Euro Crisis: Where Is The ECB? EFSF Buying Its Own Bond?13 November, 2011, 23:35. Posted by Zarathustra
Tags: Economy, Euro Crisis, Europe
While the obvious way to stabilise the situation in Europe is for the European Central Bank (ECB) to backstop the struggling governments as everyone has been wishing for, the reality is more tricky than that.
The ECB’s mandate is price stability for the Eurozone, and only price stability. The function as the lender of last resort (LOLR) is not in the Maastricht Treaty, and the Germans are very obsessed with hard money and price stability. So even though the obvious way is to have the ECB to commit to, for example, target bond yields for Italy and buy up large quantity of debt without sterilisation, it is in reality much harder to have this to happen. Yes, there were rumours about that, but no, it probably will not happen any soon, as the German Bundesbank’s president Jens Weidmann just told the Financial Times that the ECB job is not to act as the LOLR to governments, and it is politicians’ job to solve the problem, not the central bank, as that would “add to instability by violating European Law”.
Nomura has offered the some interesting perspective from game theory, explaining why the ECB is so reluctant (besides that it is “not in the Treaty”):
We can simplify this complex situation into a repeated game between the ECB and the fiscal authorities of the euro area. The fiscal authorities can behave or cheat. Behave means instituting and sticking with substantial fiscal and regulatory adjustment. Cheating means avoiding that outcome. The monetary authority can be hawkish, which in this context I take to mean no QE or dovish, offering full support for announced fiscal programmes that are aimed at guaranteeing future solvency.
The question then is there a stable solution to the game? And the answer, in my view, is no. If the ECB unilaterally decides to go dovish then the fiscal authority is better off cheating which leaves the ECB worse of than if it had remained hawkish. Therefore it doesn’t have a “dominant” strategy. Equally, there is no dominant strategy for the fiscal authority independent of what the ECB does.
But the game does have some important things to tell us. First, the ECB doesn’t want to drop into the break-up scenario and so it engages in tentative QE, better known as the SMP. This is akin to the sort of signalling one expects in this sort of repeated game – rather like the USSR and the US at the height of the cold war. Taking the analogy further one tends to see proxy battles being fought in these scenarios – in which case Greece is our cold war Vietnam whereas Italy is the Cuban missile crisis.
So how about the money printing that everyone wants? James Mackintosh of FT wrote that perhaps one should hope that there is a deep recession, so that the ECB can finally act as the economy sinks to a point that interest rate is so low that it can’t be cut any further, and price stability is no longer the issue such that money printing can be justified. If this is the most realistic scenario (which I think is actually quite likely), by the time when the ECB finally acts, the situation would have been much worse.
In the other news, while the European Financial Stability Facility (EFSF) sold some bond last week, it now appears that the sale was successful only after the EFSF bought its own bond. The Telegraph notes that the €3 billion 10-year bond was successfully sold only after the EFSF spending a “several hundred millions euros” to buy the issue as the banks doing this deal only managed to find €2.7 billion of demand. This was subsequently denied by the EFSF according to Reuters, so maybe the Telegraph is making stuff up. Maybe.