“Borrow as much as you like – the ECB will bail you out” – that was arguably the implicit message of European Central Bank president Jean-Claude Trichet last week as he announced that the ECB would continue to accept Greek sovereign bonds. The statement came after fears that Greek government bonds would be further downgraded and would therefore lose their status as collateral for ECB open market operations. In addition, a current relaxation of collateral quality requirements to BBB- is supposed to be extended.
Certainly, the ECB acted in the belief that their actions would safeguard the eurozone and the euro. If Greek government bonds were excluded from ECB monetary policy operations, Greece would find it even harder to sell their government bonds at “acceptable costs”. However, Mr Trichet’s rash promise to help Greece imposes a long-term threat for the eurozone.
Firstly, credibility is an important “tool” in today’s monetary policy. Markets must believe in monetary policy to make it effective. However, changing the rules to help Greece is highly discretionary. Accordingly, markets will anticipate discretionary policy in the future and they will treat monetary policy statements with scepticism. The resulting uncertainty in monetary policy (or even higher inflation), will not, however, help the eurozone economies recover from the crisis. Special aid to Greece will therefore have a negative impact on other members of the zone.
Secondly, the guarantee by Mr Trichet is virtual a “no-default-guarantee” and implicitly accelerates central bank financing of Greek government debt. Irrespective of rating or fiscal stance, commercial banks are likely to buy Greek government debt. They receive high yields and can use the junk bonds as collateral for low interest central bank loans. At the end of this process, Greek government bonds end up on the ECB balance sheet. This could have a “crowding out” effect on high quality collaterals. Yields of high rated countries could increase.
Thirdly, the ECB statement encourages moral hazard. Why should another country in a similar situation to Greece today (maybe Portugal) be willing to undergo painful austerity measures? Why should Greece stick to its announcements on public spending cuts? The ECB (together with the EU bailout plan) has created an environment where government debt can be rolled over repeatedly and increased. Market forces are switched off and the requirement to cut deficits and public debt is substantially reduced.
Although the ECB has acted to safeguard the eurozone, its guarantee to help Greece may prove to be counterproductive in the long term.