Redistributions in a monetary union

Karl Whelan has a good post on the exaggerated fears of ECB insolvency, rightly pointing out that standard ideas of bank or non-bank-corporate insolvency do not transfer well to a central bank with the power to create liabilities at will.

But I think Karl’s post underplays the importance of potential redistribution effects of monetary policy within a monetary union.   (Although the ECB’s stress on price stability gets most attention, my sense is that the avoidance of redistributions between members plays at least as important a role in their thinking.)   One way of seeing this is to recognise that the amount of seigniorage-related revenues available for ultimate distribution to member governments is fixed by the inflation target (given real growth and other determinants of the change in money demand.)   Losses on asset purchases will lower these revenues. 

This also relates to discussions of design flaws in the euro, and especially the absence of effective bailout mechanisms.   The revealed fragility of creditworthiness within the monetary union shows the seriousness of this flaw.  But the “no-bailout-rule” was there to reduce the risk of redistributions, and without it many countries would not have signed up.   The revealed design flaw will have to be fixed if the euro is to survive.   Yet I think there is a better chance of effective negotiated change if legitimate concerns over redistributions are recognised.

23 replies on “Redistributions in a monetary union”

Important to see (among the key Euro flaws) how a block on conditional redistributions can also act as a block on the now-standard use of lender-of-last-resort to prevent bank runs. In the standard Diamond-Dybvig model, which forms the basis of most bank stabilization policy, if a bank or collection of banks suffer a liquidity crisis due to a bank run, the central bank pumps in newly-created currency and the bank run ends. This prevents bank runs from starting in most modern countries since bank depositors can see that they are pointless. If a Eurozone country suffers a bank run, the ECB cannot stop it by pumping in newly created currency since it might (if the run were successful) generate a cross-country redistribution of ECB seignorage. Hence the run might “succeed” in destroying national banking systems in the Euro via bank runs or bank “jogs” via cross-country institutional deposit flows.

In protecting creditors and creditor countries, while allowing bank ‘jogs’, (a new one on me) the ECB facilitated a one way flow of credit during Trichets reign (reign rather than tenure).
To say therefore that
“my sense is that the avoidance of redistributions between members plays at least as important a role in their thinking” is a big stretch.
In fact by insisting on no bondholder losses, the ECB facilitated massive redistribution.

On the more general point of the money supply, the BUBU’s nightmare scenario, and an issue that I know little of could I ask the following.

How did the ECB control broader money supply / credit during the ‘boom’, when some banks increased leverage ratios to huge multiples of cash. And the obverse of that which is how the ECB now deals with reduced bank leverage ratios in its control of money supply / credit.

The redistributive effect of monetary policy? What exactly is the mechanism by which this effect is supposed to take place?

Let’s say the ECB prints money to buy government bonds through the ESM with a banking license – the dreaded monetary financing of governments. What happens? The Spanish government can finance itself at a reasonable rate and does not have to inflict even more self-defeating austerity on a population with 50% unemployment. With some encouragement, the Spanish government can implement some reforms that will allow the country to grow with the business cycle turns.

What are the side-effects of the ECB buying Spanish government bonds? Will a still broke Spanish government bound by deficit rules go on a spending spree leading to hyperinflation in the core? How about a population with huge levels of unemployment? Or a critically undercaptialised banking system.

Even if Spanish bond buying or some other form of looser monetary policy did lead to inflation in the core, this would actually be a good thing. Increased demand in the core would make it easier for Spain and Italy to grow their way out of the crisis. In addition, moderate inflation for a few years would reduce the debt burden right across the EZ. Furthermore, debasement would likely offset any decline in competitiveness caused by inflation.

And what about the redistributive effects of moderate inflation? Well, right now, the crisis itself is causing a massive redistribution from the periphery to the core. There is huge capital flight from peripheral banks to Germany. In addition, the German export economy is feeding off a massively undervalued real FX rate that is caused by the crisis.

So we have peripheral economies with intolerable levels of unemployment, broke governments and broke banks and we have core economies feeding of the crisis via capital inflows and a depressed real exchange rate – and you’re worried about the “redistributive effects of monetary policy”. These concerns are not “legitimate”.

Am I the only one that thinks this is madness?

@ bazza

An alternative view (coinciding to a large extent with the German one).

High levels of unemployment in Spain are not exactly new and pre-date the country’s membership of the euro.

The added complication in Europe is the euro.

The present situation is not madness but the unpleasant sight of a brawl between the parties with each trying to emerge with as little damage as possible. The issues raised in relation to the ECB in this post and that of Karl Whelan are sideshows and of no real significance compared to the main event.

