A few clarifications about Greece and ELA

A good part of the media (most notably in Germany) is framing the ECB’s emergency liquidity operations in Greece as ‘the ECB extending credits to Greek banks’. This is a huge misrepresentation of reality. 

A good part of the media (most notably in Germany) is framing the ECB’s emergency liquidity operations in Greece as ‘the ECB extending credits to Greek banks’. This is a huge misrepresentation of reality. The ECB is actually doing little more than what all central banks do (and, moreover, what it is legally bound to do by its own statute): provide liquidity (‘reserves’) to the banks of Member States and ‘promote the smooth operation of payment systems’ (Article 3.1 of the Statute of the European System of Central Banks). The only difference is that – contrary to ‘normal’ liquidity – the ELA is a much more expensive form of liquidity for the banks. Moreover, ELA liquidity isn’t extended directly by the ECB but by the national central banks (in this case the Bank of Greece), which – since national central banks can’t ‘print’ money in the eurozone – in turn ‘borrows’ the money from the ECB through the infamous – in Germany at least – TARGET2 system.

Since all national central banks contribute to the ECB, this increases the exposure of these central banks vis-à-vis the central bank engaging in the ELA. Does this mean that the other central banks – and most importantly, as far as Germany is concerned, the Bundesbank – risk ‘losing money’ as a result of the ELA (if, say, Greece goes bust)? Or, even worse, that the ECB risks defaulting? As for the first question, technically the answer is yes. But the mistake here – and I’m afraid that this is a common mistake among economists – is to assume that a central bank operates likes normal banks, or even worse like households. The point to understand is that a central bank – such as the ECB – cannot default because, simply put, it has the power to print its own currency. Here are some comments on the issue. The first one is by Paul De Grauwe:

A first thing to note is that a central bank cannot default as long as it has the monopoly power to issue money. Money is the ‘debt’ of the central bank but the central bank can redeem this ‘debt’ by issuing fresh money, i.e. by converting an old banknote into a new one. These banknotes do not constitute a claim on the assets of the central bank. As a result, the central bank does not need equity (in contrast to private companies). It can live perfectly with negative equity. As long as the central bank keeps its promise of price stability any amount of equity, positive or negative, is fine.

In other words, the ECB cannot ‘run out of money’. This is what Christian Noyer, Governor of the French central bank, has to say on the issue:

Third, there is a huge theoretical literature on Central Banks’ solvency. I read the conclusions as follows. Nearly all analysts agree that a Central bank cannot go technically bankrupt as it can issue as much currency and reserves as needed to face its payments and commitments. Indeed, a few Central banks with great reputation have operated in the past with negative net equity for long periods of time.

In short, the media’s fear-mongering surrounding the ELA has no basis in reality. Moreover, there have also been allegations that the ELA is funding of the Greek government via the backdoor. This is not true since the ECB has placed a clear limit on the amount of T-bills that the Greek government can issue, so the Greek banks can’t ‘take the ECB’s money and give it to the government’, as some have implied. The real problem here isn’t so much that the ECB has continued the ELA throughout the crisis – as it was legally bound to – but that it has deliberately provoked a bank run and an impending banking crisis by placing a limit on the ELA, and threatening to pull the plug altogether on the Greek banks. This is a clear violation of the ECB’s mandate – which states that the central bank’s goal is to ‘promote the financial stability’ of the euro area – and would be the first time in history that a central bank deliberately uses its power to destroy a country’s economy.


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