How the ECB could print money without breaking the law

The ECB is not allowed to buy bonds with newly-created cash and thus cannot enter a 'currency war'; but there might be a way around this

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The European Central Bank (ECB) again left its main refinancing operations interest rate unchanged at a record low 0.75%, despite complaints about the strength of the euro.

Earlier in the week, French President Francois Hollande advanced the idea of some “guidance” for the single currency to protect the eurozone economy from “unfair” competition from abroad, while preventing “irrational swings” of the exchange rate in the short term.

But German government spokesman Steffen Seibert said the euro’s exchange rate could not be used to boost exports.

“Exchange-rate policy isn’t an appropriate instrument to boost competitiveness; it relies on short-term stimulus through targeted depreciation,” Seibert told reporters after Hollande’s remarks.

In Davos last month, German chancellor Angela Merkel praised the European Central Bank (ECB) for not engaging in “currency wars” although she admitted that she was looking “with a certain degree of concern at Japan.”

Not just politicians lament the strength of the euro, but analysts too; and some have even taken inspiration from Hollande’s complaints to suggest a way in which the ECB could print money without stepping outside its mandate or breaching the Maastricht rules.

Carl Weinberg, chief economist at High Frequency Economics, has long argued that the biggest danger for the eurozone is deflation, not inflation.

Unlike the Bank of England, the Bank of Japan, the Bank of Canada and the Federal Reserve, the ECB cannot buy bonds in open-market operations with new cash, and must sterilize all purchases it makes under its programmes such as the Securities Markets Programme (SMP), now defunct, and Outright Monetary Transactions (OMT), during which it has not bought any bonds yet.

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“Nothing we can see on the ECB’s books prohibits it from buying foreign currency from the open market and paying for those purchases with newly-created reserve deposits,” Weinberg noted. “It’s nowhere in the Maastricht Treaty, is it?”

If the ECB starts buying foreign currency in the markets, it could create new euro liquidity, which would benefit the economy regardless of the success of the currency intervention in actually weakening the euro, Weinberg argued.

“The wrinkle in this programme is that some, if not most, of the euros created by these transactions would go to institutions outside Euroland,” he added.

“However, a growing overhang of euros abroad may well cheapen the currency, amping up the trade and current account surpluses. This would ultimately bring demand into the domestic economy, where reduced slack could combat deflation.”

However tempting the solution proposed by Weinberg might sound, it will likely hit the same snag that other such proposals have encountered with the ECB: both current president Mario Draghi and Jean-Claude Trichet before him have insisted that the spirit, not just the letter, of the European treaties must be respected.

And while a solution to buy dollars or yen or pounds with newly-created euros arguably does not break the letter of the Maastricht Treaty, it certainly goes against the spirit of prohibiting the monetization of debt with printed money. 

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