Italy, Europe: Please Do Something!

by Biagio Bossone, Chairman of the Group of Lecce [1]

The crisis is deepening

After fifty or more days from general elections, Italy is still ensnared in big political uncertainties and its economic recession is worsening. Negative fiscal space and private sector retrenchment in the country continue to squeeze aggregate demand, amongst persistent indications of declining productivity and falling real incomes, and with prospects for more austerity to come. Corporate bankruptcies increase by the day, unemployment figures mount. Financial markets – thanks to the “Draghi put” – are still giving the country the benefit of the doubt, in the expectation that a new government will soon be formed and play down its economic policy cards. But how longer can this market pause last? And, above all, what could the cards of the new government be?

Am increasingly fragile Italy is not only a problem for the Italians: it is a major source of instability for European region, and the international economy as an obvious consequence. The rest of the eurozone, by the way, is far from doing well. Indeed, the crisis is deepening and from peripheral Europe is now spreading to core Europe, affecting France and threatening even Germany (Wood 2013a). Economic policy in the area is gripped by rules that are not designed to deal with economic stagnation, let alone depression. There should be a strong global collective interest for pushing Italy and the other weak economies in the EU to take rapid and bold action to stimulate domestic demand.

What they could do

The solution would be for euro members to use the Emergency Liquidity Assistance (ELA) facility provided for under the statute of the European System of Central Banks (ESCB) [2],  to undertake overt money financing (OMF) of government debt in order to finance tax cuts or new spending programs. The idea of OMF has been recently revived by a number of well-known scholars, pundits, and policymakers [3].

Defended in the past by such eminent and diverse economists as Henry Simon, Irving Fisher, John Maynard Keynes, Abba Lerner, and Milton Friedman, the idea was resurrected by Bernanke (2003), when he recommended Japan to fight deflation through a program of tax cuts or public spending explicitly coupled with incremental (and permanent) central bank purchases of government debt. The money created would finance the tax cuts or the new spending programs. If the money had gone to finance tax cuts – Bernanke argued – consumers and businesses would likely spend their tax cut receipts, since no current or future debt service burden would be created to imply future.

Euro members should urgently consider undertaking OMF to achieve aggregate domestic nominal income targets. It would be a eurozone coordinated-and-decentralized effort to conjugate monetary and fiscal policies tailored on country needs in view of preserving highly compromised regional stability and prosperity.

How they could do it

The ELA facility gives national central banks of the euro area the ability to support temporarily illiquid domestic institutions and markets over and above ESCB assistance, in exceptional circumstances and on a case-by-case basis. ELA is not an ESCB function, and the power to use it lies with the national central banks and does not derive from their membership in the ESCB. Existing legal documents make it clear that its scope, terms, and procedures need to be spelt out in national law and regulations (Buiter et al, 2011). Although the use of ELA by national central banks is not constrained by the rules governing ESCB operations, restrictions apply: prohibition of overdraft facilities for official bodies, of purchasing government bonds, and of carrying out tasks that go beyond those of a central bank (ECB, 2012a). ELA does not require explicit approval of the ESCB, yet it may be terminated by vote if it is deemed to run counter to the ESCB’s mandate. Moreover, the same degree of independence is required for national central banks performing ELA functions as they enjoy in carrying out ESCB-related operations.

ELA has already been activated during the crisis [4]. However, its use should be reconsidered and broadened so as to make it truly a monetary tool available in cases of macroeconomic emergencies. ELA should be used in countries facing conditions of economic recession to finance government programs of spending or tax reduction through permanent purchases of newly issued public debt.. Much as Governor Draghi has defended his Outright Monetary Transactions as a way to safeguard “an appropriate monetary policy transmission and the singleness of the monetary policy” in the eurozone, the use of ELA could be justified as a way to make monetary policy effective and adapted to country circumstances during recessions, prolonged phases of stagnation or depression, with a view to preserving regional economic, monetary, and financial stability. The OMF should require submission by national governments of fiscal stimulus programs consistent with underlying economic conditions, to be executed under EU monitoring.

The steps they could take

Here are the basic steps:

  • A government of the eurozone submits to its parliament and the Eurogroup a pre-defined fast-track public spending package or tax-reduction plan to be financed in deficit under ELA. The government  also submits a program of structural reforms to be implemented during the use of ELA. The deficit financed under ELA is set with a view to delivering a pre-determined domestic nominal demand target
  • After consideration of the approved government program, the ECSB endorses use of ELA for OMF purposes by the central bank of the submitting member country, and the central bank communicates to the government its readiness to finance an increase in the fiscal deficit through permanent purchases of newly issued debt under the ELA facility
  • The government instructs its ministry of finance to issue special non-transferable government bonds to the central bank in exchange for newly issued euro under ELA. The new debt could either (i) bear interest, and the central bank would buy it and hold it in perpetuity, rolling over into new government debt the bonds on its balance sheet that reach maturity, and returning to the government the interests matured or (ii) be structured as special non-interest bearing and never-redeemable securities (Turner, 2013)
  • The launch of the OMF is accompanied by a central bank’s statement indicating that its purchases of newly issued debt will be permanent, and by a communication strategy exaplaining that the debt financed under ELA will not raise sustainability issues, since it may not be redeemed or sold to the market, it does not pay interests, and does not give rise to new government liabilities
  • The ECB and the Eurogroup monitor the implementation of the government program.

