“Purity is Obscurity”
“Sometimes You Have to Destroy a Village to Save It”
Anonymous in Vietnam
In contrast to the Federal Reserve System, which was established to prevent and deal with financial panics in 1913 and whose powers to do so in exigent circumstances were expanded in the 1930s (only to be taken away when they were used effectively in 2008-2009), the ECB was not designed to act as lender of last resort; and it’s monetary policy was limited (theoretically) to the single goal of preventing serious inflation. It was expected to be the guardian of the new Euro but was not given the means to do so effectively.
There is a good chance that the Euro will collapse because the ECB cannot or will not go all in like the Fed did. Is it really worth it to allow the legal niceties to trump its most important goal? I agree more with Ogden Nash that purity in this case will likely lead to obscurity than with its present apparent willingness to destroy the Euro to save it.
It does have an out, even though it may not be pure. The latest GDP statistics in the Euro-zone countries are barely positive and the trend is leading to significant negative numbers for the current quarter. In other words, a Euro-recession—likely a deep recession—is almost certain. Even though the ECB is not supposed to concern itself with recessions, it’s not much of a stretch for them to conclude that the recession makes unsterilized bond purchases much less likely to be inflationary. In other words, the recession, coming anyway, helps reconcile the ECB’s inflation mandate with the dire need to intervene to save the Euro.
The ECB should not be overly concerned that bond purchases would lead to inflation if they are not sterilized. The massive bond purchases by the Fed did not lead to massive inflation; indeed, until recently, their impact on the money supply was muted by the desire of U.S. banks to hold excess reserves, just as they did in the 1930s. The same is likely to be true of distressed European banks. During a financial crisis, central bank asset purchases are much less likely to create inflation, and the factors that make that so are the same factors that make the absence of asset purchases so destructive. So, I’m not only advocating bond purchases in volume by the ECB; I’m also advocating allowing them to expand the ECB’s balance sheet and, hopefully, the money supply, at least during the current crisis. Purity is obscurity.