Since the outbreak of the Covid-19 crisis, a debate has emerged on whether we should write off public debts owed to central banks. Despite its technical feasibility, debt cancellation is not the first-best proposal worth fighting for.
(A 🇫🇷 French translation, an 🇮🇹 Italian translation and a 🇩🇪 German translation of this article are also available.)
Since the beginning of the pandemic, a number of economic taboos – starting with the suspension of fiscal rules and the massive expansion of the ECB’s balance sheet – have been broken. Even more creativity will be required to overcome the economic damage caused by the Covid-19 recession and its aftermath.
Over the past few months, a group of French economists and commentators have revived a controversial idea – writing off public debt that has been transferred onto central banks’ balance sheets as a result of quantitative easing (QE). To complement this cancellation, eurozone member states would commit to reinvesting an equal amount of money into long-term, sustainable investments.
The proposal has recently attracted more attention after the President of the European Parliament David Sassoli said that debt forgiveness was “an interesting working hypothesis”.
At first sight, the proposal makes sense. Central banks in the Eurozone are currently holding around €2,800 billion of public debt of governments, that is around 30% of public debt in the Eurozone. In practice, national central banks are holding the debt of their country, while only a small percentage (10 to 12%) is held on the ECB’s balance sheet itself.
Share of public debt owned by central banks
Since central banks are typically owned by their states, they redistribute a large part of the profits made from this public debt throughout their usual distribution of dividends to their governments. So when a country pays back the ECB, a good fraction of money comes back as a central bank dividend.
In other words, we owe 30% of our public debt to ourselves. Which is why we might as well write this debt off. In doing so, governments would see a nominal decrease in their public debt levels and therefore have more “fiscal space” to increase public spending now, instead of going into a deadly spiral of austerity.
However the idea does not please everyone, as several high-level ECB policymakers, including Christine Lagarde, Fabio Panetta and French governor François Villeroy de Galhau, have clearly objected to the proposal.
Positive Money Europe has closely monitored this debate. In this article, we want to explain why the proposal is technically valid but poses many complications from a legal and political viewpoint. After carrying a thorough strategic analysis, we decided to maintain our current focus on other proposals.
Cancelling debt is technically feasible
But first, we want to say loud and clear that we fully endorse the technical side of the proposal.
It is crucial to understand that the proposed debt cancellation is specifically aimed at the 25% of public debt that is owned by central banks, not debt held by private investors and savers. It is, therefore, a very different kind of debt cancellation that was granted to Greece or Argentina a few years ago.
In other words, no pensioners would get hurt under this proposal. Only the central bank balance sheet would suffer. The question which arises next as to what does this imply for the central bank.
Critics often argue that if the central banks agreed to cancel public debt, they would suffer so much loss that they would quickly run into bankruptcy, and require a bailout using taxpayer money.
This objection is however not really convincing. As Christine Lagarde recently pointed out, the ECB “cannot go bankrupt or run out of money”. This is for an obvious reason – the very institution which has the power to create money, by definition, cannot run out of it. Even with negative equity, a central bank can continue to fully operate.
A more nuanced criticism is that debt cancellation by central banks is a zero-sum game. For example, the French treasury’s chief economist Agnès Benassy-Queré explained that the gains from debt cancellation would be offset by a reduction of the central bank’s profit distributions to governments, resulting from the losses incurred on the Eurosystem’s balance sheet
However, the short-term gains from the debt cancellation would be far superior to the small flow of profits that central banks annually distribute to their governments. In the case of France, the government could write off €500 billion of debt (held under both the Pandemic Emergency Purchase Programme and the Public Sector Purchase Programme), while the annual profit given by the Banque de France represents around €6 billion for 2019.
Crucially, it is important to remind ourselves that central banks are not like private companies. Their accounting and balance sheets are purely defined by conventions, and should certainly not be seen as absolute legal or economic constraints. Because of this, instead of outright cancellation, we may for instance want to convert the sovereign bonds into zero-coupon perpetual bonds, sparing the ECB’s accounting department the trouble of dealing with losses.
We therefore completely agree that cancellation of QE debt is technically feasible. But while accounting rules of ECB may be more flexible than one might think, the ECB still operates under rather strict constraints of EU law.
Legally impossible, politically complicated
Thus, we disagree with the view that it would be legal for the ECB to decide unilaterally to cancel debt from governments. It is true that Article 123 of the Treaty on the Functioning of the European Union, when referencing the monetary financing prohibition, does not explicitly envisage the case of public debt cancellation. But it is nevertheless clear that the proposal, by its very intention, goes against the spirit of the EU Treaty. If anything, there is jurisprudence (see Accorinti and Nausicaa) where the EU Court of Justice backed the ECB’s decision not to take part in the Greek debt restructuring programme of 2012 (although for the wrong reasons).
