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.