@Gtfaway – Yes you are correct it should be “the ECB will not” rather than “the ECB can not” since this is their (IMHO, wrong) choice in the circumstances.

I think that article you posted has to be one of the most nonsensical I have ever read. It is like something from an aptitude test, where the objective is to find as many logical fallacies as possible.

There is no one-to-one relationship between inflation and employment – there are multiple equilibria. To claim that because there was high inflation and high unemployment in 1980, then quantitative easing leads directly to higher unemployment is both breathtaking and stupid.

With regards to the unemployment rate in the UK and US, fiscal policy would have had a far greater impact than monetary policy. But because of the incompetence of politicians and the tireless lobbying of wealthy conservatives, Central Banks were forced to act alone in the face of the crisis.

In the EZ, the case for monetary action is more related to sovereign borrowing costs and the breakdown of the financial system, but nevermind, “growth comes from stable interest rates, low inflation and a sound currency”. Right, like they had in Japan for the last 20 years, is it?

And these issues are not a sideshow – they are front and centre in the EZ crisis, seeing as choosen fiscal policy (simultaneous austerity everywhere) has been a disaster.

I suggest you read Martin Wolf’s blog instead of this rubbish.


The post does not focus on redistributions via inflation. I take it that inflation is fixed over the longer term by the ECB’s inflation target. (You might recall from earlier discussions that support raisng the inflation target given the particular constellation of problems that the euro zone faces, but this is a bow to reality.

The focus is instead on the distribution of seigniorage. Willem Buiter’s widely cited article “Can Central Banks go Broke?” is well worth reading. (Link below). From equation (5) we can see that the pdv of seigniorage (as a share of GDP) would be fixed by the inflation target. (I am assuming the country is on the upward sloping part of the seigniorage laffer curve, so that that inflation targets is a binding constraint on potential seigniorage. From equation (2) we can see that losses on asset holdings will ultimately reduce the transfers that the central bank can make to the treasury given the fixed availability of seigniorage. The benefits of bond buying can go disproportionately to particular countries, but the risks in terms of reduced transfers will be shared within a monetary union. I believe that this explains concerns about bond buying as much — and probably more — than fears over price stability, which the central bank has the instruments to control.

My view is that the risks to the survival to the euro zone are sufficiently great that the risk of transfers (aka redistributions) must be taken. But surely it is important to at least understand where the ECB and countries most at risk of making net transfers are coming from.

Given that DOCM seems to follow the distributional battles between euro zone countries on a minute by minute basis, I am surprised he considers these redistriubtion issues a side show in the political economy of euro zone crisis resolution.

@ bazza and John McHale

I made no judgement with regard to the article in question other than to say that it was an alternative view widely shared in Germany. That is a political reality. I do follow the current negotiations daily, if not minute by minute, as I find them a source of some considerable entertainment, a task facilitated by the fact that the protagonists are kind enough to set out their positions almost on a daily basis (Merkel and Schauble being the current exceptions while they wait to see what bombshell the constitutional court lands on them on 12 September).

The issues of ECB insolvency and seigniorage hardly figure at the forefront of the participants’ occupations. What does figure is the calculation of how they can emerge from the negotiations with the greatest advantage for their countries and the least possible electoral damage to themselves. The outcome remains uncertain. But the nature of the negotiation can hardly be disputed. It is a political one between the nation states involved, often by the intermediary of the influence they exercise in the various institutions.

People are, of course, entitled to their own view and, like Father Ted, say it is mad, I tell you! But this is an opinion rather than a contribution which advances the debate.

Incidentally, according to the Wall Street Journal, the Commission will table its proposals on banking union on 11 September. It expects them to be adopted before the end of the year, a timetable which is perfectly feasible as only consultation of the EP is required, provided, and it is a big proviso, the political will is there. As they are almost certain to be in the form of Regulations, they could be part of the legal order of the EU immediately (that is if the German constitutional court still accepts it).


But this is an opinion rather than a contribution which advances the debate.

<Snorts derisively/>

For those who follow US politics DOCM’s approach (which is not unique) is very similar the Beltway Malaise endemic in American journalism and commentary where the minutiae of political manoeuvrings (who will be the next appointment for what, who is popular, which institution has the upper hand, western Kremlinology of a sort) are used to distract from the substantive political issues (left vs right, poor vs rich) and also to disguise the economic imperatives at work.

Do not be distracted.

