Financial Stability News

News about financial stability and central banking

Euro lacks a government banker, not lender of last resort

This is a useful clarification by Thomas Palley in FT:

The euro lacks a government banker, like the Federal Reserve or Bank of England, which helps finance budget deficits and keeps rates low on government debt. This explains why the US and UK can borrow at low rates and remain solvent, whereas Spain, which has a roughly similar deficit and debt profile, is under speculative attack.

The lack of a government banker reflects the euro’s neoliberal birthmark. Neoliberalism aims to diminish the role of the state and enhance the power of the market, and this goal is reflected in neoliberal monetary theory which guided the euro’s design. The theory argues central banks should control inflation, but there should be complete separation between the central bank and government finances.

According to Palley,

The solution is to create a European Public Finance Authority (EPFA) that issues collectively guaranteed debt on behalf of eurozone governments which the ECB is allowed to buy. That would enable the ECB to manage governments’ interest rates via open market operations, as does the Federal Reserve and Bank of England.

Currently, ECB is lending freely to banks so that they can buy sovereign paper instead of the ECB. The question is if this will work? It is probably not a wise strategy for banks to take, unless they are arm twisted into doing it. We will have to wait and see.

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