These are two questions posed by Jan Toporowski in a recent communication. In this post I offer brief answers:
A few days ago I received an interesting response from Jan Toporowski (School of Oriental and African Studies, and occasional contributor to the FT) regarding the Modest Proposal 2.0. Though sympathetic of the Modest Proposal (“a most interesting proposal, and very positive in its suggestion that the balance sheet of the ECB is finally activated in support of the financial system, instead of just acting as a repository of bank reserves. And the proposal to kick-start an investment programme is also very timely”), Jan raised an issue that concerns almost everyone: Will it not fall foul of the Maastricht Treaty? He also suggested that we take a good look at a recent speech by a member of the ECB’s executive board (Lorenzo Bini Smaghi) in which a central debt issuing authority is foreshadowed. Here is my reaction:
I re-read the various relevant Treaties, from Maastricht to Lisbon. Though not a legal expert, I trust that a tranche transfer is allowed, provided of course the political will is there. My reading of the treaties is that they ban outright two things:
- The purchase of member-state bonds by the ECB, which effectively rules out the financing of members states from the ‘centre’.
- Cross-financing between member states – the no ‘bail out’ clause which renders each member-state wholly liable for its debts (in association with 1 above)
The point of these two prohibitions was, of course, to preempt any attempts to free ride (that would have inflationary effects) and to segregate fully and unequivocally monetary control from control of member-state budgets. If the ‘letter of the law’ was to preclude direct ECB member state bond purchases and transfers between member-states, the law’s spirit was about maintaining the fabled discipline.
Interestingly, in terms of the ‘spirit of the law’, both objectives have broken down as a result of the crisis: Despite these strict provisions, discipline broke down, the ECB has been forced to purchase bonds (albeit in the secondary markets), the ESM has been empowered to purchase more bonds in the primary markets after 2013 and the Greek deal and the EFSF have been, for some time now, been ‘bailing out’ (admittedly at penal interest rates) Greece and Ireland. In short, the Treaty prohibitions already lay in ruins. Of course our leaders have been very skilful at packaging the EFSF/ESM loans in a manner that allows them to argue that the no bail out clause is respected. But my point here is that the tranche transfer we are suggesting is far closer to both the ‘spirit of the law’ and the ‘letter of the law’ than current practice.
The reason is straightforward: The tranche transfer is neither a bond purchase nor a form of direct financing. If the ECB could create, under current Treaties, a portfolio of bonds purchased in the secondary markets, it can surely create another one in which the transferred tranches will reside. These are not new bonds, they are not bonds purchased by the ECB, and they do not constitute any form of fiscal transfer as long as they continue to be serviced, long term, and, in a fiscally neutral manner, by the member-states.
To recap, Policy 1 of our Modest Proposal (which stipulates a tranche transfer of the Maastricht compliant member-state debt with a parallel issue of e-bonds by the ECB) is far less in breach of the Treaties than both the current ECB assets purchase program and the EFSF shenanigans.
Turning now, briefly, to Lorenzo Bini Smaghi’s proposal to create a European agency that issues centrally all government bonds on behalf of the member-states, in return for strict central control of member-states finance, I find it extremely useful, especially in view of his position as member of the ECB’s executive board. His proposal is proof that, at long last, a modicum of sanity is stirring in the guts of the beast. Regarding the place of the Smaghi proposal in the context of the Modest Proposal, we should give the matter some thought. At this stage, all I can say is that something of the sort is inevitable once the current crisis is contained and genuine recovery is kick-started. Version 2.1 should (and will) have something to say on the matter. Any ideas readers?