Of course, proponents of debt cancellation are right to argue that the monetary financing prohibition has become an obsolete rule when the risk of inflation is nowhere to be seen. Unfortunately, when it comes to Court decisions, economic arguments rarely match legal ones.
Changing this state of affairs would require enormously strong bargaining power in order for unanimity to be reached by the European Council for Treaty change. In a slightly more optimistic scenario, an implicit agreement between EU heads of state to reinterpret or curb EU rules, with the ECB’s consent, might do the trick.
Given the strong political capital required to pass such a proposal, the main question is whether the gains would be worth the effort? Unfortunately, we do not think so.
Not so obvious economic gains
According to their advocates, unless we cancel debt, policymakers will impose austerity across the eurozone at the end of the crisis, to pay back the huge amount of debt created due to Covid-19. To kill two birds with one stone, they want member states to commit to investing the equivalent of the debt write-off for climate change and the green transition.
But today European governments – even Greece – are borrowing money at negative interest rates. This means that investors are ready to lose a bit of money to hold sovereign debt (instead of losing even more money if they parked their reserves at the ECB deposit facility). In effect, while government debt has increased considerably, the cost of servicing this debt has been going down.
Public debt cost as % of GDP
Debt service due in two years on government bonds, % of GDP
Source: ECB Statistical Data Warehouse. Note: Government bonds with 1 to 2 years maturity, debt service without principal, https://sdw.ecb.europa.eu/reports.do?node=1000005712
In this context, although cancelling debt may provide an additional fiscal windfall, it is unfair to present it as an absolutely necessary precondition for investing more in the climate transition. In fact, there is an unprecedented consensus among economists to say that public debt is a non-existing problem today.
This is also why prominent academics have proposed to revise key fiscal indicators, for example by looking at debt-service to GDP instead of misleading debt-to-GDP indicators. By analyzing flow-to-flow dynamics, instead of stock (debt) to flow (GDP), such indicators would do a better job at revealing the government’s debt sustainability.
In this context, although there would be additional gains from a debt cancellation plan, they would not be as automatic and significant as one may think at first sight. There are also some risks that the plan would not work as expected.
Indeed, as pointed out by OFCE researchers, depending on how the debt cancellation is organised and communicated, all sorts of irrational behaviours could jeopardise the plan. Fear and lack of trust from private investors that after cancelling debt from central banks, they may be next on the line, is just one example of this. Similarly, (irrational) fears of inflation may cause investors to demand higher yields. If this were to happen, the immediate reduction in debt stock would be offset by an increase in the borrowing cost of new debt issuance.
Proponents of the ECB debt cancellation campaign are aware of this reality, but they are concerned that the favourable borrowing conditions will not last forever. If and when central banks start raising interest rates, this would bring austerity back with a vengeance. While they are right to flag this potential risk, it would still be a missed opportunity not to take advantage of the current negative interest rates to invest in long term investments. Doing so now would in fact increase the chance of success of bringing our economy towards a path of sustainable growth, which could in effect make debt cancellation unnecessary.
A better strategy
Positive Money Europe certainly wants to be at the forefront of new radical ideas, in particular on how the ECB can better use its money creation power to support society’s interests. We share the same goal of the proponents of debt cancellation: we need to make sure Europe avoid going back into the self-defeating austerity ideology that almost killed the Eurozone in 2010.
The debt cancellation campaign has positively contributed to raising public awareness on the powerful role the ECB can play in this endeavour. But a lot more work is still needed to change public perception on public debt, starting with the revision of fiscal rules and debunking the belief that governments are like households (they are not).
For a campaign organisation like Positive Money Europe, it is critical that we always find the best way of achieving concrete change, making the best use of the limited resources that we have.
The pivotal question is: if today progressive forces had the bargaining power needed to revisit the EU Treaty, should debt cancellation be our first priority?
Our conclusion is clear. Instead of one-shot debt relief, we would rather fight for permanent long-term changes such as a complete rewriting of the ECB’s statutes, including a revision of the monetary financing prohibition and the full revamp of the EU’s fiscal rules. Debt relief from the ECB would come as icing on the cake.
We do not shy away from proposals requiring Treaty change. As we said in the past, we believe Treaty change will inevitably be on the table in the coming years, and Positive Money Europe’s team is working hard to build a powerful movement capable of bringing this a long-term change. However, all our hopes cannot rely upon this remote and hypothetical possibility.
All in all, the proposal to cancel debt held by central banks makes sense from a technical perspective, and should certainly be debated further. If Europe fails to deliver a strong and fair post-Covid19 recovery, the proposal would certainly be a useful “last resort” policy option. But our strategic analysis reveals that the efforts required to win such campaigns would be very high, while its potential gains are uncertain and smaller than one may initially think. This is why debt cancellation cannot be our “first best” priority for now.
