepared to move by epsilon, and the other part wants the process to fail anyway so that they can force you to leave. I find it odd how some people obsess about Syriza tactics and seem to delight in their failure without thinking about what is much more worrying - the behaviour of the Troika.

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    3. "Perhaps Syriza did not believe the ECB would act in such a political way."

      This is the best explanation of the past few weeks of Eurozone news I've seen anywhere.

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  9. The kicker being that under EU rules, ELA funding is provided by the national central bank in question, not the ECB. "Responsibility for the provision of ELA lies with the NCB(s) concerned. This means that any costs of, and the risks arising from, the provision of ELA are incurred by the relevant NCB."

    So this isn't even the Bank of England refusing to provide cash. It's if the Bank of England was preventing a hypothetical central bank of Scotland provide liquidity.

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  10. Professor Wren-Lewis,

    I think you will have to comment Olivier Blanchard

    http://blog-imfdirect.imf.org/2015/07/09/greece-past-critiques-and-the-path-forward/?hootPostID=8299b6670cea64b9daad8b21e9a85fe7

    who explains every step taken in the past.

    Paul Krugman said somewhere that Olivier Blanchard, who was his teacher, was the cleverest man he had ever met. So you have a respectable adversary.

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    1. Thanks for the pointer to that blog entry, and it is amazingly obfuscatory in the best "institutions" tradition, some comment on that text that are relevant here:

      «Even before the 2010 program, debt in Greece was 300 billion euros, or 130% of GDP. The deficit was 36 billion euros, or 15½ % of GDP. Debt was increasing at 12% a year, and this was clearly unsustainable.»

      The usual neoliberal obsession about the government deficit while far more importantly the current account had net imports for €28 billion in 2010 (two years after the crisis began), and that was mainly why debt was increasing. But talking about the greek import boom seems to be "not a thing".

      «The decrease in output was indeed much larger than had been forecast. Multipliers were larger than initially assumed. But fiscal consolidation explains only a fraction of the output decline. Output above potential to start, political crises, inconsistent policies, insufficient reforms, Grexit fears, low business confidence, weak banks, all contributed to the outcome.»

      Output did not decrease in 2008-2014, it was imports (and the retail GDP they must engender) did, that is retail spending on imports went down. Greece in 2008 had much the same GDP as it has in 2001 when it also had a mostly-balanced current account and much the same domestic production unaffected by the import boom.

      This is probably elliptically implicit in "Output above potential to start", but it is still notable that talking about the greek import boom is "not a thing".

      And my impression as to why:

      * The neoliberal propaganda is that trade does not matter because private decisions are never wrong, but the only thing that matters is the government deficit.

      * Several big neoliberal countries are running large trade deficits as a way to push down wages and for other reasons, and don't want to draw attention to that.

      * The "institutions" are terrified of having to explain to their citizens how Greece could borrow in a few years the money to have a €230 billion (€63,000 per "household") import boom in an economy with a €160 billion GDP, and then why they continued lending to and subsidizing that country, as in: «But, clearly, there were and are political limits to what they can ask their own citizens to contribute.»

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    2. Anon. To me the key mistake is this sentence: "We believed that a small primary surplus, increasing over time, was absolutely necessary to maintain debt sustainability." My view would be that an increase in output, which required an easing of austerity, is absolutely necessary to maintain debt sustainability.

      Elsewhere Blanchard says that austerity explains "only a fraction" of the decline in output. PK has already commented on this. Actually I do not agree that austerity can explain all of the fall in Greek output, but the fraction it does explain is pretty large. Blanchard knows that future moves to larger primary surpluses will be a drag on growth.

      The other thing to remember is that the negotiations failed because the Troika ruled debt relief off the table. But the IMF agrees debt relief is required! So it took a political decision to follow its Troika colleagues on this, against its own beliefs. At no point does Blanchard try to justify this.

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  11. The role of a central bank is to supply unlimited liquidity to solvent institutions.

    If you suspect that Greek banks are not solvent, then the Greek sovereign would need to step in to recapitalise them. Without a programme, this option does not exist, so any lending to insolvent Greek banks is a fiscal transfer. Any fiscal transfer is not a decision which should be made by a central bank, so the ECB has acted entirely properly in this case (and, incidentally, in line with its legal framework).