The two substantive issue, for those who have forgotten, are how the losses from the European component of the global financial crisis will be distributed and whether the failed neoliberal method will be turned from ideological extremism and poor economics into worse law.

Which incidentally is what John McHale’s orginal post was about. The fight between the currently dominant forces of financial capitalism and German monetarism (though monetarism is not quite right, nor is ordoliberalism, “Crazed conservative Hayekian gold bugs” is the best match).

I think neither position deserves any respect whatsoever.

As usual, when the ECB’s PR flak takes it in the neck on his purported facts, he changes the subject.


The Indo article presents some of the reality and Prof McHale’s concerns with seigniorage and ECB redistribution seems a little arcane in the context of the arguments among the members of the fire brigade on how to put out the fire.

There is a lot of déjà vu about the recurring issues but it’s striking how ‘growth’ as an issue has disappeared from European headlines almost as fast as it appeared in those distant days when some saw François Hollande setting a direction where le rigueur (austerity) would be replaced by a new dawn of hope.

In Ireland, a growth agenda was never taken seriously by the insiders. The Ancien Régime has too many perks to risk any change.

Five years since the onset of the crisis, policy makers are now turning attention to bringing down the cost of drugs including the racket in the generic drugs market and the socialist farmer organisations are seeing their pressure regarding proposed changes in the third level grants racket show some results!

There is something seriously wrong with a system in a bankrupt country where members of parliament already in receipt of travel and lunch money plus a tax free top up of €41,000 annually, publicly demand to be paid travel money for attending anti-tax protests outside Dublin.

How do they get away with it? is an old refrain.

The limited issues which outrage Irish people is very revealing.

Courtesy of the Guardian’s “Eurozone Crisis Live” blog (by line ‘Documenting the car crash of EMU for over 1597 1598 days’.)

The European Central Bank also issued another plea to national governments to take further steps to reform their economies “swiftly and decisively”. It said;

Product market reforms to foster competitiveness and the creation of efficient and flexible labour markets are preconditions for the unwinding of existing imbalances and the achievement of robust, sustainable growth.

It is now crucial that Member States implement their country-specific recommendations with determination.

You can see the ECB’s full monthly report here (pdf).

For an apolitical body concerned only with price stability the ECB does tend to come out with a lot of neoliberal cant, does it not?

The ECB also continues to show symptoms of ‘determination’ Tourette syndrome.

Determination. Strong determination. Determinedly disciplined. Determination to continue with confidence enhancing market reforms. Burble. Mises.

It looks like the EU are backing the Greeks into a corner which might have severe repercussion…
“Sources told Kathimerini that the troika has instructed the government to reduce the public sector wage bill to the same level as 2001 in order to meet the savings target of 11.5 billion euros over the next two years. This means that general government wages and social security contributions would have to drop from 11.8 percent of gross domestic product to 10.4 percent, which is equivalent to a reduction of 3 billion euros.”

Curious that they don’t target our ps golden pensions!

The use of the word “instructed” says it all.

@John McHale

I think there are several problems with Buiter’s model and its applicability to the current crisis. At the core of his analysis is the assertion that
ln(m) = a – bi

However, this is an emprically calibrated relationship based on a study of hyperinflation! Surely we cannot use a study of hyperinflation to derive policy in the current circumstances. And what about the i? Currently this is around 0 and is even negative in some countries. Going by this model, the nominal value of seigniorage is 0 or even negative!

Going on to equation 5, Buiter discounts s by (r-g), presumably because he sees this as a perpetuity with growth rate g and discount rate r. However, s is the share of seigniorage in GDP, so as GDP grows (at rate g), s will actually fall. Therefore, the discount rate is not (r-g), but more like (r+g). Actually if you derive this from first principles I think you get a discount rate of (r+g+rg).

In any case, he seamlessly moves from trying to estimate S as defined on p6 (PV of seigniorage profits), to presenting formula (5) for the PV as a share of GDP. These are not the same things! If the correct discount rate is used (r+g+rg), then an increase in g can lead to a decrease is S just because the GDP has increased!

Furthermore, formula (5) does not provide any causal relationship between inflation, M and S. Such an argument would involve the increase of an exogenous M causing the decrease in the endogenous S or the increase in an endogenous pi. In fact the only relationship between inflation and the money supply given in the whole article is equation 4, which, as I said already, goes back to a 1956 study of hyperinflation.

Buiter really gives the game away in the second paragraph on p8 when he beings with “The effect of a higher rate of inflation on … seigniorage depends on…”. Eh, hello, the study was supposed to be about the effect of printing money on inflation (amongst other things), not the other way around.

