So what actually argues against the ECB’s writing off all the government debt instruments it has bought within the framework of its bond-purchasing programme? Nothing at all in the opinion of the economic policy spokesman of Italy’s right-wing populist party, Lega Nord. He is calling on the European monetary watchdog to remit the debt of Europe’s largest periphery, which adds up to more than EUR 400 bn, and hopes to liberate Italy from its heavy debt burden and create more fiscal leeway for the new government: after all, Italy’s right wing populists as well as its other major parliamentary groups have put generous spending programmes on the agenda for the coming legislative period. Looked at soberly, this bold proposal is already likely to come to grief in the face of the ECB’s statutes and European legislation. But assuming the idea were to be implemented nevertheless, under certain circumstances the central bank could suffer large balance sheet losses that more than erode its equity – with corresponding consequences for its creditors. In addition, the public would probably find such balance sheet operations more than just questionable. In a nutshell, the project would cast doubt on the credibility of the entire Monetary Union and the integrity of its institutions.
Were one nevertheless to go along with the notion of a debt remission financed by the ECB – in principle central banks can operate with negative equity – a debt write-off would probably allow Italy not only to enjoy massive relief for the treasury but also a significant increase in its credit worthiness, which would ultimately lead to falling funding costs. This would give the country considerable fiscal leeway not only for structural reforms, but also for investments that would drive growth and scope for tax cuts that would fuel consumer spending. So if inflation were also to remain within a controllable framework, would we not have the best of all worlds? Would the Italian government then steer its way into a sustainable fiscal policy after such a haircut? This is hardly likely. Instead, there are substantial moral hazard risks: according to the motto “the same law for all” the other euro area countries would press for debt relief from the ECB – with correspondingly far-reaching financial consequences for the ECB. Once the flood gates have been opened, regular demands for permanent support financed by the money press would follow. In addition, the euro’s external and internal value could suffer significantly from the loss of confidence – the overall long-term economic collateral damage would be hard to predict.
The voices calling for more of a financial purge and EMU-wide transfer payments are becoming increasingly loud. Among other things, debt servicing relief for Greece, debt remission for other member countries, and a euro area budget to support structurally weakened euro area countries have also been put on the table. The Merkel administration will not be able to avoid taking up a position soon. Even though it is unlikely to agree to ECB-financed debt remission in this form, with regard to the sustainability of Europe’s financial situation it will probably have to put forward compromise proposals. Otherwise the German government is likely to slide onto the defensive in the battle for the future of the EMU.