Magazine article The International Economy

Is the European Central Bank Losing Credibility? or Are Recent Criticisms Overblown? Fourteen Noted Observers Offer Their Views

Magazine article The International Economy

Is the European Central Bank Losing Credibility? or Are Recent Criticisms Overblown? Fourteen Noted Observers Offer Their Views

Article excerpt

To what extent, if any, has European central banking in general, and the ECB in particular, compromised its credibility to stabilize the sovereign debt market? Critics suggest that the ECB's flooding the market with liquidity has raised questions about 1) the quality of the securities used in repo operations; 2) the length of time the liquidity is being made available; and 3) the indiscriminate way in which funding has been allowed to include those institutions with no need of additional liquidity. Critics add that the ECB's Target2 program, which credits bank transfers within the ECB, has compromised all eurozone national central banks. Does it matter that the ECB's leverage ratio is now eight times the leverage ratio of Lehman Brothers just before that Wall Sweet firm collapsed?

Defenders counter that the Target2 imbalances are simply the reflection of the current account imbalances in the eurozone caused by Germany's large current account surpluses. And if the credibility of European central banking were at risk, why hasn't the euro collapsed? However, others argue that the imbalances reflect subsidized capital flight to the stronger countries in the euro system.

Does European central banking have a credibility problem? Or are these criticisms overblown?

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The ECB's actions will not have a good ending.

HANS-WERNER SINN

President, Ifo Institute for Economic Research, and Professor of Economics and Public Finance, University of Munich

During the financial crisis, the European Central Bank has progressively reduced its rating requirements for the collateral that banks have to provide for refinancing credit, from A- to BBB-. It accepted Greek, Portuguese, and Irish government bonds regardless of their ratings. It allowed the national central banks to provide emergency liquidity assistance credit, guaranteed only by the national central banks themselves. It allowed commercial banks to construct asset-backed securities composed from dubious ingredients. It prolonged the maturity of its refinancing operations from a maximum of three months to first one year and, recently, even three years. And it now plans to accept even company credit titles as collateral.

With this policy, it has helped the troubled countries of the eurozone to (electronically) print about 800 billion [euro] worth of central bank money beyond what they needed for their internal circulation, allowing them to redeem their foreign debt and to buy foreign assets or goods, in net terms, using the printing press. This is measured by the so-called TARGET credits. In a letter to ECB President Mario Draghi, Bundesbank President Jens Weidmann recently complained about the risk that the TARGET balances imposed on the Bundesbank, asking for guarantees.

The ECB argues that its policy was first aid, merely stepping in for the seized-up interbank market that was not providing enough credit to the periphery countries. However, this is only one interpretation. Another one is that the ECB itself helped to destroy the interbank market by establishing the money-printing press as a competitor to commercial banks. While commercial banks from the capital-exporting countries demand a substantial risk premium in the form of interest rates, the ECB has been offering its credit at a rate of only 1 percent, far undercutting the credit market. Small wonder that the periphery banks have preferred to borrow the printing press, taking the opportunity to relieve themselves of their foreign debt burden.

The policy has reduced the periphery countries' pressure to restructure and lessened the pain that the austerity measures necessary to regain international competitiveness would have inflicted on the population. But for this very reason it also has undermined the allocative function of the capital markets. After years of excessive capital flows to the periphery, the savers of Europe's core countries and their financial institutions ultimately realized their mistake and preferred to stay in their home harbor, redirecting the scarce investment capital to safer and ultimately more profitable uses, which would also result in more growth and prosperity for Europe as a whole. …

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