Working Paper: CEPR ID: DP8974
Authors: Willem H. Buiter; Ebrahim Rahbari
Abstract: The paper establishes that sovereigns, like banks, need a lender of last resort (LoLR). In the euro area the ECB, with its estimated ?3.4 trillion non-inflationary loss absorption capacity, is the only credible sovereign LoLR. The ECB/Eurosystem has been acting as sovereign LoLR through its SMP purchases of periphery sovereign debt in the secondary markets. It has also contributed, through the deeply subsidised bank funding it provided through the 3-year LTROs, half of a mechanism to purchase periphery sovereign debt in the primary issue markets. The other half has been financial repression requiring banks in Italy and Spain to purchase more of their own government?s debt than they would voluntarily and at below-market yields. We expect that, once Spain and Italy are under troika programmes, the Eurosystem will also lend to these sovereigns indirectly, through loans by the national central banks to the IMF which on-lends them to these sovereigns. We recommend that, to increase its effectiveness as LoLR, the ESM be given a banking license. To reduce the illegitimate and unaccountable abuse of the ECB/Eurosystem as a quasi-fiscal actor, we propose that all its credit risk-related losses be jointly and severally guaranteed/indemnified by the 17 euro area member states.
Keywords: central bank; EMU; financial repression; lender of last resort; quasi fiscal activities; seigniorage
JEL Codes: E02; E31; E42; E43; E44; E63; G21; G28; H12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| ECB interventions (E52) | stabilize financial markets (E44) |
| ECB interventions (E52) | prevent sovereign defaults (F34) |
| LTROs (E52) | enable banks to purchase sovereign debt (F34) |
| enable banks to purchase sovereign debt (F34) | provide liquidity to sovereigns (F34) |
| absence of credible LOLR mechanism (E44) | lead to severe financial instability (F65) |