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    1. But it turns out that the ECB is not just a central bank. In 2013, the EU expanded the ECB's responsibilities by making it the bank regulator for all Euro area countries. The ECB *is* responsible for determining whether banks are solvent, and it is mandated to take early action against insolvent institutions with the goal of preserving financial stability within the EU as a whole *and* within each Member State.

      The ECB's failure to take prompt action to resolve the Greek banking crisis is a dereliction of its duties under EU law.

      Put another way: the ECB is charged with preventing and remedying banking crises, not with causing them.

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    2. JEC - not so. A central bank cannot "resolve" a banking crisis on insolvent (rather than illiquid) institutions. It requires real fiscal resources in the form of a recapitalisation (e.g. the FED didn't bail out the US banks, it was the US Treasury through TARP, same in the UK).

      If the ECB lent to insolvent institutions, it would take a loss on those loans. It would then have to be made whole by being recapitalised itself by its shareholders - the rest of the Eurozone. This is a "bailout" by the back door - a transfer from the rest of the Eurozone to Greece. It is better that any such transfer should have the backing of the elected leaders of the other Eurozone countries, rather than ECB technocrats.

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    3. Anon: the ECB is not an ordinary central bank. (OK, it never really was ordinary, simply because the Euro is not an ordinary currency.) It combines the monetary policy duties and powers of a central bank with the duties and powers of a bank regulator. To put it in a US context, it is as if the Federal Reserve and the FDIC were the same entity.

      This was not always so. If we were having this conversation in 2012, I would probably be agreeing with you.

      Funding for bank resolution is also something on which EU policy has changed pretty radically in the last few years. Specifically, a Single Resolution Mechanism (SRM) backed by a Euro-area wide Single Resolution Fund (SRF) has already been established, and the costs of bank resolution will be fully "mutualized" over an eight-year transition period. (Detailed funding formulas have been formally adopted and everything.)

      Which means that the Euro area has already agreed to become a de facto transfer union, for this particular purpose at least. The only way they have managed to avoid saying as much is by declining to call "a compulsory levy charged against banks and paid to a governmental entity" a "tax." Therefore, no "tax money" is involved. (It sounds a lot like a tax to me, but I'm not trying to keep my seat in the Bundestag, so what do I know?)

      Curiously, none of this seems to have come up in the general press coverage of the Greek crisis.

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  12. Ha ha ha ha.
    Suddenly economist started discusing banking operations after decades of selfcensoring themselves on the nature of fiat money.
    The result is this misery of responses in comment sections.

    SW-L
    Now that you starting to write honestly about banking system and the nature of money, after decades of selfdeluding that economy can be explained without including debt, money and banking, enjoy your own amasement with such comments.

    But i have to congratulate you on starting to understand of MMT. In a year time you might even accept it as much better and easier (and much more honest) way to teach economy that is in the real world not in assumption riddenn clouds

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  13. «The Greek banking system has been insolvent for years. It's just convenient to pretend it's not...»

    There is also TARGET2 as a gauge of that, which is meant to be a settlement system, and this graph is fascinating as to how colossal its balances are and out of order:

    http://www.eurocrisismonitor.com/

    «ELA has been expanded (and so far never contracted) for months now.»
    «The ECB correctly reflects the majority opinion of the various EU governments.»

    But that is a gross violation of the ECB treaties, which forbid absolutely the ECB from doing fiscal or quasi-fiscal interventions in favour of one government or other entities. In particular bailouts of private or public companies like banks are strictly reserved to the democratically approved fiscal intervention by elected governments by the EU and ECB treaties.

    Of course the EU and eurozone governments know very well how unpopular it would be to operate fiscally to subsidize greek bank bailouts, so they prevaricate by letting the ECB violate those treaties and run its own fiscal policy in favour of Greece pretending it is monetary or credit intervention.

    The ECB, either encouraged by the other 18 governments of the eurozone, or by its own independent will, has therefore been absurdly generous to the greek government, acting as an euro donor of second resort whenever the greek government "obtained" funds from greek banks by stuffing them with its own liabilities.

    In the bailout as well as the ECB situation the deficit in democracy is mostly that the greek government has been given immense fiscal transfers along with hypocritical tough talk by both EU politicians and ECB management, who use that tough talk as cover because they know how illegal and undemocratic those enormous subsidies to Greece are.

    The SYRIZA government have not gone along with the "tough talk to cover huge handouts" game, and have behaved as if the tough talk by its donors was true to try to get even bigger and more overt handouts. The donor governments, put in difficulty with their own voters, won't forget that.

