C&B Notes

Making It Up As They Go

As yields move ever lower, the ECB is being forced to revisit some bond-buying constraints that it introduced at the beginning of its QE experiment.  Intervention so often creates unintended consequences that then require more intervention — a spiral of incrementalism that leads to situations and outcomes never envisioned originally.

Under current rules, the scale of purchases under QE match the size of a member state’s economy, meaning that Germany’s Bundesbank must buy around €10bn of government debt each month — more than any other central bank in the region. But because of the recent bond market shifts, more than 50 per cent of German bonds previously eligible for QE have now become too expensive for the Bundesbank to purchase, yielding less than the ECB’s self-imposed floor of minus 0.4 per cent, according to data from Bank of America Merrill Lynch.  The ECB’s ultra-loose monetary policy is already a deeply controversial issue in Germany, where negative interest rates have been widely denounced as hurting savers.  Some of the possible solutions to any shortage of eligible bonds for QE would also be heavily politically charged in the country.  The ECB has insisted in the past that scarcity is not a problem and that the design of QE is flexible enough to accommodate any shortages.

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There are five ways the ECB could change the rules on government debt purchases to remove obstacles to its quantitative easing program. The ECB could:

  • buy bonds that yield less than minus 0.4 per cent.  This is widely seen as the least controversial option but could expose the ECB to big losses.
  • scrap the rule that prevents the ECB holding more than a third of any one country’s debt.  But that could open up the bank to criticism that it is becoming too dominant a creditor of an individual member state.
  • scrap the rule that prevents the ECB from holding more than a third of any specific bond issue. This could also open the way for criticism that the bank is becoming too dominant a creditor — but in this instance such objections would only refer to individual bonds rather than the entirety of a country’s debt.
  • scrap the rule that keeps purchases in line with the size of member states’ economies, leading more bond purchases from more indebted member states.  This could anger voters in countries such as Germany which object to apparent subsidies to the eurozone’s more indebted southern economies.
  • buy debt with maturities shorter than two or longer than 30 years.  However, there are relatively few bonds with maturities beyond 30 years, even though some eurozone governments have recently issued debt at 50 years.