What the Modest Proposal asks of the ECB: Responses to a reader’s criticisms

Manos Makrakis, a reader of this blog, has expressed strong reservations about the newfangled role that our Modest Proposal assigns to the European Central Bank (see Policy 1). His text appears below in full. Here are, in numbered points, my reply:

1. The Modest Proposal is a Second Best Solution to the eurozone’s problems:

Second Best solutions are proposed when the equivalent First Best solution is unavailable, infeasible or downright impossible. Naturally, European federation and a eurozone Federal Treasury, with the powers to tax, spend and borrow (i.e. issue eurobonds), would be the First Best. But, it is utterly infeasible within the timeframe that would be necessary to avert the eurozone’s disintegration. Thus, the Modest Proposal is recommended as the next best (or Second Best) policy initiative; the only policy mix which is: (a) readily implementable by means of existing institutions (the ECB, the EIB and the EFSF) and (b) capable of ending the process of eurozone disintegration.

2. The ECB’s exceptionalism was a fait accomplis from its inception. The Modest Proposal simply extends its exceptionalism in a manner that is essential for the ECB to perform its, already exceptional, mission

Your empirical point is absolutely correct: Bonds  have never in the past been issued by a Central Bank. Equally, however, no Central Bank has ever been called upon to keep a currency union going without a counterparty Treasury with jurisdiction over the same currency area. Yet, this is precisely what the EU has asked of the ECB: to perform the unique, exceptional, never-tried-out-in-the-past role of safeguarding the euro without a Treasury opposite number. In this light, my response to your criticism that we are asking of the ECB to do what no other Central Bank has ever done before is that Europe has been asking precisely this of the ECBC from its very inception. All we are suggesting is that, since it is, in any case, doing things differently to all other Central Banks in the history of capitalism, then it should do one more thing that will help stabilise the currency union over which it the ECB turns out to be the uniquely responsible EU institution (along with the non-credible Growth and Stability Pact).

To recap, the ECB’s exceptionalism is part of its very existence. Alas, as it stands it renders the currency unstable. To stabilise it it needs to do one more thing: Issue bonds in its own name.

3. The ECB’s reputation vis-a-vis bond issuance

You write: “I hope we can agree on one thing. The ECB has zero reputation in managing eurozone members’ debt. The sterling reputation that you claim it has in the capital markets may have to do with the degree its role as a central bank that implements eurozone’s monetary policy has been successful so far.” Correct. But this is the beauty of a strong reputation. If Apple all of a sudden markets a new video projector, a device over which Apple has no track record (and thus no reputation per se), its overall reputation will put it in good stead with video projector buyers. The question, therefore, is not whether ECB-issued bonds will find buyers but whether they will, in the long run, prove a good investment (just as in the case of Apple’s hypothetical video projectors the issue is whether they will prove to be decent projectors that preserve, as opposed to jeopardise, Apple’s good name.

 4. How well will the new ECB eurobonds fare once issued?

The reputation of the ECB as a bond issuers will depend on two factors, only one of which you mention: The extent to which (a) a liquid, buoyant market will ensure that the ECB-bonds will create a self-maintained momentum that is comparable to that of US Treasury Bills, and (b) the ECB will be able to enforce repayments to itself by the eurozone’s member-states whose Maastricht-compliant debt has been transferred onto the ECB’s books.

Starting with point (a), which you skipped, there is little doubt in my mind that were the ECB to issue bonds of a face value that, ultimately, tends to 60% of the eurozone’s GDP, the new bond market’s liquidity will be precisely that which is necessary in order to create a self-perpetuating market and one, to boot, which helps the euro turn into more of an international reserve currency (albeit without challenging the dollar’s position) than it already is.

