VoxEU Column Monetary Policy

Time for the Eurozone to shift gear: Issuing euros to finance new spending

The crisis in peripheral Europe is deepening and spreading to the core of Europe. This column argues that it’s time for the Eurozone to shift gear. Eurozone members should use the Emergency Liquidity Assistance facility provided for under the statute of the European System of Central Banks to undertake ‘overt money financing’ of government debt. Greater cooperation – for a time – between central banks and fiscal authorities is, despite arguments to the contrary, in no way inconsistent with the independence of the central banks.

The crisis in peripheral Europe is deepening and spreading to core Europe, affecting France and now threatening Germany (Wood 2013). Political concerns in a number of Eurozone countries undermine confidence within the region. The Cyprus blunder has added to overall nervousness (see Wyplosz 2013). In Italy, falling productivity and falling real incomes, as well as prospects for yet more austerity to come, are further depressing the economy. Financial markets are giving the country the benefit of the doubt, in the expectation that a new government will soon be in charge. But how can the new government and Eurozone countries avoid a retrenching Italy becoming a major factor of instability for the whole Eurozone?

There is a need for radical action. A large pro-growth stimulus programme is necessary, especially in the countries where the economy is weaker. This would give a signal that Europe can still find the moral resources to regenerate hope amongst its growing masses of dangerously discontent citizens. Just recently, the European Commission’s Economic Sentiment Indicator decreased in both the Eurozone and the EU (EC 2013).

What can be done?

The solution would be for Eurozone members to use the Emergency Liquidity Assistance facility provided for under the statute of the European System of Central Banks to undertake what could be called ‘overt money financing’ (OMF) of government debt in order to finance tax cuts or new spending programmes.1 The idea of OMF has been recently revived by a number of well-known scholars, pundits, and policymakers (see McCullay and Pozsar 2013, Wolf 2013, and Wood 2013b). Turner (2013) has dissected it analytically, comparing it to existing policy alternatives and concluding it to be superior.

Defended in the past by such eminent and diverse economists as Henry Simon, Irving Fisher, John Maynard Keynes, Abba Lerner, and Milton Friedman as the most effective macroeconomic policy lever when it comes to stimulating a stagnating economy, the idea was resurrected by Bernanke (2003) when he recommended Japan fight deflation through a programme of tax cuts or public spending explicitly coupled with incremental (and permanent) central bank purchases of government debt. The money created would finance the tax cuts or the new spending programmes. If the money had gone to finance tax cuts – Bernanke argued – consumers and businesses would probably spend their tax-cut receipts, since no current or future debt-service burden would be created to imply future taxes (i.e. there would be no rational Ricardian equivalence effects).

Eurozone members should urgently consider undertaking OMF to achieve aggregate domestic nominal-income targets. It would be a Eurozone ‘coordinated-and-decentralised’ effort to conjugate monetary and fiscal policies tailored on country needs in view of preserving highly compromised regional stability and prosperity.

How can this be done?

The Emergency Liquidity Assistance facility gives national central banks of the Eurozone the ability to support temporarily illiquid domestic institutions and markets over and above European System of Central Banks assistance, in exceptional circumstances and on a case-by-case basis. Emergency Liquidity Assistance is not an European System of Central Banks function, and the power to use it lies with the national central banks and does not derive from their membership in the European System of Central Banks. Existing legal documents make it clear that its scope, terms, and procedures need to be spelt out in national law and regulations (Buiter et al. 2011). Although the use of Emergency Liquidity Assistance by national central banks is not constrained by the rules governing European System of Central Banks operations, restrictions apply:

  • Prohibition of overdraft facilities for official bodies;
  • Purchasing government bonds;
  • Undertaking tasks that go beyond those of a central bank (ECB 2012a).

Emergency Liquidity Assistance does not require explicit approval of the European System of Central Banks, yet it may be terminated by vote if it is deemed to run counter to the European System of Central Banks’ mandate. Moreover, the same degree of independence is required for national central banks performing Emergency Liquidity Assistance functions as they enjoy in carrying out European System of Central Banks-related operations.

In Vistesen’s (2012) reconstruction, during the crisis Emergency Liquidity Assistance was used by the Bundesbank in 2008 to save Hypo Real Estate against €42 billion guarantee by the German government, and by the National Bank of Belgium in 2009 to bail out Fortis Bank with €54 billion on the eve of its collapse. It was also used in Ireland and Greece, although for a completely different purpose than the one originally intended for the facility. At the time of Vistesen’s writing, Ireland had reportedly had a constant use of the facility since 2008 with the central bank providing anything between €40 and €60 billion since 2010, and Greece had resorted to Emergency Liquidity Assistance for about €55 billion. Such constant use of the facility was not envisioned under the European System of Central Banks statute, and suggests that Emergency Liquidity Assistance has been used during the crisis as a source of additional bailout funding.

It is here proposed that Emergency Liquidity Assistance be used in countries facing conditions of economic recession to finance government programs of spending or tax reduction through permanent purchases of newly issued public debt. Based on the policy precedent of the European System of Central Banks’ Outright Monetary Transactions, the European Central Bank could extend its legal interpretation of Emergency Liquidity Assistance, allowing for its use as here proposed, and ensuring coherence with the European System of Central Banks’ principles. Under the new legal interpretation, Emergency Liquidity Assistance could be used as last-resort demand management tool to fight local recessions and preserve monetary and financial stability in the Eurozone. The ECB could always sterilise any undesired effects of the additional local supplies of euros on the Eurozone’s aggregate money supply. Much as the Outright Monetary Transactions must be supported by conditionality through macroeconomic adjustment or precautionary programmes under the European Financial Stability Facility/European Stability Mechanism (ECB 2012b), Outright Monetary Transactions should require submission by national governments of fiscal stimulus programmes consistent with underlying economic conditions, to be executed under EU monitoring.

