The euro zone is operationally sustainable as is

While the way the euro zone is currently function would not be my first choice for public policy, it is operationally sustainable.

The ECB is writing the check, and can continue to do so indefinitely.

For example,
as long as the ECB buys sufficient quantities of Greek bonds in the secondary markets,
Greece will be able to fund itself.

The ECB debt purchases merely shift net financial assets held by the ‘economy’ from Greek govt. liabilities
to ECB liabilities in the form of clearing balances at the ECB, which does not alter any ‘flows’ in the real economy.

So as long as the ECB imposes austeric terms and conditions, their bond buying will not be inflationary.
Inflation from this channel comes from spending,
and in this case the ECB support comes only with reduced spending.

For the ECB this also means they accrue substantial net interest margins on their portfolio of Greek debt.
And as long as they keep funding Greece in any manner, Greece need not default.

This means the ECB books profits from their portfolio that adds to their stated capital.
While this is of no operational consequence,
it does help satisfy political concerns over ECB capital adequacy.

Nor is this ‘Ponzi’ in any sense,
as the ECB is not dependent on external funding
to make payments in euro.

Additionally, the ECB no officially has stated it will provide unlimited euro liquidity to its banks.
This too is not inflationary or expansionary, as bank assets remain constrained by regulation
including capital adequacy and asset eligibility which is required for them to receive ECB support.

So while politics is and will always be a factor in government in general, the current state of affairs can be operationally sustained.

The problem then shifts to political sustainability which is necessarily less certain.

The near universally accepted austerity theme is likely to result in continually elevated unemployment,
and a large output gap in general characterized by a lagging standard of living and high personal stress in general.

With ECB continuing to fund, this can, operationally be readily adjusted via a loosening of the Growth and Stability Pact budget constraints, but politically this possibility remains remote without a substantial increase in popular opposition.

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29 Responses to The euro zone is operationally sustainable as is

  1. Walter says:

    Last week the new president of the Dutch Central Bank (DNB), Klaas Knot, gave (one of) his first interviews. He mentioned not to exclude a Greek default.
    In Holland such remark by the president of DNB gave a lot of noise. Many interprete it in the way that when the president of DNB makes such a remark this Greek default is likely going to happen.
    Maybe this is DNB new style, maybe it’s a beginner’s mistake.

    How do you see this remark of a central banker?



    sorry, don’t have any insight into that.


  2. Walter says:

    Don’t you make the following mistake in your way of thinking?

    When the FED, BoE, BoJ (all cbs of countries that have currency issuer status) buy govt bonds it is indeed merely a swap of net fin assets where counterparty remains the same State, consolidated govt. For example in the US. We, in the economy, first have govt bonds where counterparty is the Treasury and when the FED buys these bonds from us then we have reserves at the FED. FED and US treasury are both part of the same consolidated govt, in both cases we have the USA as counterparty.

    In the eurozone the picture is different. When we buy Greek bonds we have as counterparty the Greek state that like us is currency user, with all its limitations as counterparty. When then the ECB buys those Greek bonds from us we have reserves at the ECB that has currency issuer status.

    Doesn’t it go too far to consolidate GR govt and ECB?



    it only ‘goes too far’ if it translates into unconstrained Greek spending. Hence the sgp and austerity, etc.


  3. Rem123 says:

    I agree that the ECB infinitely buying sovereign debt would lead to a ‘sustainable’ solution. But in essence it’s the same as Eurobonds, no? One way or another, infinite ECB buying means member states are liable for other member state’s debt.

    By buying infinite debt and imposing austerity measures, the ECB essentially becomes the fiscal agent. Without a form of democratic legitimacy. A very unwanted situation, I think.

    Also, it doesn’t solve the problem of current account deficit nations in the Eurozone, right? To solve that you need fiscal transfers. If not, the private sector indebtness will increase in ever greater quantities as the ECB imposes austerity on the public sector.


    Peerke Reply:

    but how is deficit spending different from any other? It can all be ‘financed’ with eurobonds or buying sovereign debt by ECB after the fact. It is just SGP that prevents deficits greater than 3% or whatever the arbitrary number is. The ECB has no business vetoing decisions of member parliaments to spend surely? All it takes is for all the deficit countries to demand ECB buys sovereign debt, then spend. Hey presto, SGP is redundant.


  4. Peerke says:

    I am unclear why the ECB has to ‘impose austeric terms and conditions’. Politically I could see why but economically I don’t see it. If there is a lack of aggregate demand in the greek economy ie unused resources, then the greek gov can spend i.e run a deficit to maintain demand as long as it does not overspend to cause inflation.Or am I wrong? What is my error in thinking?


    Anders Reply:

    @Peerke, The ECB will continue to impose an austere regime because the ECB doesn’t get MMT.


    Walter Reply:


    Member states lost their currency issuer status when they entered the EZ and became just currency users. Their borrowing capacity is limited, their debt levels matter. They are all in ‘ponzi’, i.e. need new loans to be able to repay old loans. they are all dependent on lenders.


