Home > Uncategorized > We told you so. Ireland and the ECB edition.

We told you so. Ireland and the ECB edition.

From the Peterson Institute the executive summary of a report written by Ajai Chopra.

EXECUTIVE SUMMARY

The incompleteness of the euro area’s institutional design, especially the absence of a

banking and fiscal union, has propelled the ECB’s role in the design and implementation

of EU-IMF programs for euro area countries. This role gives the ECB great power and

influence but also generates controversy and resentment in these program countries.

In a gratuitous November 2010 letter to the Irish Finance Minister, the ECB threatened

to cut off liquidity support for Irish banks unless the government agreed to a financial

assistance program with the EU and IMF. The letter also made demands in the areas of

fiscal austerity and structural reform that were not only beyond the ECB’s remit but

were also wrong for Ireland’s circumstances.

The ECB opposed imposing losses on Irish banks’ senior bond holders and made it clear

that it would not support a program that included this feature. Even if the ECB believed

that spillover risks dominated at the time, why should Irish taxpayers bear a

disproportionate burden to address wider euro area concerns? Furthermore, why was

the ECB unwilling to consider forceful liquidity support for euro area banks at the time

to mitigate potential contagion in bank funding markets?

The ECB initially pressed for swift deleveraging of Ireland’s banking sector through

front-loaded and large-scale asset sales to reduce quickly in its large exposure to

Ireland. In doing so, it put protection of its own balance sheet before the cost to the

Irish taxpayer. Later the ECB accepted that fire sales of assets would be

counterproductive, but by then trust in the institution and its legitimacy had been

damaged.

Even though ECB liquidity support for the Irish banking system was a critical

component of the program, the ECB was unwilling to make an ex ante commitment on

this front. More vocal public support by the ECB from an early stage would have

inspired greater confidence and would have likely reduced the required amount of

Eurosystem funding.

Looking beyond the Ireland program, the ECB’s monetary policy has been much too

tight since the start of the crisis in 2008. This has damaged the economic recovery not

only of crisis countries but the entire euro area. Countries’ debt burdens are harder to

bear because low inflation moderates nominal income while leaving debts untouched.

The ECB’s asymmetric view of its inflation target makes it important have a debate

about the appropriate definition of price stability to guide a more pro-active monetary

policy. For example, an explicitly symmetric inflation target of 2 percent should be

considered.

The ECB threatened to cut off emergency liquidity assistance (ELA) in Ireland and

Cyprus, but in Greece it actually did so. The discretion exercised by the ECB in the

provision of ELA has made it more of a political actor instead of an independent

technocratic institution. An overhaul of procedures for granting ELA with the aim of

increasing transparency and accountability should be a high priority. As the ECB is now

the single supervisor for large euro area banks, ELA should no longer be provided via

national central banks and instead should be fully in the hands of the ECB.

The ECB is the central bank and bank supervisor of each euro area country and the

entire euro area. It should therefore not be a part of the troika where it sits across the

table from country authorities and negotiates and monitors financial assistance

programs. The ECB belongs on the country’s side of the table.

 

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