Tony Yates yesterday commented on my two recent pieces on Germany. The second issue he raises, on countercyclical fiscal policy, is I think quite easy to deal with. He may be right that there was general unhappiness with how fiscal freedoms had been abused in the past. But if so, that suggested something very similar to the SGP (i.e. rules designed to reduce debt policed by Brussels), but with an additional countercyclical element. That in particular would have applied pressure on the Irish and Spanish governments before the recession, pressure that the actual SGP notably failed to do.
His discussion of OMT (the ECB acting as a sovereign lender of last resort) suggests OMT is a bluff. The argument is that if, under the protection of OMT, the market still refused to buy a government’s debt, the ECB would be forced to buy it, and because there was the possibility of a loss for the ECB they would not do so. I think this is unlikely in practice and is certainly wrong if it is true.
OMT is not extended to any Eurozone country that gets into difficulties. The ECB has to have the right to say no, leading to almost certain immediate default. The test is whether the government is willing and able to stay solvent. The ECB also has to have the right to withdraw support if conditions change sufficiently to put its earlier judgement in question. That is a good argument for why OMT support should come with some form of conditionality, so as to give the country fair warning that support might be withdrawn.
If the ECB gets that judgement right, then there are no implications for inflation. Just as with QE, the central bank will have created money to buy assets which it will at some point sell off again. In fact the central bank makes profits, because the interest it receives from the government on that debt will exceed the interest it pays on reserves. If the ECB gets it wrong there will be costs, but they are not unlimited: they are simply the amount of debt it bought until it decided to withdraw support. The benefits that OMT provides surely outweigh the expected value of those costs, although I agree with Tony that some in countries that are never likely to require OMT may take a more narrow view. Even then there are no necessary implications for inflation, as Eurozone governments should make good the ECB’s losses.
The most worrying thing in Tony’s post is his suggestion that limits should be applied to the amount central banks outside the Eurozone should provide as a sovereign lender of last resort. Such limits can only do harm. They are based on a myth that independent central banks can stop a highly profligate government from raising inflation. It is a myth because the first thing such a government would do is abolish those limits. More generally, a government that is so profligate that future default was inevitable would have no hesitation in abolishing central bank independence. You cannot stop a government of central bank nightmares. Such limits are therefore either meaningless, or could do harm.