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    1. It might be a violation of the treaties, but all the Eu government go along with it, so it doesn't seem that undemocratic to me... It's a common law kinda approach: law reflects the popular consensus even when we don't go through the explicit act of changing the laws... I think it's a fairly pragmatic approach...

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    2. «It might be a violation of the treaties, but all the Eu government go along with it,»

      That's indeed my point, and most importantly that they violate the treaties *in favour* of Greece, using the ECB to do covert fiscal support. Apparently SimonL our blogger thinks that the current treaty violations do not go far enough, but he writes as if the ECB was violating the treaties to operate against Greece instead of subsidizing it.

      «so it doesn't seem that undemocratic to me.»

      It is undemocratic because the 18 EU governments are using the ECB and various other means to deceive their voters by doing huge fiscal subsidies to Greece while talking tough. If the 18 EU governments had done referendum last weekend about whether to continue to subsidize the greek government's bankruptcy the democratic will of the vast majority would have been NO, and that's why they deceive them.

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    3. Exactly: if the ECB was democratically controlled, it would give much *less* credit to Greece (and other crisis countries).
      ELA/TARGET2 credits are forced onto the creditor countries' national central banks and are only backed with low-qualitiy collaterals.

      Regards

      M.S.

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    4. BTW I found in another blog (by JW Mason) a link to a very detailed paper on the TARGET2 controversy:

      https://ideas.repec.org/a/ces/ifofor/vy2013ip05-50.html
      CESifo Forum Volume 14, April 2013 Special Issue
      Philippine Cour-Thimann "Target Balances and the Crisis in the Euro Area"

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  14. Martin Hellwig, co-author of "The Bankers' New Clothes: What’s Wrong with Banking and What to Do about It", compares the ECB's cap on the ELA credit facility with the Detonation of an atomic bomb. ("Wie die Zündung einer Atombombe",taz 8. Juli, 2015, in german)
    http://taz.de/Oekonom-ueber-die-EZB-und-Griechenland/!5209078/
    "For a country's economy, the destruction of the banking system and the payment processes is something like the firing of a nuclear bomb. The damage is highly visible."

    Here is another article from the same author, originally published in "Handelsblatt"(3. Juli 2015):
    http://www.oekonomenstimme.org/artikel/2015/07/die-ezb-und-die-deutschen-in-der-griechenlandkrise/

    Here you can see an interview with the austrian OeNB-Gouverneur Nowotny on greece from monday
    http://tvthek.orf.at/program/ZIB-2/1211/ZIB-2/10142867 (in german)
    Nowotny (1:50)
    "Dieses Schliessen der Banken hat ja verheerende Folgen für die Wirtschaft, weil Finanzierung ist der Blutkreislauf einer Volkswirtschaft. ... Das ist schon eine sehr ernste Situation" (1:50)
    The closing of the banks has disastrous consequences for the economy, because finance is the blood circulation of an economy. ... This is really a very serious situation"
    So, they know what they are doing.

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  15. “Why should the failure to reach an agreement influence the solvency of the Greek banks? Is it because without an agreement there would be a Greek exit? But Greece does not want to abandon the Euro, and the other Eurozone countries have no formal grounds to expel Greece. Greece will only leave the Eurozone if the ECB stops supplying Euros.”

    Grexit is conceivable. It has to be. Otherwise, there is no consequence to Greece in simply refusing to come to an agreement with the Troika. Greece has nothing to fear from failing to negotiate in good faith on that basis, which is ridiculous.

    If Grexit is conceivable, the ECB has to take that into account as a risk.

    And one of things associated with that is that under Grexit, the Greek NCB must somehow be extracted from the Eurosystem of central banks.

    And when that happens, the liabilities of the Greek NCB take on quite a different characteristic.

    Both the Target2 liability and the currency liability become debt.

    To believe otherwise is a contraction. An ex-Greece Eurozone will not fund Greece forever through its Target2 surplus, and it will not want to permit the existence of Euro seigniorage capacity on a foreign central bank balance sheet forever. Those are problems.

    The ECB must consider the prospect of those problems as an element in the probability of Grexit, which is non-zero. Both of those problems involved increased exposure of a post –Grexit ex-Greece Eurozone to Greece. Both get exacerbated when the Greek public perceives Grexit risk in the same way. So the ECB must protect its position until an agreement is reached.

