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No printing of money, not on my watch, says Trichet

Eurozone deficit | No printing of money, not on my watch, says Trichet Anthony Harrington

In an earlier blog we looked at the degree to which the European Central Bank (ECB) is throwing its considerable weight behind the idea of a move to create some form of fiscal union in the European Union. However, in addition to addressing what is now widely seen as the fundamental weakness of the eurozone (monetary union without a fiscal union), the ECB has a further dilemma to solve, how to deal with the structural imbalances as they currently exist in the EU.

The popular view is that these imbalances, which show up as huge deficits and budgets that run way over the 3% set out in the EU’s financial stability pack, are caused by profligate spending. In reality, as a number of analysts have pointed out, the causes are far more complex, particularly where Spain is concerned.

Spain fell from one of Western Europe’s most successful economies to one that is seen as nudging Greece as a problem case, but it did not get there via the Greek road of concealing massive overspending through accounting chicanery. In fact the Spanish are near apoplectic over what its Infrastructure Minister José Blanco dubbed “an international conspiracy carried out via apocalyptic editorials in foreign media”, aimed at destroying Spain. That said, there are probably very few people in Spain who do not know that the country is currently reeling from the bursting of a massive property, real estate and infrastructure bubble.

When Spain joined the euro money flooded into the country and much of that went into speculative property development, which fuelled rising employment and personal prosperity. Spanish banks lent freely, using money raised on the European capital markets at low euro interest rates and their lending fuelled yet more construction. Then the credit crunch hit and the model broke. Unemployment is now 20% and rising and the Spanish deficit was 11.4% of GDP in 2009. You can fold the Greek and Portugese economies into the Spanish economies twice over and still have room for an Icelandic bank or two, so the prospect of Spain defaulting at some future date is immeasurably worse than Greece defaulting.

This is why some economists have been calling for the ECB to wake up and smell the coffee, and start printing money! A little judicious inflation, at say 4 or 5%, would escalate in the peripheral countries to 10% or more, which would be a huge help to them in reducing their debt mountains. The other way out for Spain, namely that its workers become as or more productive than German workers, hence bringing about a major increase in Spain’s competitive position viz the rest of Europe, looks hugely unlikely. However, ECB President Jean Claude Trichet once again reiterated the ECB’s complete opposition to letting the printing presses role. Instead, he says, the ECB has focused on “non-standard measures” which it terms “enhanced credit support”. The aim of these measures is to “sustain financing conditions and credit flows above and beyond what could be achieved through reductions in key ECB interest rates alone. They include:

“…   lengthening of the maximum maturity of refinancing operations, extension of the eligible collateral list, provision of liquidity in foreign currencies, covered bond purchases, and, above all, provision of unlimited liquidity in all refinancing operations at a fixed rate.”

And from 10 May, following “renewed market tensions,” the ECB embarked on an EU state bond buying spree, launching its Securities Market Programme. The logic here is that the functioning of the market for government bonds is central to the transmission of the ECB’s policy rates into the wider economy. If the market for sovereign debt collapses, pricing signals in the market go haywire. By providing a market the ECB directly influences and sustains stable short-term interest rates in the money market, which in turn feed through to the costs of funding for households, corporates and governments. The ECB also influences liquidity, since “guvvies” are used as collateral in interbank lending, and with the ECB happily buying government paper, it stops looking so toxic.

However, while some economists would have loved the ECB to do this by injecting more paper money into the economy, through rolling the presses, Trichet is adamant that the ECB is “sterilising” the impact of its securities buying programme as it goes.

“Let me now explain how the Securities Markets Programme works. The programme consists of interventions in the euro area’s public and private debt securities markets. In order to sterilise the impact of these interventions on the liquidity conditions in the banking system, we re-absorb the liquidity injected. Thus, these measures do not influence our monetary policy stance … The Securities Markets Programme should not be confused with quantitative easing. In simple words: We are not printing money. This confirms and underpins our commitment to price stability.” (Speech on May 31 to the 38th Economic Conference of the Oesterrieichische Nationalbank, Vienna).

In Trichet’s view, price stability rules. Expect eurozone inflation five years hence to be 1.9% to 2.0%. So get out of it any way you can, Spain, but don’t look to euro inflation to help you…

Further reading on Eurozone deficit and European macroeconomics

Tags: EU , European Central Bank , European Monetary Union , financial crisis , Greece , inflation , Spain
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