What about central bank independence?

When we talk about overcoming phases of economic stagnation or depression, we definitely are in a radically different world than when we fight inflation. The institutional rules that fit one type of situation may need to be adapted in other situations, especially during macroeconomic emergencies. Research from McCullay and Pozsar (2013) recognizes this need, and shows that central bank-government coordination is the most appropriate policy response under conditions of economic stagnation or deflation As they conclude their study,

“[G]reater cooperation for a time between [central banks] and fiscal authorities is in no way inconsistent with the independence of the central banks, any more than cooperation between two independent nations in pursuit of a common objective (or for that matter, cooperation between central banks and fiscal authorities to finance war) is inconsistent with the principle of national sovereignty.

References

Bernanke B. (2003). “Some thoughts on monetary policy in Japan.” Tokyo, May

Buiter  W H, J Michels, and E Rahbari (2011), “ELA: an emperor without clothes.” Global Economics View. Citigroup Global Markets, 21 January www.willembuiter.com/ela.pdf

EC (2013). “Business and Cosumer Surveys.” European Commission, Economic and Financial Affairs, 27 March

ECB (2012a). Opinion of the European Central Bank of 24 January 2012 on a guarantee scheme for the liabilities of Italian banks and on the exchange of lira banknotes (CON/2012/4)

ECB (2012b). “Technical features of Outright Monetary Transactions.” European Central Bank, Press release, 6 September www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html

ESCB (2008). Protocol (no 4) On the Statute of the European System of Central Banks and of the European Central Bank. Official Journal of the European Union, 9 May

McCulley P and Z Pozsar (2013). “Helicopter money: or how I stopped worrying and love fiscal-monetary cooperation.” Global Society of Fellows, 7 January.

Turner A (2013). “Debt, money and Mephistopheles: how do we get out of this mess.” Cass Business School Lecture, 6 February

Vistesen C (2012). “Emergency Liquidity Assistance in the Eurozone: Draghi’s irreversible euro put explained.”  Credit Writedowns, 9 August www.creditwritedowns.com/2012/08/emergency-liquidity-assistance-in-the-eurozone-draghis-irreversible-euro-put-explained.html

Wolf M (2013). “The case for helicopter money.’ Financial Times, 12 February

Wood R  (2013a). “Periphery economies: national governments must be prepared to provide stimulus.” VoxEu, 4 March

Wood R (2013b). “Helicopter money is purely about initial stimulus.” Financial Times Letters, 17 February


[1] I would like to thank Luigi Passamonti for his very useful insights and comments. Responsibility is only mine.

[2] Article 14.4 of the ESCB statute states that: “National central banks may perform functions other than those specified in this Statute unless the Governing Council finds, by a majority of two thirds of the votes cast, that these interfere with the objectives and tasks of the ESCB. Such functions shall be performed on the responsibility and liability of national central banks and shall not be regarded as being part of the functions of the ESCB.” (ESCB 2008)

[3] See McCullay and Pozsar (2013), Wolf (2013), and Wood (2013b). Turner (2013) has compared OMF to the existing policy alternatives and has shown its superiority.

[4] In Vistesen’s (2012) reconstruction, during the crisis ELA was used by the Bundesbank in 2008 to save Hypo Real Estate against €42 billion guarantee by the German government, and by the National Bank of Belgium in 2009 to bail out Fortis Bank with €54 billion on the eve of its collapse. It was also used in Ireland and Greece, although for a completely different purpose than the one originally intended for the facility. At the time of Vistesen’s writing, Ireland reportedly had had a constant use of the facility since 2008 with the central bank providing anything between €40 and €60 billion since 2010, and Greece had resorted to ELA for about €55 billion. Such constant use of the facility was not envisioned under the ESCB statute, and suggests that ELA has been used during the crisis as a source of additional bailout funding.

2 Responses to "Italy, Europe: Please Do Something!"

  1. Tom   April 20, 2013 at 9:23 pm

    Wow, sounds like total monetary policy anarchy to me.

    BTW Japan's central bank actually did what Bernanke recommended years earlier. The term "quantitative easing" is a translation of the term used to describe it in the Japanese press.

  2. Per Kurowski   April 23, 2013 at 8:06 am

    While you hang on to silly bank regulations that give banks enormous incentives to only lend to “The Infallible” and to stay away from “The Risky”, like small businesses or entrepreneurs, all you will do is just waste precious scarce fiscal and monetary space.
    http://subprimeregulations.blogspot.com/2013/04/q