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    1. "Both the Target2 liability and the currency liability become debt"

      Currency as debt may seem weird. But the Greek NCB would discharge that liability by sending it to the ex-Greece ECB along with payment of Euro bank balances. The Greek NCB would no longer redeem Euro currency and the ECB would wait for what might then be an excess supply of Euro bank notes to start being redeemed.

      Something like that.

      The fact that Greece might not go along with that just adds to default risk in aggregate, similar to Target2 risk to the ex-Greece Eurozone.

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    2. «Grexit is conceivable. It has to be. Otherwise, there is no consequence to Greece in simply refusing to come to an agreement with the Troika. Greece has nothing to fear from failing to negotiate in good faith on that basis, which is ridiculous.»

      But that's exactly the strategy Y Varoufakis described:

      yanisvaroufakis.eu/2012/02/18/greek-default-does-not-equal-greek-exit/

      «The Greek state, let me remind you, is quite close to a primary surplus. With judicious top-down reductions wages and pensions, plus the issue of tax-bonds, the Greek public sector could finance itself for the foreseeable future. All that is needed is that the ECB continues to provide liquidity to the Greek banks.»

      Put another way, all that is needed is that every time the greek government takes euros out of the banks (e.g. by "selling" to them a new batch of greek government bonds), the ECB supplies more euros to them. Very clever.

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    3. "Grexit is conceivable. It has to be. Otherwise, there is no consequence to Greece in simply refusing to come to an agreement with the Troika. Greece has nothing to fear from failing to negotiate in good faith on that basis, which is ridiculous."

      I see this line of reasoning a lot: Greece is a sovereign debtor running a primary surplus, so it doesn't actually need the good grace of its creditors. This, people say, is intolerable. Therefore, it is not true.

      The first point is correct. The second is a matter of opinion. And the third is simply magical thinking. Or, perhaps, an attempted justification for breaking the law when the legal situation makes you angry enough.

      The creditors' problem is that they have no actual, legitimate leverage. (Huffing and puffing is, as usual, a reliable sign of a weak position.)

      As thing stand, the ECB appears to have decided that providing *illegitimate* leverage is more important than carrying out its duty to preserve the stability of the banking system within every Euro-area member state.

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  16. The BoE would definitely supply liquidity. RBS et al are very important to the English economy. Maybe the lesson for ea banks is that they need to have much larger cross-border exposures?

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  17. I agree with your analysis, except I think the Bank of England would do the same thing in analogous circumstances. Nobody should expect a central bank to act independently of the financial interests of its owner(s).

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    1. But the Bank of England is owned by all the UK states, just as the ECB is responsible to all the EZ states, including Greece.

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  18. Hello Simon,
    Indeed, the ECB acted politically in capping ELA to the Greek financial system. However, the ECB, as an EU institution, should toe the line of policy laid out by other EU institutions that have democratic legitimacy, such as the EU Council. If the EU Council decides that there is no place for Greece in the Euro Area and gives such a signal, the ECB should also follow this playbook. This appears to be what it has been doing these last weeks, waiting for the result of EU Council and Eurogroup meetings, then basing its actions on the political decisions that come out of these meetings. Its decisions always FOLLOW EU or Euro Area Head of State or ministerial meetings.

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    1. I would have thought that, as an EU institution, the ECB should be expected to follow the treaties and laws that define the EU and to implement the regulations duly enacted by the competent bodies.

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    2. JEC, I agree that the ECB should stick to the laws and regulations that govern it. However, that is in normal times. The prospect of Greece leaving the Euro Area, and even the EU, is anything but normal, a situation not provided for in the treaties. Law should, can, and is, interpreted (this is simply jurisprudence). This is one time when political interpretation seems understandable. However, personally, I do regret that the EU Council leaves such room for interpretation, allowing the idea of a Grexit to become a possibility.

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    3. JEC, Note also that the limits to ELA and the rules applied in the ECB's "Collateral Framework" are left very much to the discretion of the ECB Governing Council. Thus, the ECB always did and does follow the "rules" in this respect, indeed it more or less makes those rules with complete discretion. Its just that it acts politically within the limits of the rules it sets.

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    4. Patrick: so what EU Council decision was it enacting on 28th June?

