A new instrument for the ECB?

_ Dr. Roland Vaubel, emeritus professor, University of Mannheim. Oekonomenstimme. 8 July 2022.*

ECB President Lagarde has announced a “new tool” to make Italian public finance cheaper. These can only be targeted purchases of Italian government bonds. It is not the task of the central bank to make Italian state financing cheaper. Only the ESM can do this.

ECB President Lagarde sees the interest rate differentials for Italian and German government bonds as a “fragmentation” of the euro area. The term is misleading. Economists understand fragmentation to mean differences in interest rates on identical securities in different countries. If Italian government bonds were traded at different interest rates on Italian stock exchanges than on German stock exchanges, the market would be fragmented.

ECB President Lagarde wants the Italian state to be able to finance itself at the same low interest rate as the German state. One can assume that the impetus came from the Italian Prime Minister Draghi. The ECB can only push the interest rates on Italian government bonds to the level of German government bonds by buying Italian government bonds or by announcing such purchases, thereby changing the expectations of market participants. So far, ECB President Lagarde has limited herself to making announcements to test their effectiveness. Labelling asset purchases as an “instrument” is unusual among economists. The bonds themselves are (financial) instruments, but the purchases would constitute a new “program”.

The ECB has decided that it will no longer engage in “net bond purchases”. But it will replace the maturing bonds in its portfolio with new bonds. Instead of a roughly representative market portfolio – as has been the case up to now – this could only be Italian government bonds. If the scope of purchases of Italian government bonds were limited by the volume of maturing bonds, the ECB’s announcement that it would lower interest rates on Italian government bonds to the level of interest rates on German government bonds would have only limited credibility. “Whatever it takes” looks different; it tolerates no limitation. This also applies to a lesser extent if the ECB reserves the right to replace all non-Italian bonds in its portfolio, i.e. not just those that are due, with Italian ones.

Would such a program be compatible with the ban on monetary financing of the state under Art. 123 TFEU? An appeal signed by 136 economics professors and published in the Frankfurter Allgemeine Zeitung on September 12, 2013 states:

Article 123 TFEU prohibits the ECB from “directly acquiring debt instruments” from member states. This makes it clear that monetary state financing of the member states is prohibited. Bond purchases on the secondary market are only permitted if they do not serve monetary government financing but monetary policy goals. If the ECB’s bond purchases were motivated by monetary policy, it would buy a representative portfolio…

The ECB subsequently did just that. But even before that, Trichet’s strategy at the time differed from Lagarde’s strategy today. Although the ECB only bought the bonds of a few member states (Greece, Italy, Spain) as part of Trichet’s “Securities Markets Program” (SMP), he made it a condition that the member states set up a fund – first the EFSF, then the ESM – which would impose economic policy conditions. Why is ECB President Lagarde not referring Italy to the ESM? The interest rate on Italian government bonds could also be significantly reduced by means of appropriate conditions. This is the better method because it tackles the causes of the Italian malaise.

*Republished with kind permission by the author from the original: Vaubel R. (2022). Ein neues Instrument für die EZB? URL: https://www.oekonomenstimme.org/artikel/2022/06/ein-neues-instrument-fuer-die-ezb/ 

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