Yves here. I guarantee this post will make some readers’ heads explode. It also explains why Germany would benefit from OMT.
By Paul De Grauwe, Professor of international economics, London School of Economics, and former member of the Belgian parliament, and Yuemei Ji, Economist, LICOS, University of Leuven. Cross posted from VoxEU
The monetary-fiscal policy connection is under scrutiny by the German Constitutional Court in the context of the ECB’s OMT bond-buying programme. This column argues that most analyses are deeply flawed by the misapplication of private-company default principles to the central bank. ECB bond-buying transforms public bonds into monetary base, and sovereign-default risk into inflation risk. The real question is: What is the non-inflationary limit to money-base expansion? This depends upon the economic situation and is much higher in the current liquidity-trap setting.
There is a lot of confusion about the fiscal implications of the government bond-buying programme – the OMT, or Outright Monetary Transactions – that the ECB announced last year.
This confusion arises mainly because the principles that guide the solvency of private companies (including banks) are applied to central banks.
• The level of confusion is so high that the president of the Bundesbank turned to the German Constitutional Court arguing that the OMT programme of the ECB would make German citizens liable for paying taxes to cover potential losses made by the ECB.
• In this column we argue that the fears that German taxpayers may have to cover losses made by the ECB are misplaced. They are based on a misunderstanding of solvency issues that central banks face.
Indeed, German taxpayers are the main beneficiaries of such a bond-buying programme.