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    5. Hi Simon, I guess you are referring to the ECB decision to cap its ELA for Greece. This came right after a refusal by Greece to accept Eurogroup demands and the call for a referendum. I saw it as an attempt to increase fear, to cause panic in Greece (Varoufakis spoke, rightly I think, of an attempt to terrorize the Greek people into submission). I interpreted this as the ECB following the lead of the EU Council/Eurogroup to "tighten the screws" even further on Greece, to indicate that the latest refusal and call for a No in the referendum would push Greece out of the Euro Area, break its banks and bring even greater hardship to the economy. It was, I thought, an attempt by the ECB to align with the other EU institutions to force Tsipras to accept the creditor demands. Very political, but fully covered by the will of the Euro Area ministers, I guessed. And totally legitimate, following the ECB's own rules.

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    6. Patrick: Let me ask the question in another way. If it happened to be the will of the Euro area ministers to prioritize employment over price stability in the Euro area -- i.e. to raise inflation in an effort to reduce unemployment -- would it be legitimate for the ECB to execute this policy?

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    7. Hello JEC: The problem here is a conflict with the ECB's primary mandate, 2% upper limit price stability. Difficult, but given that it is the EU head of states who, in the end, sign the EU treaties, and these ministers can rewrite them and change the ECB's mandate, I'd say that the ECB should toe the line here too, with caution and guarantees that this is their will and that treaty change will come on this basis... But, yes, difficult problem...

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  19. http://www.3spoken.co.uk/2014/03/scottish-independence-myths-national.html?m=0
    Scotland also has a share of the bank of England, its 'national assets', you conveniently miss this out? The two can be written off against each other since sovereign "debt" isn't really debt anyway.

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  20. Damn right Simon.
    http://bilbo.economicoutlook.net/blog/?p=9922
    Central bank independence is BS!

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  21. This article posted on Mark Thoma's blog is a miserable example of how historically poorly informed mainstream economics excuses the sort of behaviour behind Osborne, the IMF's SAPs and austerity policies towards Greece:

    http://www.voxeu.org/article/effects-income-inequality-economic-growth

    Basically it argues that income inequality helps growth in poor countries. A preposterous argument, of course. Any historian would tell you that before industrialisation happened anywhere there had to be things like land reform that allowed peasants to keep surpluses from their labour. There had to be a way of redistributing property rights, power and resources away from a governing oligarchy. The argument is in the details, not in the broad principles. And yet we get these type of people who use theoretical models and run huge amounts of data without historical context through computers. This sort of stuff was also behind Volcker, Thatcher, the Washington Consensus and others, and all they needed was stuff like Sargent (1981), rational expectations and policy ineffectiveness propositions. Basically it excuses the one-percent and their power sources for pursuing what they do.

    Plainly unhelpful.

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    1. "it argues that income inequality helps growth in poor countries".

      That' what Marx said from the Communist Manifesto onward.

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    2. I think he emphasised how inequality breeds more inequality - ie it increases divergences between capital and labour, including between countries where capital is or is not concentrated. So really the situation in poorer countries - basically colonies of industrialised countries - worsens and so with it global inequality.

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  22. Simon,

    It is also worth pointing out in the context of your post how the ECB behaved during the Irish bailout.

    It is well established that the ECB effectively vetoed the imposition of losses on unguaranteed senior bonds at insolvent Irish banks. Irrespective of the wisdom of imposing such losses it is outrageous that the ECB decision should be made by the ECB and then enforced by threats of shutting down the financial system of a member state. The ECB effectively said it wouldn't refinance Irish banks if losses were imposed even though imposing losses would of course have IMPROVED the solvency of Irish banks (at least on if we only take into account first order effects) and should therefore have removed an obstacle to funding. The obvious real rationale was to avoid contagion in senior debt markets. And the solvency of Irish banks had nothing to do with the decision at all. But the key point is that if EU members wished to avoid contagion they should have coughed up some or all of the money to bail out the senior bonds themselves. Instead the used the ECB and the funding it provides as a weapon to strengthen their hand in negotiations. The ECB is doing the same thing to Greece now.

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    1. «The ECB effectively said it wouldn't refinance Irish banks if losses were imposed even though imposing losses would of course have IMPROVED the solvency of Irish banks (at least on if we only take into account first order effects) and should therefore have removed an obstacle to funding. The obvious real rationale was to avoid contagion in senior debt markets.»

      I am surprised that the ECB regards its mandate as covering the stability of the whole EU financial system instead of that of the Irish republic only :-).

      «if EU members wished to avoid contagion they should have coughed up some or all of the money to bail out the senior bonds themselves.»