Moving on to point (b), which is troubling you, the following point needs to be made: While nothing stops any country, in theory, from defaulting on its international obligations, it is impossible to imagine that any eurozone member-state will choose to default on its long-term debt to the ECB (for this is the spectre that you raise as an argument against the Modest Proposal). The reason is simple: Doing so would, in effect, cut it off from eurobond financing of its investment programs via the EIB (see Policy 3 of our Modest Proposal). It would constitute an act of economic suicide. “What if a member-state, like Greece, finds it impossible to service its debts?”, I hear you ask. Well, even in that case, debts to the ECB (accrued because of the tranche transfer we propose) will be repaid even if a member-state defaults on its obligations to others. For you must not forget that the Modest Proposal decrees that only the Maastricht compliant debt is transferred to the ECB (and financed through ECB-issued eurobonds). The rest is the responsibility of the member-state. If a default occurs, it will not affect the member-state’s obligations to the ECB.

At this point, it is helpful to note the following: First, the last point amounts to super-seniority for the member-state’s debts toward the ECB. Secondly, this is no different to how the IMF, or indeed the EFSF, currently binds borrowers to a commitment that their monies will be returned first, in case of a default. Thirdly, under the Modest Proposal a default to third parties will be highly manageable (unlike now).

To recap, you chastised the Modest Proposal for not specifying the mechanism by which the ECB will ensure that member-states will repay their debts to it, thus ensuring that the eurobond issue is revenue neutral from the ECB’s perspective. My response is twofold: First, there is an inbuilt incentive mechanism within the Modest Proposal (Policy 3) and, secondly, these are solved problems (for if the EFSF can enforce its terms and conditions on member-states under EFSF programs then the ECB can do so far more powerfully).

5. The limits between monetary and fiscal policy and the former’s credibility under the Modest Proposal

At some point you write that the role we assign the ECB goes beyond monetary policy and spills over into ‘debt servicing’. Here we must agree to disagree on what a Central Bank really does (besides the rhetoric). As Mr Bernanke, and even Mr Trichet, have so vividly demonstrated, the limits between monetary policy and debt management are bound to be blurred, especially so during a Crisis (like the present one). When Central Banks buy bonds on the secondary market, as they have been doing with aplomb, what exactly are they doing? Is it monetary policy? Is it debt management? I submit to you that carrying out their monetary policy task is impossible without indulging in a degree of debt management. For if they were to abstain from the bond market at a time of crisis, the very currency that they are the guardians of will be put under great strain. Monetising debt is, and has always been, part of what Central Banks do at poignant historical moments.

From this perspective, the Modest Proposal is proposing a path that is more, rather than less, ‘conservative’, from a monetarist perspective. Without the ECB-issued eurobonds the Crisis continues to progress, the eurozone unravels, and the ECB is forced, kicking and screaming, to use its own meagre resources (backed up bby the prospect of printing money) to buy bonds as if there is no tomorrow. And since this is ineffective as a means of combating the crisis, this unfunded ‘debt management’ continues without rhyme, reason or limit. Compare and contrast this to our proposal: The crisis is arrested by an ECB that performs the same ‘debt management’ task within strict limits (up to but no more than 60% of eurozone GDP) and in a fully funded manner (as it presses into the service of debt management the capital of Chinese/Norwegian Sovereign Wealth Funds, private investors globally etc.)

In short, it is illusory to think that Central Banks do not delve in debt management. They do. What distinguishes monetary from fiscal policy is not that the Central Bank never touches the ‘filthy’ debt of the sovereign but that it does so  only in the secondary markets. The beauty of the Modest Proposal is that it allows the ECB to do what it is already doing in a fully funded manner (thus averting the inevitable money printing which is now the order of the day) and in a way that actually helps arrest the Crisis (which the current open ended, unfunded money printing has singularly failed to do).


Manos Makrakis comments, which gave rise to the text above, follow:

The most important part that still does not make sense to me is exactly the role you are asking ECB to take in your proposal. Exactly the part as you describe it in the paragraph I quoted in my comment above. I have asked again in this blog here.