How would the Outright Monetary Transactions scheme work?
  • A government of the Eurozone submits to its parliament and the Eurogroup a pre-defined fast-track public-spending package or tax-reduction plan to be financed in deficit under Emergency Liquidity Assistance.

The corresponding deficit is set with a view to delivering a pre-determined domestic nominal-demand target.

  • After consideration of the approved government programme, the European System of Central Banks endorses use of Emergency Liquidity Assistance for OMF purposes by the central bank of the submitting member country.
  • The central bank communicates to the government its readiness to finance an increase in the fiscal deficit through permanent purchases of newly issued debt under the Emergency Liquidity Assistance facility.
  • The government instructs its ministry of finance to issue special non-transferable government bonds to the central bank in exchange for newly issued euros under Emergency Liquidity Assistance.

The new debt could either bear interest, and the central bank would buy it and hold it in perpetuity, rolling over into new government debt the bonds on its balance sheet that reach maturity, and returning to the government the interests matured; or be structured as special non-interest bearing and never-redeemable securities (Turner 2013).

  • The launch of the OMF is accompanied by a central bank’s statement indicating that its purchases of newly issued debt will be permanent, and by a communication strategy explaining that the debt financed under Emergency Liquidity Assistance will not raise sustainability issues, since it may not be redeemed or sold to the market, it does not pay interests, and does not give rise to new government liabilities.

The ECB and the Eurogroup monitor the implementation of the government program.

Would central-bank independence be in jeopardy?

Whereas the OMF scheme above demands a high degree of coordination between central banks and governments (Grenville 2013), it does not entail a breach of central-bank independence. In fact, as recent research indicates, central bank-government coordination is the most appropriate policy response under conditions of economic stagnation or deflation (McCullay and Pozsar 2013). A technical dialogue between the two institutions will be necessary, for instance, to identify the type of deficit programme (public spending or private spending through tax cuts) with the highest expected impact on nominal demand. But this dialogue can take place in full respect of the prerogatives of each institution, with the government having the last word on the composition of the deficit programme to be financed and the central bank deliberating on the volume of OMF intervention. Coordination should aim at leading both governments and central banks to form common views on the real needs of the economy and the desired impact of the intervention.

In such a framework, the central bank subjects itself to cooperating with the government in stimulating economic growth directly and for as long as necessary, in order to reduce economic slack and root out deflationary pressures, but retains the authority to say ‘no’ to the continuation of the operation in the event of excessive money creation. As McCullay and Pozsar have written:

“[G]reater cooperation for a time between [central banks] and fiscal authorities is in no way inconsistent with the independence of the central banks, any more than cooperation between two independent nations in pursuit of a common objective … is inconsistent with the principle of national sovereignty”.


Bernanke B (2003), “Some thoughts on monetary policy in Japan”, Tokyo, May.

Bovi M (2013), "Realism, austerity or demagogy? Evidence from Italy”, VoxEU.org, 20 March.

Buiter W H, J Michels, and E Rahbari (2011), “ELA: an emperor without clothes”, Global Economics View, Citigroup Global Markets, 21 January.

EC (2013), “Business and Consumer Surveys”, European Commission, Economic and Financial Affairs, 27 March.

ECB (2012a), Opinion of the European Central Bank of 24 January 2012 on a guarantee scheme for the liabilities of Italian banks and on the exchange of lira banknotes (CON/2012/4).

ECB (2012b), “Technical features of Outright Monetary Transactions”, European Central Bank, Press release, 6 September, available at www.ecb.int/press/pr/date/2012/html/pr120906_1.en.html.

ESCB (2008), Protocol (no 4) On the Statute of the European System of Central Banks and of the European Central Bank, Official Journal of the European Union, 9 May.

Grenville S (2013), “ HYPERLINK "http://www.voxeu.org/article/helicopter-money" Helicopter money”, VoxEU.org, 24 February.

McCulley P and Z Pozsar (2013), “Helicopter money: or how I stopped worrying and love fiscal-monetary cooperation”, Global Society of Fellows, 7 January.

Turner A (2013), “Debt, money and Mephistopheles: how do we get out of this mess”, Cass Business School Lecture, 6 February.

Vistesen C (2012), “Emergency Liquidity Assistance in the Eurozone: Draghi’s irreversible euro put explained”, Credit Writedowns, 9 August.

Wolf M (2013), “The case for helicopter money”, Financial Times, 12 February.

Wood R (2013), “Periphery economies: national governments must be prepared to provide stimulus”, VoxEU.org, 4 March.

Wood R (2013b), “Helicopter money is purely about initial stimulus”, Financial Times Letters, 17 February.

Wyplosz, Charles (2013), “Cyprus: The next blunder”, VoxEU.org, 18 March.

1 Article 14.4 of the ESCB statute states that: “National central banks may perform functions other than those specified in this Statute unless the Governing Council finds, by a majority of two thirds of the votes cast, that these interfere with the objectives and tasks of the ESCB. Such functions shall be performed on the responsibility and liability of national central banks and shall not be regarded as being part of the functions of the ESCB.” (ESCB 2008).


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