      In the end the Irish republic government, who is responsible for Irish banks, did do that, and was very generously helped by their partner governments in shouldering the burden. They could have done more, of course. But the result has been that the position of the government of Poland in recent talks with the government of the Irish republic is:

      www.independent.ie/business/world/ministers-refuse-to-support-debt-writedown-for-greece-as-fears-of-contagion-increase-31356910.html
      «Mr Flanagan made the remarks after holding talks in Dublin with his Polish counterpart Grzegorz Schetyna. Mr Schetyna said the Eurozone must consider whether to assist countries like Ireland which have shown positive engage with its partners, or countries like Greece which he said are in “the process of just spending money”. “I am in favour of supporting the first example,” Mr Schetyna told the Irish Independent.»

      The Irish republic in the past decades (just like Poland today) received very large amounts of net contributions, no-strings-attached, from the richer EU countries, principally funded by Germany's taxpayers. Even more so than Greece a lot of useful stuff in Ireland has been donated by german generosity.

      When it came to blowing up Germany's main banks or buying time for their partners the Irish republic government chose to be grateful. This has been noticed as far as Warszaw. The EU is an ugly compromise, and its politicians are often ruthless or bastards or both, but sometimes it works.

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    2. Don't know where to even start with that response

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  23. " I also think it was possible that the ECB could have been a more independent central bank."

    Unlikely. First, you have to ask how independent central banks anywhere are. Of course it is made more complicated by the fact the EU in the first place is not a democracy. So I really do not know who the ECB thinks it is accountable to, except its member governments (not the EU commission).

    This tragic mess is just another example of the cost of having monetary union and just assuming political and fiscal union would shortly follow.

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  24. «the ECB thinks it is accountable to, except its member governments (not the EU commission).»

    My understanding is that like say the BoE or the Fed they are accountable to their board.

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    1. You would be wrong. The Treasury has reserve powers over the BoE. They have to do what they are told.

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  25. The conspiracy theorists who believe the ECB is oh so dependent on some Eurozone governments may have forgotten that it is continually annoying the Germans with decisions against the Bundesbank and the German government. So it must be dependent on the others - and that is what German conspiracy theorists believe.

    What about a dose of reality?

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    1. When I said that the ECB bowed to political pressure I did not mean to imply that it was simply being told what to do by a government. What I meant that is was bowing to the pressure of politics, which could simply come from the politics of the ECB board members themselves.

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  26. exceptional piece and logic here. Makes it really clear that what we are seeing here is blackmail. Jens Weidmann even said that the ECB will only keep up ELA supply if the solvency of the Greek state and Greek banks is sorted out... like the former should even bother him.
    Unfortunately the public does not get it. The public thinks we are sending more money to Greece and those unthankful, lazy greedy bastards are rejecting our generous offer.

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  27. A good analogy thanks, but while we are all watching Greece and the way they have been so atrociously treated we mustn't forget that they are scapegoats too for any disaster that may unravel in Europe or indeed globally as China's carefully crafted unravelling takes place having been given an extraordinarily long rope to hang itself.

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    1. This is pretty unusual comment. Let me explain why.
      China is doing what Greece needs to be doing. Or to be more precise, what ECB should be doing in order to solve the greek (euro) problem. China is using it's CB to finance and hide defaulted loans from its books by providing more loans to economy. China is using its control of CB to provide liquidity to the system where free market failed and prrices started to colapse.
      This is exactly what Greece needs, more liquidity in order to pay off old loans and provide new loans.
      But if you want China to fail as an enemy of yours and Greece to succede as your friend you will deny to your enemy what you want for your friend.
      That is how Germans also think about Greece as enemy and to northerners as friends so what northerners doo all the time with ECB is not permited to southerners.

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    2. If this is correct, then ECB and other policy are being driven, in part, by not just nationalism but a form of racism. Not good. But alas, policy and racism/sexism/etc. seem inseparable.

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    3. Yes, a form of racism. You should hear Germans talk about Greeks. They use all the code words of a US southern segregationist talking about blacks. Greeks are lazy, they say. Spendthrift. Spend all their time sexing rather than working. Must be forced to behave like good Germans with all tools necessary because they're too stupid to know how to behave properly. If Greece grew watermelons I have no doubt these fine Deutschfolk would talk about how those Greeks just sit around on their front porches eating watermelon all the time. So it is not just economics and politics here, there is a decided bigotry against Greeks in Germany, at the very least, and as we both know Germans dominate the ECB.

