European Central Bank Governing Council member Jens Weidmann said Ireland’s promissory note transaction comes dangerously close to contravening a ban on the monetary financing of governments.
The transaction “has a fiscal nature, as stated by the Irish government, that’s clear enough,” Weidmann, who heads Germany’s Bundesbank, said in an interview on Feb. 13. The ECB will re-examine the issue and “has to make sure that its actions are in conformity with its rules and statutes,” he said. “I’m very concerned about monetary policy being too closely intertwined with fiscal policy and crossing the line to monetary financing.”
Ireland’s asset swap via the country’s central bank stretches out the cost of rescuing the former Anglo Irish Bank Corp., easing the nation’s borrowing needs over the next decade by 20 billion euros ($26.7 billion). The ECB, which so far has only “taken note” of the transaction, has stressed it mustn’t contravene Article 123 of the European Union treaty that outlaws central-bank financing of governments.
The asset swap has “potential repercussions on net financial assets and has to be assessed against the background of Article 123,” Weidmann said. “The transaction in Ireland demonstrates how difficult it is for monetary policy to free itself from the embrace of fiscal policy once you are engaged.”
The Irish government “fully understands the need for the ECB to ensure it is operating within its mandate,” Ireland’s Finance Ministry said in an e-mailed statement.
However, the government “is not concerned” by Weidmann’s remarks and “would point to ECB President Draghi’s comments last week that the ECB ‘unanimously took note’ of the promissory note arrangement,” it said.
Financial markets have lauded the swap, with the yield on Ireland’s five-year government debt falling to the lowest in more than seven years. Standard and Poor’s Ratings Services also revised its outlook on Ireland to stable from negative after the swap was announced.
Under the plan, dubbed “Project Red,” Ireland will swap so-called promissory notes used to rescue the failed bank with 25 billion euros of government bonds with maturities of up to 40 years. The bonds will be held by the Irish Central Bank, which will ease them onto the market, allowing the state to side-step annual payments of 3.1 billion euros a year that would have been due if the promissory notes had been kept.
The ECB, which didn’t vote to either approve or condemn the plan on Feb. 7, is likely to take a view as part of an annual report on national central banks’ portfolio holdings, normally due each December.
If Ireland succeeds in easing the burden of its legacy bank debt via the central bank, other countries in the euro area with similar problems may eventually demand the right to do the same, Weidmann said.
“Once you cross a certain line, setting a precedent, it’s very difficult to come back and argue against the next similar transaction,” he said. “That’s why it is important to define our mandate narrowly, so we’re not drawn into fiscal policy matters.”
One looming example is a prospective bailout for Cyprus, which could cost as much as 17.5 billion euros. Private creditors should play a role, Weidmann said.
Cyprus will “certainly need a substantial bail-in component” in order to fill the gap in banks’ balance sheets without making the country’s national debt unsustainable, Weidmann said.
At the same time, he said he doesn’t foresee Greece receiving any more relief on its debt.
“I don’t see this as being in the cards,” Weidmann said. “This is a debate we’ve had, and the result of this was the last adjustment of the program and its financing conditions.”
As Europe seeks to re-shape the institutions that govern its economy and single currency following a three-year debt crisis that saw the ECB repeatedly step in to save the day, Weidmann said there’s still the danger of over-burdening the central bank.
The task of supervising Europe’s banking sector, to be taken up by the ECB by March next year, has the potential to make the central bank’s primary task of ensuring price stability more difficult, Weidmann said. He added it may ultimately be better to have that task performed by a separate institution.
“I would find it reassuring to set up the supervisory mechanism with the ultimate objective to separate it from the central bank or at least build much more reliable Chinese walls between monetary policy and supervisory decisions,” he said. “I think this is a view shared by others.”
The Bundesbank president said he sees the hard-won independence of central banks everywhere coming under threat, as institutions are asked to do more and governments interfere. That will ultimately endanger price stability, he said, citing Japan and Ireland as examples of increasing politicization of monetary policy.
“The independence of central banks being is questioned more and more, academically and politically. I think that’s a serious mistake, not because I’m sticking to principles but because it’s a key lesson learnt from history,” Weidmann said. “Independent central banks focused on the primary goal of price stability are best suited to deliver on that without jeopardizing growth.”
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