    Peerke Reply:

    @Walter, Walter thanks, I understand that but I am thinking that it could and should work like this: The greek gov user of Euro sells bonds to allow it to spend – interest on that bond may be high – ECB then buys bond in secondary market from the bond holder. If the ECB guarantees to buy the bond (at some point in time) it does not matter what the interest is since the greeks can always sell more bonds.
    For a currency sovereign government spending creates deposits and bonds are sold as a ‘courtesy’ after the fact.
    For non sovereign euro user governments, bonds are sold, then government spends, ECB buys the bonds. The operations are more or less done in reverse for non sovereign governments.
    All that the EU has to do is recognize that in times of stress governments can exceed the 3% rule for deficit spending.
    I am new to this so bear with me.


    Walter Reply:

    Yes, you can or even should run deficits up to the level of full employment.

    To protect against overspending by some euro states they all made themselves subject to market discipline (currency user status, dependency on lenders) and the sgp limits.

    I agree that sgp limits are arbitrary and have proven to make a simple functioning of automatic stabilizers impossible. I think all members violate them by now, but without penalties. With everybody violating penalties have of course no place to go. Before they received a letter when they violated. A real authority to audit in the first place, but also to then step in and dictate always lacked as far as I can see.

    So, sgp limits are ignored and mkt discipline avoided via ecb bond buying. The only thing left to potect against the risk of overspending by some member states is to limit their spending thru austerity linked to the ecb bond buying.

    It seems to me that thru austerity they focus on more efficient govt spending so that deficits come down without harming gdp growth. As we see in the short term that works, but we have probably already reached the tipping point where gdp starts shrinking and deficits increase via aut stabilizers.

  5. Roger Erickson says:

    Semantics is again one prominent, underlying problem.

    The terms assumed in perceptions of what “Growth and Stability” means vary wildly between voters, bankers & politicians.

    The G&S Pact essentially tries to enforce non-monetary stability via monetary terms. In reality, the accounting terms have to follow, not lead real terms. Reality does NOT follow any rules-based approach that we can yet fathom.

    That’s why we experiment first, then account for observations after the fact.


    Roger Erickson Reply:

    @Roger Erickson,

    re: rules-based approach; we have huge collections of rules, the utility of which are ALWAYS proportionally applicable to local context

    Group reality is tracked via artfully proportional application of existing rules to emerging contexts.


    anarchistas Reply:

    @Roger Erickson,

    where is your blog?


    Roger Erickson Reply:


    ?? don’t have one

  6. Thomas Bergbusch says:

    The Governor of the Bank of Canada is now overtly calling for your ECB trillion-dollar solution:

    THE HOUSE: Europe debt bailout needs ‘big pot of money’, Carney says
    Last Updated: Sep 24, 2011 2:56 PM ET

    Bank of Canada governor Mark Carney says Europe must find the political will to support its debt-saddled countries for a period of time as those nations adjust. Bank of Canada governor Mark Carney says Europe must find the political will to support its debt-saddled countries for a period of time as those nations adjust. (Sean Kilpatrick/Canadian Press)
    Related Story Content
    Story Sharing Tools
    This week on The House, with Europe tethering on the brink of financial collapse, finance ministers and central bankers from around the world have gathered in Washington, D.C., to find a solution. Bank of Canada Governor Mark Carney is there. He says the issue that could affect Canada is not whether Greece will default or not, but whether Europe’s monetary union can handle the crisis.Mark Carney – Interview13:38
    Beginning of Story Content

    Bank of Canada governor Mark Carney says Europe must come up with a trillion euros immediately to stave off its sovereign debt crisis and stabilize financially crippled countries such as Greece.

    “However you want to design this … you need a big pot of money to get from today to that point, which is going to be two, three years in the future, and you need it now,” Carney told CBC Radio’s The House in an interview with host Evan Solomon airing Saturday.

    “What is important here, what is not being asked, what the Europeans are not discussing is a transfer of a trillion euros from one set of countries to another set of countries. It’s support for a transition, for a period of time as those countries adjust.”

    Finance Minister Jim Flaherty says he is confident European officials will tackle the debt crisis, but adds it will take another few weeks to get all 17 countries to ratify a plan to bolster Europe’s financial stability fund.

    “I’m satisfied certainly that they understand that it’s imperative to take action,” Flaherty told CBC News Network on Saturday during a break in G20 meetings in Washington.

    Flaherty stressed Canada is watching the Europe situation carefully and would react to any “shock” from the continent in a “flexible and pragmatic way” to protect Canada’s economic growth.

    “We’ve done it before and we’ll do it again,” the finance minister said.

    Carney also insisted Canada has “every tool we had” in the 2008 financial meltdown if another crisis were to strike the global economy.

    “We’ve learned some very valuable lessons about what worked better than others,” he said. “We’re not an island. We will be affected if things get worse. But we can address it.”

    Carney said European officials have to ensure financial institutions have enough capital and that the European Financial Stability Facility — the fund created in May 2010 to inject cash into banks in the region in the event of a financial crisis — is large enough.

    “And the complication there is, we’re talking 17 different governments, we’re also talking about the European Commission and the European Central Bank, so there are a variety of players that have to take the decisions along the same lines, at the same time,” he said.