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  28. The problem is not any lack of " independence" of the ECB. it is acting in its own right, reflecting the views of the board. Ever since its creation the ECB pressed for tighter fiscal policy. In this it continues the Bundesbank tradition of demanding austerity and low wage settlements in Germany.
    I once asked a senior Bundesbank official why they kept saying high settlements would mean higher interest rates, even though inflation was low. "We are pursuing a threat strategy," he replied. I asked what their strategy would be if that failed. "Revenge."

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    1. You are right, and I did not express myself well. I meant independent of politics, rather than independent of government. Another way of putting it is that the ECB has a much more political view of what an ICB should be than the view in the US, UK or among academics.

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  29. Lets simplify. Take a unitary state with its own central bank. But the central bank has a fixed exchange rate policy, and can hold either domestic or foreign government bonds. Now suppose the domestic government is at risk of insolvency.

    A truly independent central bank would stop buying domestic government bonds and hold only foreign government bonds.

    A central bank cannot act as unlimited lender of last resort to an insolvent entity and at the same time have an independent monetary policy. If it does act as unlimited lender of last resort to that insolvent entity, it hands over control of monetary policy to that insolvent entity.

    It's the European Central Bank, not the Central Bank of the Greek government.

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    1. This is not at issue. The issue is what happened just before 28th June to transform Greece for solvency to insolvency?

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    2. The probability that the MoU would expire without extension went up, so the probability the ECB would not be repaid for additional Greek liabilities went up, so the ECB would be stuck with them? It's the payment of Greek liabilities to the ECB that (should) matter to the ECB, not whether Greece will repay all its liabilities to others. Didn't YV himself say (soon after June 28) that the ECB would be stuck with Greek Target2 liabilities if there weren't an agreement?

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    3. The prospect of imminent receipt of further outside funding to fill a then-existing insolvency of the Greek government (and its bonds serving as ELA collateral) was removed when the referendum was announced. The Greek banks have been insolvent for the entire relevant period, but ECB justified overlooking that so long as new funding was deemed probable; that all ended with the referendum - the ECB couldn't justify ignoring it any longer - reality had to be acknowledged.

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    4. Nick, it's all rather circular, because Greece was committed to remaining in the euro until the ECB pulled liquidity. So the risk to the ECB was generated by the ECB. It makes sense only if the ECB is acting in solidarity with the creditors.

      Delete
    5. "Take a unitary state with its own central bank. But the central bank has a fixed exchange rate policy, and can hold either domestic or foreign government bonds. Now suppose the domestic government is at risk of insolvency.

      A truly independent central bank would stop buying domestic government bonds and hold only foreign government bonds."
      This is completely insane. The "independent central bank" thing is a religious thing among economists. I guess if the people at the central bank will have to be run by sociopaths.
      I notice none of these comment mention real people or real resources and are all about money.
      Absolutely disgusting.

      Delete
  30. I hope Greece is buying time to print drachmas, its their only hope

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  31. Simon - I know this isn't an "ask me anything" blog, but thought I'd try my luck! I guess you'll have read Varoufakis' guardian blog post yesterday. I was wondering what your views were about his take on the monumental practical difficulties of returning to the Drachma? Quote: "To exit, we would have to create a new currency from scratch. In occupied Iraq, the introduction of new paper money took almost a year, 20 or so Boeing 747s, the mobilisation of the US military’s might, three printing firms and hundreds of trucks. In the absence of such support, Grexit would be the equivalent of announcing a large devaluation more than 18 months in advance: a recipe for liquidating all Greek capital stock and transferring it abroad by any means available."

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    1. I think this is an underestimated point in the way the drama has unfolded. As the Greek government had no meaningful capacity to create a new currency, then the ECB inevitably had them over a barrel. A lot of what we've seen in the media has been posturing and self-justification - trying to control the narrative. Underneath, it's pure power politics.

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    2. Athens prints its own banknotes. I do not understand why Varoufakis thought that this would be difficult. Simply print Greek euros. If the other eurozone members refuse to recognize them, the fallout happens in the *other* eurozone countries.

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  32. I read Blanchard's post just now. I know he is a brilliant econimist and likes puppies. But he seemed like a lackey covering his behind. Is the IMF in this case along with the troika a puppet enforcer for Germany and the North?