You offer two arguments here that in my view are very weak as presented, in supporting the assertion that the ECB *alone* will be succesful in convincing the markets that it can command low interest rates if it were to issue eurobonds under the scheme that the modest proposal describes.

I hope we can agree on one thing. The ECB has zero reputation in managing eurozone members’ debt. The sterling reputation that you claim it has in the capital markets may have to do with the degree its role as a central bank that implements eurozone’s monetary policy has been succesful so far. Even if we were to agree that this has been really exceptional, this has nothing to do with its hypothetical reputation in the bond markets as a debt issuer. As far as I know, when the investment public reffers to a government’s reputation in the bond markets, they allude to its ability to be fiscally responsible and its ability to generate revenue through its economy to pay back the bondholders. The ECB has no such track record and in your modest proposal it does not appear to have those elements that would convince the investment public that something new is happening here and that the ECB will be the comander of it. You are presenting the ECB in a role of a facade for the existing and future debt requirements of each member state with no power to enforce fiscal policy upon them(which in turn would assure that member states do not borrow what they cannot repay). You do not present some revenue generating mechanism that could service these eurbonds other than that of the individual borrowers paying back the ECB on time on their bonds. You do not suggest what will happen if a member state in that scheme cannot pay back its debt to the ECB on its bonds. Where will this money come from? Printing money? I don’t thing that this will run along well with the public. You don’t want to now have somebody who borrows money and they have a “money printer” to pay you back right? I would assume that this will destroy the reputation of the whole central banking system as we know it. This is not monetary policy. This is debt servicing we are talking about.

In your second point, it sounds like you then need to give the ECB all the tools that it will require to really enforce the “sound debt” management you want it to implement. But you haven’t done so yet. I actually agree with that part. But in your proposal, and of course correct me if I am wrong, there is no such mechanism proposed. What you are referring to which I think is the missing link to make your proposal achieve the desired effect is exactly what is missing. A common european treasury assuming fiscal policy over local eurozone member economies.


  • Well well, the debate blows the smoke away and all we can see is a classic example; huge bureaucracy using vast loans, 60% of European GDP, to create private industrial jobs to create a flow of new, non government inspired tax income; of a medieval feudal mercantile economy.

    We are all toast!

  • Hi Yani,
    I’ll pick up the ball and continue the play to respond to most of your points. I will not bother you with more though as I think I already have caused perhaps more stir that I have intended to do.

    1. I agree with you that :”Second Best solutions are proposed when the equivalent First Best solution is unavailable, infeasible or downright impossible”. This of course alone is not an argument that proves that the current version of the modest proposal will do the trick. Let’s continue
    2. I will state it again (I think it may be the 3rd time I am doing it in some form) and will leave it here as I already think I sound like a broken record. The fact that the ECB was asked to do something unique -namely implemented monetary policy in a common currency union that does not have a common treasury- does not prove that the role that the modest proposal requires it to play now will be a fit role for it and a role that will turn out to be the medicine for the crisis. I view this as a logical fallacy. Your argument misses at least one step to convince me. It needs to show me that the new role you are asking it to play, is analogous to some reasonable extent to the one it had played so far. Otherwise it requires a big leap of faith. Actually this is an argument that can easily be used to support exactly the opposite : So yes indeed the ECB has been called to implement something unique, something that no other central bank has done so far. So how has this worked out so far for the Eurozone as a whole? Not so good I’d dare say as we have experienced it with the current crisis. So why continue giving the current ECB yet an extra responsibility, unique in its nature hoping that it will assure the public that it will work? If the right medicine is the so called dept. of treasury or some similar institution, what makes us think that continuing on testing yet another untested role for a central bank will convince everybody that things will now be better?
    3. Sorry but I feel the analogy to Apple is off. As I said reputation as a debt issuer in the bond markets means one specific thing. Reputation in implementing monetary policy does not automatically translate to reputation in paying you back on money I borrowed from you. The US treasury notes, even at this state, have strong reputation almost exclusively because of the reputation of the country as a whole in the global stage (namely economy, politics, dollar as reserve currency). It does not follow in my view that just because the ECB may have been a successful monetary policy implementer, the markets will give their highest rating in bonds that will bare only its name on them. What constitutes ECB’s “good reputation” if nothing else changes in the eurozone in terms of how individual states manage their finances, and the ECB just implements an off-hands proxy role?
    4. I am not familiar with the concept you mention in point (a) so thus I didn’t mention it. I think I understand for the most part your explanation as far as point (b) is concerned. Though I think that if Greece (or any other state for that matter) were to default on third party lenders, this would have a direct effect on the perception of the market on whether it would be able to repay their eurobonds to the ECB and subsequently would most likely affect (on a weighted average scale) the credit rating of those bonds as well. Also you can’t trust member states finance ministers for their statistics clearly (i.e. loans, GDP figures, OTC derivative products etc) . So yet another point that more central intervention is necessary to ensure prudent finances, which points to tighter fiscal planning/policy centrally monitored (if not mandated). — who knows what kind of hole we will suddenly find out once Berlusconi says “arrivederci”