So the whole argument boils down to the assumption that in a hyperinflationary environment, printing more money might be useless. There is nothing in the argument about inflation targets so I don’t see how we can be worried about redistributive effects of loose monetary policy based on this article. At best, one could claim that in a hyperinflationary environment where the Euro and EZ has lost all credibility, the ECB would have to be recapitalised and this cost would be disproportionately borne by Germany, but we are a million miles away from that situation and the article doesn’t say anything about how we would get there.

The prospect of the break up of the Euro is bad and real enough without worrying about low probability future crises.

In any case, thanks for raising the point. I think the more light that is shed on these flimsy arguments the better. I think however that you are overestimating the legitimacy of these worries. Buba’s inflationary fear is a quasi-religious dogma that no amount of logic will get around.


Thanks for the response.

I hope that the model didn’t ruin your afternoon and you still got to watch the boxing.

I think you are taking the model a bit too literally. The model nicely captures the intuitive point that beyond a certain point that printing money actually reduces seigniorage, as people stop holding money because of how quickly it depreciates due to inflation — many other formulations could be used to make the same point. But this is not central to the point I am making in the post — nobody thinks we are in this range in the euro zone. Instead, the model is a useful way of showing that the amount of seigniorage is fixed by the inflation target. The real action is then in equation (2), which shows that with fixed seigniorage losses on ECB asset holding reduce the profits available for distribution to governments. I admit that this is quite an obvious point, for which no model is really required. But it does help highlight that the balance sheet insolvency, or otherwise, is a bit of a red herring. The real point is that losses on asset holdings are real losses to euro zone countries. And if the benefits of those asset holdings go disproportionately to some countries, bond buying creates the risk of redistributions. Governments — and not just the German government/Bundesbank — are concerned about such redistributions. I hope I have made it clear that I do not think these concerns trump the need for decisive action to stem the very real risk to the euro zone. But it is important to understand the nature of the opposition being faced. There is a disheartening and I think unhelpful tendency to view the actions of the ECB or the German government or the Bundesbank as “stupid”, though that is not to say that misjudgements are not made on the balance of their own or broader European interests. But there are also conflicting interests — the stuff of redistributive politics, here fought at the level of the euro zone. The potential losses on bond holdings are just one of the battlefields.

@John McHale
“The real point is that losses on asset holdings are real losses to euro zone countries. And if the benefits of those asset holdings go disproportionately to some countries, bond buying creates the risk of redistributions. .. such redistributions.”

ECB losses on bank liquidity, arise only because the ECB decided to nationalise those losses onto the taxpayers, rather than have the original investors take the losses. A calculated redistribution of loss strategy.

Potential ECB losses on State assets (bonds) are principally, with the exception of Greece, a direct result of its bank bond policy.

The bottom line is that the creditor countries have used every means and argument possible firstly to limit their private bank losses, then to nationalise bank debt in debtor countries, then to socialise it and finally to extract it.
They were facilitated all the way in their objectives by the ECB and EZ institutions.
If some of those losses now have to be inflated out of the system over a period of years, who is going to shed tears for the creditor countries that cry foul?
The first foul was on their part.

@Shay Begorragh

“Do not be distracted.

The two substantive issue, for those who have forgotten, are how the losses from the European component of the global financial crisis will be distributed and whether the failed neoliberal method will be turned from ideological extremism and poor economics into worse law.”


At best the EZ is headed for a few more few rounds of “too little, too late “. The EZ is headed for disaster.

Without further dilly dallying it behooves us to consider seriously that the PIIGS and France will come to the conclusion that life outside the EZ will be more tolerable than life inside the EZ. The Irish Gov’t should start negotiations immediately on how best PIIGSF can progress collectively or individually.
The Germans are quite incapable of being flexible enough to ensure EZ survival in its present form. They will be delighted to throw their lot in with countries like Austria, Finland and possibly the Netherlands. A form of Germany enlarged with a Deutschmark worthy of worship.

In a nutshell the PIIGSF do an Italy and the Germans hew to their iteration of a new nearly as good as gold standard.

Is the “no-bailout-rule” incompatible with the no-sovereign-default rule? It a law of arithmetic, I think, that if the debtor cannot repay a loan, there is either a default or someone else must pay the debt.

Ireland had great fun with their faux democracy and accompanying referendums. If we are to believe Der Spiegel, Germany is now going to solve its domestic internal political problems by holding referendums. The Germans found it quite strange that Ireland could hold the EZ and EU up for ransom during our democratic shenanigan period. Having provided bad example we can now live with the blow back.

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