    I don't think they care so much about Greece other than that they sadistically like inflicting pain on putative deadbeats. They have bigger fish to fry. This is the local loanshark saying to the neighborhood if you don't play ball you're entering a world of pain. Spain? Portugal ? Italy? France? Take note. This is Germany's world, you're just living in it. _

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  33. I think something is missing in your Scottish story: you claim after the bank run has started, the central bank should be the lender of last resort.
    Surely, something must be done to stop the bank run too, otherwise the banks will go bust anyway.
    I would assume the government needs to nationalize the banks, and take other measures to bring back trust into the banking system. Like what happened in the UK and other countries during the crisis.
    But in Greece government did the opposite of bringing back trust: there was already a slow motion bankrun going on for months, and than the Greek government called for a referendum, accelerating the bank run. Calling for a referendum is their democratic right you may say, but what about the responsibility of the Greek government to prevent and/or stop a bank run?
    Imagine the UK government would not have acted when banks were in trouble during the crisis, would the BoE have provided unlimited support?
    Ofcourse it's inconceivable this would have happened in the UK, as BoE and government would work together. In the case of Greece, the Greek government used the slow motion bank run going on for months as a political tool, as they knew it would cost the taxpayers of others countries money if negotiations collapsed and emergency loans would not be paid back. It just shows what a mess the eurozone structure is.
    I think ECB was well aware the Greek government was playing a dangerous game, they had to do something.

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  34. Some years ago there was a bank strike in the Republic of Ireland for several months. Did the economy collapse? In Greece what is happening to the vast amount of cash (euros) that is not being deposited into the banks? The economy is a high cash economy, which is why the government finds it so difficult to collect taxes. If Grexit is decided this weekend, the losers will be the creditors. The Greek economy will continue on a cash basis using euros until the new drachma is printed and circulated. Sure, many Greeks will be hurt, but the economy will recover and thrive under a sovereign currency.

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  35. "But Greece does not want to abandon the Euro, and the other Eurozone countries have no formal grounds to expel Greece. Greece will only leave the Eurozone if the ECB stops supplying Euros."

    I don't know if that is so obvious.

    The question is: will there be a Grexit given that 1) the ECB continues supplying liquidity to Greek banks and 2) the Greek gov't and the Troika fail on negotiating a deal and the Greek gov't defaults on Troika money.

    If the ECB perceives an increase in Grexit risk due to the referendum, despite supplying Greek banks, its decision is not political (maybe their risk analysis is flawed, but that is a technical discussion, not a political one).

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  36. "Now it is almost the definition of a private bank that if everyone who has an account at the bank wants to withdraw their money, the bank will run out of cash and go bust. That is why bank runs are so dangerous. It is also why one of the key roles of a central bank is to supply an otherwise solvent private bank with all the cash they need, so they will never deny depositors their money. (To be a lender of last resort.) If they did not do this, anyone could start a rumour that a bank was insolvent, and as people withdrew their cash just in case the rumour was true, the bank would run out of money and go bust anyway."

    Is the exchange rate fixed (emphasis on the fixed part) at 1 to 1 even if price inflation went above target?

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  37. Three of the Scottish banks print their own banknotes, so Scotland would have a powerful way of fighting back against this sort of BoE tactic.

    The thing is, Athens *also* prints its own banknotes. Unfortunately, nobody in Syriza was quite radical enough to realize what that meant... what happens if the Bank of Greece prints euros against the instructions of the ECB? Well, the ECB becomes somewhat powerless... and it all becomes politics.

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    1. Most currency transfers today are electronic via the EFT system, and only currency that has been "printed" electronically by the ECB is accepted as Euros. The Bank of Greece can indeed print Euros to fill up its ATM machines, and dare the ECB to do anything about it, but the ECB will then simply subtract that amount from the amount from the assets of the Greek banks that it recognizes as valid for EFT purposes.

      Reality is that we haven't had a cash economy for decades, and printing cash is no longer how money gets created. It'll keep Greece's local cash-based economy going, but won't do diddly for the problem of importing and exporting goods, neither of which have been done in cash since the early 20th century. No bank is going to accept EFT transfers from a Greek bank if there's illegal money printing going on, because of fear that they'll have Euros taken out of *their* accounts on file with the ECB if they do. And without EFT transfers, there's no imports to Greece -- and since Greece's main exports rely on imports as their inputs, thus no exports.

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