Is the ECB Powerless or Unwilling? (Ctd)

Michael Stephens | November 15, 2011

Relevant to the question of the legal limits of relying on the European Central Bank as lender of last resort, Tyler Durden observes Jens Weidmann, head of the Bundesbank, defending the narrow view of the ECB’s role in a recent Financial Times interview:

FT: Can you explain why the ECB cannot be lender of last resort?

JW: The eurosystem is a lender of last resort – for solvent but illiquid banks. It must not be a lender of last resort for sovereigns because this would violate Article 123 of the EU treaty [prohibiting monetary financing – or central bank funding of governments]. I cannot see how you can ensure the stability of a monetary union by violating its legal provisions.

I think the prohibition of monetary financing is very important in ensuring the credibility and independence of the central bank, which allow us to deliver on our primary objective of price stability. This is a very fundamental issue. If we now overstep that mandate, we call into question our own independence.

This looks like two separate arguments:  (1) lender of last resort activities would violate Article 123; (2) this prohibition of LLR activities (“for sovereigns”) is a good idea anyway, because it preserves ECB independence.

The second argument, if this is what Weidmann intends, would imply that a great many central banks that do have LLR roles, including the Fed, lack sufficient independence.  As Brad DeLong argues, this narrow, LLR-less mandate for the ECB represents a radical break with central banking tradition (which, in and of itself, needn’t count as a decisive objection, but it is important to keep all of this in context—in DeLong’s story, Weidmann’s vision for the ECB does not represent some staid, tested, conservative approach).  DeLong:

Our current political and economic institutions rest upon the wager that a decentralized market provides a better social-planning, coordination, and capital-allocation mechanism than any other that we have yet been able to devise. But, since the dawn of the Industrial Revolution, part of that system has been a central financial authority that preserves trust that contracts will be fulfilled and promises kept. Time and again, the lender-of-last-resort role has been an indispensable part of that function.


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