Simon Wren-Lewis on conditionality in bond-buying programmes
This post was written by John McHale
Simon has an interesting post that challenges arguments against unconditional bond-buying (QE) by the ECB. He makes a convincing case that such bond-buying for specific countries to avoid a “bad equilibrium” would not violate the ECB’s price stability mandate.
But I think his analysis misses another key (if implicit) aspect of the ECB’s mandate: in a highly incomplete political union, the ECB must minimise the risk of redistributions between members through its monetary policy (see this earlier post). Losses on bonds will be shared across the monetary union. Concerns that monetary union is a vehicle for such redistributions could doom the entire project. Of course, there is risk of such losses even on normal monetary policy operations. But this is why these operations take place within a strict risk control framework. For bond-buying, fiscal conditionality can be viewed as an effort to reduce the risk of losses, and ultimately redistributions between monetary union members.
Now it could be argued that fiscal conditionality actually increases the risk of losses. This would be the case if fiscal conditionality is self-defeating — that is, slows the economy so much that the fiscal situation actually deteriorates. Opinions differ on whether this is the case. However, if influential members believe that the ECB’s actions would unacceptably increase the risks of losses without conditionality, then the ECB would find it difficult to proceed with bond-buying, and find it particularly difficult to make the strong commitment necessary to keep yields low enough to credibly remove the danger of the bad equilibrium (see here).
The bottom line that redistributive politics within the monetary union mean that the kind of strong commitment needed to keep yields low is near impossible without conditionality. The choice may be for the ECB to act with conditionality or not to act at all.