The ECB’s Latest Big Mistake

One of the great mistakes among economists is to receive the measures of central banks as if it was the revealed truth. It is surprising and concerning that it is considered mandatory to defend each one of the actions of central banks. That, of course, in public. In private, many colleagues shake their heads in disbelief at the accumulation of bubbles and imbalances. And, as on so many occasions, the lack of constructive criticism leads to institution complacency and a chain of errors that all citizens later regret.

Monetary policy in Europe has gone from being a tool to help states make structural reforms to become an excuse not to carry them out.

The steady funding of deficits of countries that perpetuate structural imbalances has not helped strengthen growth, as the Eurozone has seen constant GDP estimate cuts already before the Covid-19 crisis, but it is whitewashing the extreme left populists that defend massive money printing and MMT, threatening the progress and growth of the eurozone. Populism is not fought by whitewashing it, and the medium and long-term impact on the euro area of this misguided policy is unquestionably negative.

Today, citizens are being told by numerous European extreme left politicians that structural reforms and budgetary prudence are things that were implemented by evil politicians with malicious intent, and the message that there is unlimited money for anything, whenever and however is whitewashed by the central bank actions.

It is surprising to hear some serious economists at the European Central Bank or the Federal Reserve say that they do not understand how the idea that money can be printed eternally without risk is spread all over the political debate when it is central banks themselves who are providing that false sense of security. The central bank may disguise risk for a time but does not eliminate it.

Greece, Cyprus, Lithuania, Slovakia, Spain, Portugal, and Slovenia are already borrowing at negative real rates. However, negative rates are not a sign of confidence in the government policies, but an aberration of monetary policy that hides the real risk. And sooner or later, it bursts.

When politicians say that negative yields reflect the confidence of markets in the country it is simply lying. The ECB is on its way to own 70% of outstanding sovereign debt in the eurozone and buys all the net issuances after redemptions, according to Pictet and the Financial Times. There is no market.

This temporary confidence in the capacity of the ECB to alter risk is only sustained if the euro area grows its trade surplus and its economic output, but mostly if Germany continues to finance it. It is not eternal; it is not unlimited, and it is definitely not without risk.

Many readers will say that this is an exceptional policy due to the Covid-19 crisis which requires exceptional measures. There is only one problem with that argument: that it is false.
The ECB’s policy has been ultra-expansive for more than ten years, in crisis, recovery, growth, and stabilization periods. Interest rates were cut to negative and asset purchases extended in growth and stable periods where there were no liquidity risks in the economy.

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