Charles Goodhart, doyen of central banking economists and veteran professor at the London School of Economics, told OMFIF that the best way to engineer a debt-for-reserves swap would be to trade the reserves for tranches of bonds from one to five years in maturity. This is all well and good in single monetary-fiscal areas like the UK and US, but what about the euro area? Writing debt off and maintaining a high level of reserves indefinitely would be difficult treaty-wise, as would replacing the debt with perpetual, zero-interest debt, as the 100 economists suggested. Both would require a broad renegotiation of EU treaties.
‘No one wants a grand renegotiation,’ Emilios Avgouleas, chair in international banking law and finance at the University of Edinburgh, told OMFIF. Instead, in a paper he co-authored with Stefano Micossi, director of Italian business association Assonime, he suggested bonds held by the ECB are sold to the European Stability Mechanism, with the ESM issuing its own bonds to finance the purchases.
The paper envisages the ESM acquiring them over a 10-year period, but purchases could accelerate if the ECB needs to sell parts of its holdings for monetary policy purposes. This would allow it to unwind policy without causing fiscal crises in countries with high levels of debt. The paper also says that this would fulfil demand for a common euro area asset, as well as end the ‘doom loop’ between banks and their sovereigns. It is essentially the sort of liability swap described above, but one which navigates the treaties rather than requires changing them.
The euro area, the authors write, needs a common policy to manage the rollover and recovery risk on sovereign debt. The paper, written for the Centre for European Policy Studies, said: ‘This task could not be permanently entrusted to the ECB without crossing the line that separates monetary policy from fiscal policy, as established by the European Court of Justice… The ESM, which is an institution set up by euro area governments as a crisis management tool, and which has enough capital to cover any losses from such operations, looks like the natural choice.
The ESM could then evolve into a common debt manager. A coordinated debt management policy makes sense. The ECB is keen to prevent the yield curve steepening unless it reflects stronger growth expectations for the euro area, which would encourage debt management offices to issue long-dated debt. The more that is issued at the long end, the more the ECB will need to buy to prevent upward pressure on long-term rates. Debt management offices and the ECB are pushing in opposite directions and some coordination would be welcome. Italy’s debt management office, for example, introduced a policy of lengthening the maturity of its debt last year and recently issued its first 50-year bond in five years, raising €5bn.
Following this policy now would be straightforward, says Avgouleas, and would help take legal pressure off the ECB with regard to constitutional challenges in Germany. To change the ESM into a euro area debt manager would require changes to the ESM treaty and not a ‘grand renegotiation’ of the kind required to write off debts. The main problem he sees is a common European one: will policy-makers act to preempt a potential fiscal crisis or will it require a crisis to motivate them?
This is an extract from the Spring OMFIF Bulletin on central banks and QE. Click here to download.