With the crisis caused by the pandemic, the proposal to cancel the debt contracted to cope with the emergency is back in vogue. An empty expression that hides a distorted idea of the role of the ECB. With the risk that the costs outweigh the benefits.
The role of the ECB
The crisis resulting from Covid is generating large increases in public debt in several European countries. In recent reports, some members of Italian and European institutions have returned to hovering extreme solutions to tackle the debt problem, going so far as to suggest that Europe should take charge of the outright cancellation of the debt from Covid. In what sense is it possible even to conceive of debt cancellation? What consequences could it bring? Let’s see some essential points.
The concept of “debt cancellation” is completely empty. It would be like saying “biodegrading” the debt. Completely meaningless if the mechanisms and procedures are not illustrated. There are actually so-called “unorthodox” strategies to normalize the debt level: (i) redefinition of contracts, ie a controlled default; (ii) imposition of taxes on wealth, that is, property taxes; (iii) financial repression, i.e. a disguised default. The only possibility therefore exists is a default or debt restructuring, which is nothing more than a partial default.
It is likely that by cancellation someone means “monetization” of the debt. The idea would probably be that the ECB purchases all (or part) of the existing (for example the Italian) and newly issued debt. But to do what? At the very least, to hold these securities until maturity, without reselling them on the market. Nothing to do, however, with the “cancellation” of the debt. Alternatively, in the minds of the “cancellations”, the ECB could restructure the government bonds it holds. For example by transforming them from 20-year bonds into bonds with an infinite maturity. But it could not be a decision that the ECB takes unilaterally. He should negotiate the matter with each debtor state.
In both cases, however, the central point is that the ECB would suffer a budget loss. The government bonds that the ECB holds are in fact an asset on the central bank’s balance sheet. If the maturity of these bonds were simply extended (to say the least), the ECB would suffer a budget loss. The budget losses of the ECB are not neutral. They simply mean fewer downstream profits redistributed to Eurozone national central banks, and in turn to governments. While it is unclear how this could work out in practice, if all of a sudden all Italian government bonds held by the ECB were “canceled” the ECB would see a huge loss on the asset side. Which would be nothing more than a game of rounds, because the governments of the euro zone would in turn suffer huge losses.
The risks to the Eurozone
It is possible at this point that someone objects: what does it matter if the ECB suffers a budget loss? It can print money with one click, and make up for the loss. Too bad that “printing money” for the ECB does not mean creating more balance sheet assets, but the opposite, given that money (circulating and deposits) constitutes a liability in the balance sheet of any central bank. Couldn’t the ECB then simply continue with the losses on the asset side? What would happen in that case? It would happen that the ECB would stop being a central bank. For a central bank, controlling the quantity of money (its job) consists of buying and selling bonds (mainly government). When the central bank buys securities, it expands the quantity of money (issues reserves in favor of the banks); when the central bank sells bonds, the bank itself induces a contraction in the quantity of money. If the ECB generates a huge balance sheet hole on the asset side (because, by hypothesis, Italian government bonds have been “canceled”) how would it, for example, withdraw money from the market, which is what typically a central bank does it do when it wants to contain the rise of inflation?
Given that a central bank could not function with persistent balance sheet losses (because it would not have sufficient securities on the asset side to conduct its open market operations), the ECB could not simply “restructure” the one-off debt, and then return to the normal budget management? Anything is possible (while ignoring the prohibitions imposed by the European treaties), as long as the costs are understood and declared. And in this case, the costs would be enormous to say the least, and of two types. First of all, to return to the normal management of its budget, the ECB would have to be recapitalized, with enormous costs for the governments of the Euro zone at the expense of much more functional uses. Secondly, Europe should say goodbye to the independence and credibility of its central bank, a fundamental public good whose importance is never stressed enough.
If canceling the debt is a “non datur” from a logical and economic point of view, it would be important that those who evoke such drastic solutions clarify procedures and mechanisms in an unequivocal way. It is only from a correct dictionary that such a strategy would emerge in all its (huge) costs and (completely uncertain) benefits.
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