  • Without getting into complicated arguments and long winded responses let’s put it in the simplest possible terms:

    Those against the Modest Proposal(aka Eurobond solution) are engaging in big time hypocricy (whether they know it or not).

    The argument usually boils down to distrust of central power and mechanisms thought to erode national sovereignty. It’s in essence the age old argument of resisting change.

    And while they give plenty and free advice to Greece on how to surrender its own sovereignty, they are deep down paranoid in tampering with theirs.

    You can’t have it both ways! Either we are building the United States of Europe or we are not.

    Above all, Europe can not remain static. It will be the death of everything we have strived for to achieve just like in the experiment when the frog dies when temperature is raised gradually in a pot; unless the frog is thrown in boiling water in which case the frog immediatelly jumps and saves its life.

    • >>>Either we are building the United States of Europe or we are not.

      Looks like it is (b) we are not.

      People are using their second voting right now: Their wallet. I tried to buy more gold in one of the three biggest cities in Germany end of last week. I failed. Everything was sold out. Ok they had some coins, but nothing to get rid of a lot of Euros.

      Even the mainstream news now see bailing out Italy very critical. Looks like they finally got it that a merger of 23 loss makers plus 4 countries with small losses into the United States of Europe will create a huge loss maker!

  • As I always said: IT & ES are too big to bail out.

    Let´s see if the Euro still exists in its current form before I go on or after I come back from vacation :-). Looks like the spook will (thank god) have an end soon!

    Below a paragraph from the telegraph, which was also in Der Spiegel.

    “Berlin is losing patience. Der Spiegel cites unnamed officials warning that Italy is too big to save, and that escalating demands may “overwhelm” Germany itself.

    The search for a scapegoat has begun. German MEPs and officials have begun to blame Brussels for triggering this crisis, though all it did was admit that the €440bn bail-out fund is too small to restore confidence, and that EMU is in systemic danger as contagion spreads to the core.

    Even Germany’s most ardent pro-Europeans seem to have given up trying to find a solution. They are building an alibi for EMU break-up instead”

    Source: http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/8687496/We-face-recession-without-shock-absorbers-as-Berlin-loses-patience-with-the-eurozone.html

    • really, it’s aep. he’s writing the same article for years…

      no need to read, we all know what he’ll say. I still don’t understand why they pay him to write the same thing.

    • Knut34:

      RE: you gold comment. You are too late buying gold now.

      You should have bought gold in 2001 when it was $200/ounce. Not at $1700 today.

      You also could have bought gold around $700 in 2008.

      And enough with the Austrian School of Economics and Von Mises. Gold is in a bubble of its own. Perhaps one of the last bubbles to go off.

      But I forgot your national preference for gold, especially if it comes free from another country, usually confiscated using some pretext or another.

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