Euro Area

[phonicsmonkey]

I do not see the ECB acting as lender of last resort.

Why not? That is one of the primary purposes of a central bank after all.

I get the sense that were probably past the whole lender of last resort arguement the ECB could buy all the bonds it wants now all that will happen is people will sell to it then refuse to buy new ones. This is like announcing to the whole village you will buy all there cattle at the mart in the back end and that you will be back to sell the same ones in the spring, your price per kilo next Janurary baring a massive move in beef prices globaly would tank.

If the ECB says it will stand behind all euro-zone issued debt it will not have to outright buy many bonds anyway, at least nothing like the amount on issue. Confidence will be restored and the markets will normalize with the backstop of the strong central bank. All bondholders want to know is that they will get their money back as planned. Italy is solvent, it's just illiquid in the near term. The ECB can provide the support it needs to carry it through until it is liquid once more.

But even if it did massive bond purchases and took all this debt on its balance sheet, so what? It can just create euros out of thin air to use to repay or cancel the loans! It can do that because it is a central bank and has the ability literally to print money.

The reason it has not done so? Fear of inflation and fear of moral hazard.

Inflation is not the eurozone's problem right now. Output is so far below potential capacity that it can surely be dismissed as a serious issue for at least the coming years. And once we're through this, if we want to rein in inflation the good old ECB can just raise interest rates!

Moral hazard? Well I think to some extent that issue has been dealt with by the hard line taken by Merkel and Sarkozy so far. Governments have fallen rather than been allowed to get away wtih fiscal profligacy.

The ECB should act like a proper central bank. Look at the Fed. There's a reason that every time bad news comes out about the US economy there is a flight to US treasuries. It's because the markets have faith in the Fed to set policy.

Is any of this desirable? No, of course not, it would be far preferable not to be in this position in the first place.

Have there been massive errors in political leadership in Europe which have led us to this point? Yes, the eurozone is now clearly structurally unsound and needs serious reform to avoid more issues like these in the future.

None of this changes the fact that the right thing to do, right now, is for the ECB to announce it will provide unlimited support to otherwise solvent eurozone governments with liquidity issues. Like Italy, Spain, France and Germany.

Countries that are clearly insolvent should be allowed to default in a controlled manner - Greece, Portugal.

sorry gaelic, I'm not clear on the position of Ireland in this analysis but it would probably now fall into the first group wouldn't it?