    Greece, Carney said, is just a symptom of the Eurozone’s problems. If Greece still had its own currency, it would have the option to devalue it, which would drive inflation up for Greeks but also shrink the national debt.

    “The way [the eurozone] was originally designed 10 years ago has a flaw, to put it mildly,” Carney told Solomon.

    Carney made the remarks as he and Finance Minister Jim Flaherty are attending meetings of the G20 finance ministers and International Monetary Fund in Washington.

    “The issue is, can European authorities put in place an alternative for these countries so that for a period of time … while they take the necessary fiscal actions and other reforms, they can access financing at reasonable terms?” the bank governor said.

    “And if you want to be safe, if you want to overwhelm markets, which is really what you want to do once you get into these types of situations, you want to put more money on the table than you really need. Then you start in the neighbourhood of a trillion Euros.”

    Flaherty has said he expects European leaders to stick to the commitments they made at this week’s G20 meeting, adding he believes the EFSF was insufficient to deal with the size of Europe’s “very serious” financial crisis.

    On Friday, the head of the International Monetary Fund, Christine Lagarde, said the world faces a similar problem as it confronted in 2008, at the start of the worst economic crisis in decades.


  7. Jim says:

    This idea creates a relationship between ECB and the EZ states that resembles a federal union between non sovereign states. But the politics of the EZ is one of sovereign states that do their accounts on a sovereign/national basis. Each EZ state can make a political decision to socialize the debts of it’s own or other states’ banks. Each EZ state has it’s own political taxation policy. Each EZ state also makes it’s own political decisions about external trade, capital and currency relations with any other state (EZ and non-EZ states). This is a complex matrix. Superimposed on this are also economic ideologies of deficit reduction and rentier privilege, welfare provision, equality, autonomy and even free market ‘efficiency’. This takes some unpicking!


    Jim Reply:

    @Jim, Can I just simply ask by way of exploration of an idea if what you say would make the euro (via the ECB but without a political mandate?) function like a reserve currency across the EZ in the way that the $US functions across the world? I’m happy for this to be poopoo’d but it would add another way of looking at the costs that have to be taken into account as they are in Michael Pettis’ examination of the cost of the $US reserve status to the US. However, in the case of the EZ there is political fragmentation that leads me to ask, for example, is Germany prepared to accept it’s share of any cost?


  8. jonf says:

    I suppse if you have a rich uncle and he likes you, he can bail you out forever. But it is not a very good long term solution, especially if austerity gets too rough.


  9. Max says:

    ECB purchases are useless and certainly not sustainable. What happens when yields go to infinity? That’s hardly a stable situation.


    MamMoTh Reply:

    @Max, unlimited ECB purchases mean yields can be kept at whatever finite number.


    Max Reply:

    Greek bonds are not like baseball cards, becoming more valuable with scarcity. The price is set based on default risk. And no amount of ECB purchases reduces default risk. But if the ECB were to guarantee the bonds, then the yield would go to the risk-free (German) rate without any purchases being required.



    true, but what the ECB does is buy enough so that the dealers can get short to set up for the next auction.
    since that hasn’t yet meant buying more than all the outstanding bonds seems there are some bond holders content to hold

  10. Sven says:

    Re: Some form of a United States of Europe.

    To propose this is to not understand Europe.


  11. The ECB can buy Greek debt forever, if it . . . buys Greek debt, forever, i.e. always will support Greece via the debt mechanism. It is a cockamamie approach, however. Far better for the ECB simply to pay Greek debt and not continue the charade.

    Otherwise, the Greek debt number will rise to astronomical levels. Functionally, no problem, but will the IMF and other Greek creditors really stand by and watch Greek debt soar into the multi-trillions? Very soon, there will be no other Greek creditors, as they will not trust the ECB to continue supporting Greece.

    There still remain only two long-term solutions:
    1. Greek return to Monetary Sovereignty
    2. Some form of a United States of Europe.

    Everything else is just applying spit, strings and glue to a broken system.


    Kristjan Reply:

    @Rodger Malcolm Mitchell,

    number 2 will not happen
    just like South America and North America fiscal union will not happen


    Luigi Reply:

    @Rodger Malcolm Mitchell,

    I agree, and Greek doesn’t issue dracma, so debt is onerous in every sense, and it could be or it is a real fiscal problem to pay principal + interests, also if the holder is ECB (anyway, what’s the difference?).


  12. Gary says:

    I find that everything in economics eventually depends on politics.
    Even though operationally ECB can keep buying Greek, Spanish and Italian debt and thus keep them afloat – politically that makes other countries complain about perceived “free ride”. From Greek perspective it still does satisfy them because they see their real life deteriorate because of imposed austerity. So eventually it does not satisfy anybody but the “markets”.
    “Markets” might understand that Greek debt is sustainable while ECB buys it – but then that sustainability depends on ECB, on Greeks, and on other euro countries. And who can measure the political risk? Especially that political risk in this case depends on all parties understanding how financial mechanics work – and they do not understand that – and that is politics again.


    Roger Erickson Reply:


    > everything in economics … depends on politics

    Classic statement, Gary. Should be the opening sentence in every economics textbook.


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