Institute for New Economic Thinking
December 9, 2011
The ECB has always been the protagonist of the eurozone crisis story. At times it has seemed the arch-villain, coldly standing on principle even as the financial system crumbles around it. At other times it has seemed the hero in waiting, ready to step in at the eleventh hour to bring a moral-hazard-free end to the turmoil with its unlimited balance sheet.
What is becoming increasingly clear, however, is that the plot is taking a twist. The question is no longer whether the ECB is villain or hero, but whether it exists at all. (And today's collateral eligibility expansion doesn't resolve the question.) Let me explain.
The meaning of European monetary union is that a euro is a euro, whether you are in Greece or in Germany. If you have a euro on deposit in a Greek bank, you can use it to make payment in Germany, or anywhere in the eurozone. What's essential is the payment system, which guarantees this, and it is the normal operation of the payment system that the guarantor of monetary union must ensure.
All payment systems are based on credit. As a first resort, banks can extend credit to one another to clear payments between their customers, credit which will net out as payments flow the other way in the near future. If two banks do not wish to extend credit to each other, a third party can stand between them, extending credit to both parties. The central bank commits to doing just this to uphold monetary union: if a balance sheet must expand to complete a payment, and no one else will do it, then the central bank must. If it does not, then a euro in Greece is not a euro in Germany, and monetary union will have come to an end.
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