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Why Greek debt spells goodnight to ECB independence

ECB | Why Greek debt spells goodnight to ECB independence Anthony Harrington

As the euro sovereign debt crisis continues to gnaw away at market confidence, sometimes fading into the background, sometimes zooming back to centre focus as some funding or political crisis affecting the peripheral countries grabs the headlines, it is worth bearing in mind that all the bailout fund has done so far is to kick the can of a Greek or Irish default further down the road.

Greek austerity

Greek politicians are in thrall to at least four different sources of high spending. These are the country’s military, strong unions, a disproportionately large and overpaid public sector (overpaid in comparison to what the country could afford without EU backing) and the Greek welfare state, which is nice if you are a Greek citizen, but would be entirely unaffordable for any Greek government without a constant (admittedly opaque) transfer of funds in their favour from the EU. The Greek government is trying to impose austerity measures, including public sector pay cuts and the raising of the retirement age to the norm of the Northern European states, but there is no saying that it will succeed in getting its citizens to tolerate the pain associated with the kind of austerity that will be necessary.

This is one of the paradoxes of democracy. Politics teaches politicians about the central importance of winning elections. Once they “get” this lesson, it becomes the paramount lesson and saving the country becomes  something you do after you have won the next election. The process of getting into office forces them to focus very precisely on the problem of how to win an election. It is a kind of baptism of fire with a wonderful prize at the end. They get to stand on the platform on election night, hands clasped in a victory salute while their supporters cheer like crazy and they get to stare the defeated opposition in the face. At that moment, the gravy train of high office is theirs to board and membership of their country’s most exclusive club, parliamentary office, is secured. It is an absolutely intoxicating brew.

'Cheating to join the club'

With the benefit of hindsight it is abundantly clear that Greece should never have been allowed to join the euro when it did. However, since entry to the euro had, in the past, been fogged and fudged over by a variety of accounting tricks all designed to disguise the fact that a particular candidate country had not, at the time of entry, actually been able to meet the entry conditions, Greece’s application was bound to receive a less rigorous scrutiny than it should have. In other words, cheating to join this club was endemic, and, provided things were not absolutely hopelessly out of whack in a naked, in-your-face kind of way, the political project of creating the ingredients for an ever larger euro state was judged by the political classes controlling membership to be far more important than accounting niceties.

In his book Tragedy of the Euro, Philipp Bagus, professor of economics at Universidad Rey Juan Carlos in Madrid, succinctly summarises the problem of what military strategists like to call “mission creep” as far as the euro is concerned. The European Central Bank, modeled as it was on the German Bundesbank, was initially fiercely independent. Part of this independence was that it did not buy government bonds directly. It did accept government bonds as collateral from banks wanting funds from the ECB, but before the financial crisis of 2008, as Bagus points out, it only accepted A- sovereign bonds as collateral. Then, during the crisis, that criterion was weakened down to BBB ranked bonds, enabling the ECB to keep liquidity flowing to banks that were in danger of hitting a major liquidity crisis.

The “special provision” about BBB ranked bonds was only supposed to be in force for a year, by which time the ECB clearly hoped that all would be well again. Then it became apparent that Greece wouldn’t be in any condition to get an A- rating any time soon, and German and French banks really wanted to shift Greek debt to the ECB, so the ECB dropped its “one year only” condition, which, had it remained, would have simply made the markets skittish. Finally, Bagus notes, “the ECB, in contrast to its stated principles of not applying special rules to a single country, announced it would accept Greek debt even if rated junk.”

ECB losing independence?

As if this slide down the hill and away from the high ground of independent monetary policy by the ECB were not enough, the ECB then said it would buy Government debt outright. Again we had a similar story of “only AA rated debt; OK, maybe B- rated debt; oh what the hell, we’ll take junk rated debt too (Greek debt having been down rated to junk status).” In the process, for many, the ECB gave up any pretentions to Bundesbank-like independence, and became, in effect, the executive mechanism for carrying through a purely political project, namely, to ensure the survivability of the euro. (This can also be viewed as a lesson in self preservation too, since without the euro there is also not the slightest need for an ECB). The ECB still produces theoretical papers from time to time. It will be interesting to see the ECB’s slide down the slippery slope recast as theoretically sound monetary policy, though one has to pity any ECB economist who draws the short straw on this task...

Further reading on the ECB, European institutions and sovereign debt:



Tags: democracies , ECB , government bonds , Greek debt , Philipp Bagus , sovereign debt crisis , The Tragedy of the Euro
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