There are other, more effective routes to win progressive macroeconomic policies in the Eurozone. Positive Money Europe’s campaigns efforts are currently focusing on key issues such as aligning the ECB’s monetary policy with the EU’s climate goals, and creating political room for “helicopter money”. Next year, we also hope to start new campaigns to fight post-Covid-19 over-indebtedness in SMEs and households, and we wish to increase momentum for a progressive fiscal framework. If we keep focused and grow our movement, we stand a real chance to win concrete victories in the next few months.
Good decision to focus on structural solutions instead of one-offs.
But the key policy question is whether in the current economic situation monetary stimulus should be provided by forgiving private or public debts. Helikopter money constitutes direct private debt forgiveness and makes indeed more sense now. In both cases the ability to forgive would have to be strengthened by digital cash (cbdc with zero interest)
It’s a good point indeed. Helicopter money would indeed primarily support over-indebted households and SMEs. Outright private debt forgiveness of bank loans is also an option to be further considered, and one that would clearly not fall under monetary financing prohibition. We’re planning to work on this next year too!
Cancelling government is not a good idea. Most governments would channel monies saved to the rich and could not be trusted to share with the common people. As you say the best way to achieve fairness would be to support SMEs and helicopter money to the underprivileged.
The core issue is not this – but the realisation and acceptance that the modern money system is fundamentally flawed and unsustainable. It is entirely debt based and it properly called Debt Monetization. As long as this system is allowed to continue – ie Money creation by private entities out of ‘thin air’, and the inability of sovereign governments to create money and ‘spend’ it into the general money supply – all this talk is tinkering with chairs on the Titanic. Please wake up and see what is happening.
The debt based system is likely to catastrophically fail in the near future – and that is what you need to be talking about. Fair money is a real solution and sadly will only be countenanced after unimaginable suffering of the general masses.
Take a look at fairmoney.info
Actually the amount of central bank created money in circulation, at least in the US, now exceeds the amount of commercial bank created money. I assume something similar applies to the EZ. Source:
https://twitter.com/GeorgeSelgin/status/1352430289683931136?s=20
Thanks for this. It can be hard to know how to pick one’s battles, and I agree that it’s good to take as holistic a view as possible.
I look forward to seeing PME’s proposals concerning private debt forgiveness.
I think we need to be very careful not to automatically assume that ‘sustainable growth’ is possible in the aggregate. The scientific evidence overwhelmingly indicates that it will be very difficult, if not impossible, to decouple GDP growth from environmental breakdown (please see for example https://eeb.org/library/decoupling-debunked/).
In the short term, I agree that taking on more debt is the only feasible solution to getting started on the green transition. However, I believe in the longer term, biosphere limits will ensure that much of this debt – even on negative-interest terms – is going to end up needing to be cancelled as well, and it’s good to be as clear-eyed as possible about this from the outset. We will be kicking the can down the road in taking on this debt.
We need a monetary system that can function adequately, and over a long period, in conditions of zero aggregate GDP growth or even sustained contraction. In other words, there needs to be an adequate supply and circulation of money in the economy in circumstances where there is zero effective demand for credit. If I’m understanding correctly, a digital CBDC could help with this, if it was well-designed and introduced into the economy carefully.
I suggest the real flaw in the “write off the debt” idea is that government debt is essentially just central bank created money which has been lodged with government for a period of time. As Warren Mosler, founder of MMT, said, government debt is essentially a term account at a bank called “government”.
Thus if €X of government debt is written off, the private sector’s stock of money falls by €X. Assuming the private sector had its desired stock of money BEFORE the write off, it will then regard itself as having an inadequate stock AFTERWARDS. It will then try to save so as to acquire its desired stock. The result will be Keynes’s “paradox of thrift” unemployment.
Let we start with the cancellation of the central banks false liabilities to expose their REAL profits: “Each of those matters of law exposes the deeply problematic nature of accounting for Central Bank Money as ‘liabilities’ of the central bank, which some central banks already acknowledge. For example, the Swiss National Bank disapplies the relevant accounting principles regarding financial liabilities…”. Extracted from: Central Bank Money: Liability, Asset, or Equity of the Nation? – Michael Kumhof, Jason Allen, Will Bateman, Rosa Lastra, Simon Gleeson, Saule Omarova, Cornell Law School research paper No. 20-46, 2020.
The main reason that I hear for saying that debt cancellation won’t work is that “the Germans and Dutch would never agree”. They would see it is bailing out irresponsible governments in countries like Greece, Italy, France and Spain. But I believe there is a very simple solution. Instead of the ECB writing off debt uniformly, it could write off debt according to the population size in each country. Germany, since it has the largest population in the Eurozone would get a larger amount than other countries. And since its debt to GDP ratio is lower, it would actually end up with an even more favourable situation. Actually, this would be fair. This way of splitting aid between countries is something that I have been pushing since 2012 https://simonthorpesideas.blogspot.com/2012/10/the-16-quadrillion-of-eurozone.html and could be applied to many different types of operation, including Positive Money’s favoured helicopter money methods.
