Monday, December 12, 2011

The ECB as Lender and Owner of Last Resort (amv)

I wrote a non-technical policy note on the sovereign debt crisis in the Eurozone. I argue that the only feasible as well as incentive-compatible solution to the current sovereign debt crisis in the Eurozone involves the European Central Bank (ECB)
  • as a Lender of Last Resort to the Eurozone’s core countries like France, Austria, Finland, and The Netherlands, and
  • as the Owner of Last Resort to the European banking system, thereby setting the stage for haircuts on the debt of potentially insolvent peripheral Member States like Greece, Italy, Spain, and Portugal.
Lars Christensen (The Market Monetarist) and Kantoos (Kantoos Economics) kindly published a summary of the paper. I am grateful to both of them.

Remark: It is argued that a proper management of NGDP-expectations would suffice to eliminate all distress on financial markets. Even though my paper argues that a shift by the ECB to an output-gap adjusted price-level-targeting regime is important to ease the debt crisis, I doubt that such a regime-change will be sufficient. One important reason is that there will be no return to the "old normal". Markets as well as regulators finally come to understand that there ain't no such thing like a "risk-free asset". The time of the zero-risk weighting rule is over. Positive risk-weights will remain, and so will higher equilibrium yields on sovereign bonds. It follows that recapitalization needs are real even in the case of perfect NGDP-expectation management.