Wednesday, April 28, 2010

Can the ECB bail out Southern Europe?

Unlike the Fed, the ECB does not have a growth or stability mandate. The hawkish Germans insisted that its charter focus exclusively on price stability. To my knowledge there are no doves on the ECB's board. 

But despite this, would it be prudent for the ECB to stand idly by while the dominoes fall in Southern Europe? If the contagion spreads to Portugal, Spain, Italy and Ireland, eurozone nominal GDP will fall,  prices will fall, and the euro will collapse. 

Bernanke, speaking of the Great Depression, famously said "We [the Fed] did it. It was our fault." Does Trichet want a European collapse to be his historical legacy?

Today's FT:
“We have gone past the point of no return,” said Jacques Cailloux, chief Europe economist at the Royal Bank of Scotland.“There is a complete loss of confidence. The bond markets are in disintegration and it is getting worse every day. The ECB has been side-lined in the Greek crisis so far but do you allow a bond crash in your region if you are the lender-of-last resort? They may have to act as contagion spreads to larger countries such as Italy. We started to see the first glimpse of that today.”

Mr Cailloux said the ECB should resort to its “nuclear option” of intervening directly in the markets to purchase government bonds.
This is prohibited in normal times under the EU Treaties but the bank can buy a wide range of assets under its “structural operations” mandate in times of systemic crisis, theoretically in unlimited quantities.

Mr Cailloux added: “This feels like the banking crisis in late 2008 post-Lehman, though it has not yet spread to other asset classes. The ECB will have to act it if does.”

I would add that the consolidated assets of the ECB and its member central banks is EUR 2 trillion, which should leave considerable room for offsetting asset sales in order to sterilize the monetary impact.

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