Posted by WARREN MOSLER on August 20th, 2010
Still feels like the weakness is coming out of events in the euro zone,
as evidenced by the euro going down as gold goes up phenomena re emerging
It’s all being held together by the ECB buying national govt debt in the secondary market.
The question I’ve seen, is how long can the ECB keep doing this/what are the limits?
The short answer is there are no nominal limits, just political limits.
And the political limit is tolerance of inflation, and inflation control is their single mandate.
They don’t want deflation or inflation.
They are buying national govt debt to prevent a euro zone wide deflationary collapse.
So how much can they buy before it’s all inflationary?
Inflation comes from spending.
Traditionally, knowing the ECB is buying your debt and that you can’t default opened the door to moral hazard issues
A nation being supported would expand spending as much as possible.
But the ECB is first imposing ‘terms and conditions’ to prevent that before buying the national govt bonds.
So not only is (deficit) spending not being expanded, it is being cut back.
And, in any case, the euro zone national govts are complying with ECB demands, directly or indirectly.
So if it doesn’t work, it’s up to the ECB to implement alternative strategies.
It would make no sense for the ECB to cut off funding because an ECB directed policy fails.
With the ECB directly or indirectly in control of member nation fiscal policy,
And with no one increasing their spending in any material way,
I don’t see a demand pull inflation possible as a function of ECB securities buying, no matter how large.
And with deficits over there already high enough for at least modest growth, which seems to be materializing,
it will be a while before fiscal gets too tight for modestly positive growth.