ANALYSIS:Leaving the euro is unrealistic but what else could the Central Bank do? Why not print more money and lend it to the Government?
THE IRISH banks are very short of cash and the European Central Bank (ECB) and Irish Central Bank are lending €160 billion to them.
The Irish exchequer is also extremely strapped for cash. One government has collapsed, its replacement is agonising over expenditure cuts and tax hikes and the nation can’t borrow from the capital markets. The International Monetary Fund (IMF) and EU are providing €67.5 billion on condition that they run the country and are also charging a high interest rate.
After the recent stress-testing exercise, we now know that the banks may need an additional injection of €24 billion, bringing the total to somewhere between €70 billion and €100 billion. So why does the Central Bank not simply print more money at least to take some of the pressure off the Government?
Printing money might cause price inflation later on, but in our circumstances would that be so bad? It might encourage consumer spending and it would also inflate away some of the real burden of our present debt. Other countries have done this in extreme situations.
Quantitative easing is a euphemism for printing money and the US authorities, under a responsible president, have no qualms about it. Even the conservative ECB is doing it to some degree, despite tut-tutting from Germany. In any case, when a government borrows abroad (from the markets or the IMF) this borrowing also increases the money supply in the borrowing country (unless offset by other means).
It is interesting to note that the Central Bank is already creating money to some extent, because when the ECB became nervous when its lending to Irish banks went above €100 billion, it passed the buck to the Central Bank, which has now lent some €60 billion to the Irish banks. That is much the same as using the printing press.
When you or I pay someone, we must have money in our account to meet the cheque. So existing money is merely shifted from one account to another. Central banks alone can create new money by the stroke of a pen.
Over the years, the Central Bank occasionally lent money, albeit reluctantly, to the government of the day to part-finance its fiscal deficit. The central banks of other countries did likewise. (The Bank of England was set up to finance Britain’s wars!)
Imagine if the Central Bank were in a position to lend €3 billion a year (say) to the Government over the next four years, on a strictly emergency basis. This would prevent recession becoming entrenched, reduce unemployment and emigration, avoid punitive interest charges and protect the most vulnerable in our society.
What then is the problem? Lawyers would no doubt argue that the money that is being created at present by the Central Bank (€60 billion) has been endorsed by the ECB and that to do more would require further permission. While the ECB might give permission for money creation to help the banks, including European banks, it probably would not do so to finance the Irish Government.
Legislation setting up the ECB ruled out direct lending to governments. Nevertheless, the money creation going on at present would suggest some diminution of the force of that legislation – which, incidentally, did not envisage the present crisis or the possibility of default by European Monetary Union (EMU) member countries.
Lawyers would also argue that in a monetary union, individual countries cannot go on solo runs and alter the money supply, any more than they can devalue their currency or change the interest rate.
On paper that is true. In practice, however, it’s fuzzy. In Ireland, for example, the banks have gone on solo runs by changing their mortgage interest rates without any permission from the ECB. Monetary policy is implemented by means of changes in retail interest rates by banks. One Irish bank has increased its mortgage rates on four occasions in the last year by unprecedented amounts!
This is a de facto tightening of monetary policy in Ireland – indeed the most extreme degree of tightening ever recorded – without any signal or permission from the ECB. It is also a very serious situation, coming as it does on top of severe deflation. Technically, this solo run by Irish banks is not illegal, even though it breaches the spirit of EMU legislation. In short, it departs from the notion of a single monetary policy throughout the euro zone.
It is also worth noting that the architecture of the single currency is badly flawed because of the lack of fiscal federalism, the different economic structures of member economies, and the grossly inadequate focus on financial stability.
These flaws were bound to put pressure on the more peripheral countries.
Is there more scope for independent monetary policy in Ireland than we realise?
Purists might argue that if we choose to exercise that independence we should go the whole hog – leave the euro and link the Irish punt to a weighted basket of currencies. There would, however, be a most serious downside to such action – the signal we would be sending to US multinational companies that are greatly impressed by Ireland’s membership of the euro.
To avoid any misinterpretation, there is no suggestion that joining the euro in the first place was a mistake. The government simply didn’t know how to behave in such a regime and made extraordinary mistakes. Nevertheless, having placed ourselves in serious difficulties, our membership of the single currency is limiting our scope for emergence from them.
Leaving the euro is not really a viable option but a greater degree of monetary autonomy – particularly the ability to lend to our own Government – should be considered as a matter of urgency, even though it would probably involve significant and long-drawn out legislative changes at European level. When EMU legislation was being signed, the majority of people did not understand that the sovereign ability to create money was being removed. So much for democracy and the principle of subsidiarity.
There are already a few items on the agenda for future negotiations, including the treatment of bondholders, a reduction in the IMF-EU interest rate and the issuance of euro bonds. A greater degree of monetary autonomy in emergency situations should be added to this list – at the very least as a bargaining counter.
As a quid pro quo, we should offer the EU our whole-hearted support for a euro zone cost pact that would ring alarm bells whenever a member country was in danger of losing competitiveness.
Michael Casey is a former chief economist with the Central Bank and board member of the International Monetary Fund. He is also author of Ireland’s Malaise – The Troubled Personality of the Irish Economy, Liffey Press. @michael_g_casey