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Home > Capital Markets White Papers > A European Stabilization Bank?

Capital Markets White Papers

A European Stabilization Bank?

John A. Morrison, Peter Lindmark, and Robert McDowell, Asymptotix

Executive Summary

This paper, "A European Stabilization Bank?" is a collection of blog posts published earlier this year on asymptotix.eu aimed to the European Commission, MEPs, the ECB and anyone else interested in European politics. Due to the huge interest and discussions which followed, we decided to collate the material into one White Paper. This White Paper highlights our concerns over the European Institution’s response to the crisis in terms of funding, regulation and supervision. It does not provide answers to all problems but it tries to formulate a few proposals, among them the need for a European Stabilization Bank.

The Super-SPV

Why is such a dodgy legal concept, key to the Credit Crisis in facilitating off-balance sheet manoeuvring, thought to be nailed by the new ethos of transparency, being phoenixed up again to support this European emergency response? (It is ironic that the SPV was designed to facilitate "bankruptcy remoteness"). The "EU" is institutionally missing a lobe of its brain, a leg of its table or a bulb in the chandelier. The SPV facilitates the European Commission (which part, which section which scion, they only know; since the concept of DG's has gone flying out of the window) behaving in the role of European Debt Management Office. We are where we are, capital has transitioned to the state, we need public institutions which can properly manage us through this second phase sovereign debt crisis and develop a roadmap for free markets beyond a properly constituted European "Bretton Woods" style "Public Debt Bank" (it’s not for me to coin the name); philosophically in line with Keynes' thinking.

The Implications of Extraordinary Measures

One has to take some regard of the challenges of "Kapital"; its function in society, its inherent drivers, the subtle differences in how it morphs along the liquidity spectrum and the complex interlinked signals which it sends through that wireless network. If you throw large amounts of monetary base as a stimulant to asset markets, of course they are going to gyrate a little, don't we know they are essentially adolescent? But the principal downside risk of this kind of open market operation is that its consequences are indeterminate. This kind of quasi-state activity happens so rarely that there is insufficient data to empirically support a determinate analysis of what the implication of a waterfall or hose pipe of liquidity causes in the (global) asset spectrum in the medium term. What we do know is that quantity of liquidity has to be "absorbed" i.e. it will re-shuffle the asset spectrum, altering relative yields and thus will effectively settle somewhere by creating relative winners and losers in the asset portfolio globally. The problem is we don't know who the relative winners and losers are.1

The Function of a Central Bank

A central bank not only has the capacity but indeed must strive to separate the conduct of its monetary policy, which must seek to ensure medium and long-term price stability, from that of its credit policy, which is driven by short-term imperatives and consists in supplying the banking system with liquidity in the event of temporary money demand shocks. During the first part of the crisis, the ECB acted in accordance with the separation principle. However, it became increasingly difficult to apply as interest rates approached the zero-lower-bound. In effect, the unconventional measures adopted by the ECB created interference between its monetary policy, its credit policy and its interest rate policy. The suspension of the separation principle raises questions about the ECB’s true purpose and the incentives provided to the private sector, in particular the banking sector, in the euro area.2

The Message of This Paper

Asymptotix simple message is the following: New institutional structure needs to be planned and implemented now! The ECB is the European Central Bank for the eurozone countries, but not for non-eurozone countries such as Denmark, Sweden and the UK. Our argument here is that we are deceiving ourselves if we fail to examine how measures to mitigate the effects of the Credit crunch were actually funded. This should be done before finalising a policy for Resolution Funds to pay for orderly winding up of failed banks. If the Commission looks carefully at this aspect, perhaps with the assistance of the ECB and the BoE, it may appreciate that its policy aims and objectives can be satisfied in better ways?

1. www.ft.com/cms/s/0/55e103f2-d495-11df-b230-00144feabdc0.html

2. C. Bordes and L. Clerc. “The ECB art of central banking and the separation principle.” Banque de France, August 2010. Online at: www.banque-france.fr/gb/publications/telechar/ner/DT290.pdf

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White Paper details

Original publication date:
October 2010
URL:
www.asymptotix.eu

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