In an epic myth-busting exercise, Christine Lagarde recently affirmed that “the ECB will neither run out of liquidity nor fail”, clarifying the special nature of central bank accounting, which means they cannot go bankrupt even if they make financial losses.
More than a decade ago, the global financial crisis forced major central banks across the world to intervene in unprecedented ways. This included purchasing vast amounts of assets from banks and financial institutions, through so-called quantitative easing.
As a result, central banks’ balance sheets have ballooned as they piled up lots of debt in their portfolios, especially debt from governments. Central banks have virtually become the biggest investors on earth. The U.S. Federal Reserve ($7.2 trillion, 33% of GDP), ECB (€7 trillion, 55% of euro area GDP) and Bank of Japan’s ($6.7 trillion, 126% of GDP) combined balance sheet stands at $22.18 trillion as of end 2020.
Balance sheet of world’s largest central banks.
(Trillion $)
Source: St.Louis FRED.
In the Eurozone, the ECB started buying government bonds in smaller quantities in 2010 under the so-called Securities Markets Programme (SMP). SMP was essentially a precursor version of quantitative easing, restricted mostly to Southern European countries. Although the programme was broadly a failure due to its limited nature, it did temporarily delay the contagion of the self-fulfilling market panic and speculations against the Eurozone.
These unprecedented actions by central banks triggered all sorts of criticisms and controversies. One of these was the idea that by purchasing lots of debt, the ECB would unavoidably risk making huge losses, as some governments like those of Greece or Italy may default and require debt restructuring.
This question was at the heart of an intense debate a few years ago, with some naysayers arguing that QE programmes were putting taxpayers’ money on the line. Those orthodox economists claimed that if the ECB would accumulate losses on its balance sheet, it could become insolvent and require governments to provide a bail-out by putting more money into their capital share of the ECB. In other words, what the ECB can give with one hand, it will have to take it back with the other.
However, this was always an intellectual shortcut.
A central bank cannot lack something it can create infinitely
Central banks are public institutions which have been given the powerful role of creating a legal tender and supervising credit creation by private banks. Logically, and as explained extensively in the literature, a central bank cannot lack something it can create infinitely. It is, therefore, possible for a central bank to run into “negative equity” – that is, to appear financially insolvent on paper – without any immediate operational problems.
In this context, it is extremely reassuring that the ECB President Christine Lagarde has made a remarkably clear statement on this, when asked by French MEP Manon Aubry in a Written Question to the ECB:
“In response to your question on how the Eurosystem technically provides liquidity to the financial system, the Eurosystem, as part of its monetary policy measures, purchases securities – in net terms – and by doing so creates central bank money. Central bank money is also created when commercial banks, through the Eurosystem’s refinancing operations, borrow money from the Eurosystem against adequate collateral. The electronically created central bank money is held on the commercial banks’ accounts with their NCBs, which are also referred to as bank reserves with the central bank. As the sole issuer of euro-denominated central bank money (i.e. banknotes and bank reserves), the Eurosystem will always be able to generate additional liquidity as needed to fulfil its mandate. Therefore, as I had the opportunity to clarify at the last hearing at the ECON Committee, by definition, the ECB will neither run out of liquidity nor fail.”
This matter of fact should have been made clear long ago. But for reasons unknown, it was not mentioned, or at least not stated so clearly. For example, we remember an epic episode where Mario Draghi was asked a similar question by a Swedish journalist. Draghi was laughably embarrassed.
In contrast, Lagarde’s clear-cut response illustrates how ECB’s doctrine on this issue has finally evolved. It should now be put to bed for good.
Childish, Basic stuff. This is described in every text book over the last 100 years or so. So what’s the fuss?
So when the Eu central bank raises money for the Eu it isuues Euro bonds and pays for them by creating Euro currency from thin air and gives this money to the Eu and it collects interest from the Euro bonds it has issued from theEu to pay the interrest and to eventually pay back the debt. But all its surplus money belongs to the Eu member countries as its shareholders. It a deceit perpetrated on citizens called quantative easing. That merely ultimately devalues the currency and causes inflation that only growth can hide!! With citizens being the only ones to suffer the catastrophic consequences Of a total loss in confidence in the currency, when it goes badly wrong as inevitably it will, especially when it has been abused for so long without real growth but with inevitable inflation rearing its ugly head!
The comments about the article above in the comments section, describe the lack of vision that exists relating to how money enters the economy.
1. when we talk about inflation we never hear comments about rising prices and the need for price controls or taxes used to redistribute wealth as a break on inflation – but we always accept the Neo-liberal/Neo-Classical idea that we cut wages and public services to solve inflation, which in fact depresses the economy as Keynes proved after the war.
2. Its how money is spent in the economy that creates problems not how much money is chasing goods and services.
3. People create wealth, not the financial sector, and when people are given the opportunity to use their talents to serve the common good, there is nothing they can’t achieve. The myth that only the private sector can create wealth has been deployed to rob those very creators of wealth of the wealth they create.
4. When has any politician ever questioned the need for stock exchanges that produce nothing, because they are the users of the currency, and only add speculation into a system that gambles on monetary growth, rather than producing things that are worth while?
5. Money properly directed, can produce whatever we need, and sound investment serves the interests of everyone. The lie that governments are impotent and don’t have any money of its own, only that which is raised in taxation, is solely to protect the interests of the already rich and powerful.
6. Its the job of government to serve the interests of all its citizens, not just the corporate sector, they have the money, all it needs to do is ensure that the human and natural resources are available to achieve it.