I agree with your conclusion that debt cancellation is not on the cards and is not a solution.
I do not agree that it is “technically” feasible unless one addresses first a series of problems that your analysis overlooks:
1. Who will negotiate the cancellation: will it be the ECB (alone) or with their affiliated “national banks” that hold most of the cancellable Member State’s debt on the one hand and the European Council, the Eurogroup together with the 27/19 Member States on the other? Do you really think it is posssible to get an agreement that all Member States would consider fair.
2. There is an obvious conflict of interest the Member States being the owners of the ECB.
3. The proportion of national debt held by the Eurosystem is not the same for each Member State. Should the cancellation be proportionate to the ownership of the ECB capital in order to ensure equality of treatment?
Curiously your paper evacuates “inflation” as the time tested best answer to repaying excessive indebtedness. Keeping it under control cannot, as at present, be the exclusive responsibility of the ECB which is why Eurozone Members subscribed (in exchange of their illusory economic and fiscal sovereignty) to the Stability and Growth Plan, the European Semester, the limitation on debt issuance etc. all constraints which have been waived as a result of the pandemic. This situation is unsustainable over time.
Next you mention that government finances are not the same as households. While obviously true, this statement overlooks the fact that pooling their monetary sovereignty and giving up the right to print money individually or devalue, the solvency of a Eurozone Member acquires many of the characteristics of a household.
To compensate for these weaknesses Treaty change (that you envisge also) is imperative. It should aim at creating an European Executive Authority (that means a federal government) that would be the single interlocutor of the ECB for coordination of monetary, economic and fiscal power (on the model of the USA, the UK, China, Japan,etc..). It implies also extending the Eurozone to the EU 27 (an existing treaty obligation).
Conclusion:
Maybe the current pandemic and the looming economic and social crisis will focus minds of our authorities to take – with the support of public opinion – these bold steps, unthinkable, in normal times. Afterall, both Salvini in Italy and Marine Le Pen in France seem to have embraced the € and the EU!
The status quo will inevitably lead to the breakup of the Euro and the EU, reestablishing fully sovereign national governments, exchange controls, severe limitations to the freedom of movements of people, goods and capital.
Now is not the time to dream up clever “technical” solutions to meet the chronic burden of excessive indebtedness but to answer the fundamental question: do European citizens wish to face the difficult times ahead individually or mobilize the considerable resources avaialble by facing the future together!
I find it a very sensible assessment. With reserve regarding the so called helicopter money, as a one off or UBI . There is something to responsibility, including in taking debt, and people are spending money they don’t have to buy stuff they don’t need to impress people they don’t like. I would rather favor a job guaranty. I find it better in terms of human dignity, personal sense of self worth, general productivity, social and economic resiliency and political participation and inclusion. There is no representation without taxation.
The foundation of a post-corona society:
Accounts for digital central bank money with special features
They replace the ECB’s zero interest rate policy.
They finance the unconditional basic income independently of the states.
Since 2015 the ECB has tried in vain to achieve its inflation target of 2% through a program called quantitative easing.
There are many reasons for failure, but one is likely to be that two of the functions of money (store of value and medium of exchange) work against each other: the more money is saved, the less is available for consumption.
A second reason lies in the fact that the recipients of the QE program are commercial banks.
So a system is needed that separates the two functions and identifies consumers as the target group.
This can be implemented as follows:
A twin account is set up for each individual checking account in the Eurozone, which is to be called the c-account. (To distinguish them, the normal current accounts will be called g-accounts below.)
This does not apply to current accounts from states, federal states, municipalities, etc., as well as banks and insurance companies.
The system is controlled by software that is implemented by the ECB and is to be called PLUVIA.
Every month, PLUVIA increases the account balance of the c-accounts of the physical persons by 1200.- Euro, and daily PLUVIA reduces the account balance of all c-accounts by 4 per thousand.
As a result, the money supply only increases during the first four years and then remains constant at a level of around 3,400 billion euros. In comparison, the M1 money supply is around 8,500 billion euros.
All payments are made only from g-account to g-account and/or from c-account to c-account.
Since the consequences of introducing the system are unpredictable, one should start with a monthly rate of 300 euros and analyze the effects before increasing it gradually.
The system with the two parameters of monthly payment amount and daily loss rate is a powerful tool for regulating the money supply M1 as well as the purchasing power of the citizens and, subsequently, the inflation rate.
Behind all of this sophisticated financial discussion is the aim of transferring political power from elected voters to unelected financial institutions . A big brother approach of unprecedented proportions .