by Lorenzo Codogno and Giampaolo Galli, 22 novembre 2020
Much has already been said to explain why it is not wise to cancel the debt of Eurozone Member States in the portfolio of the ECB. What has perhaps not been argued clearly enough is why cancellation would not be a good idea even for a high-debt country like Italy.
There are two key points. The first is that the cancellation of government bonds held by the Eurosystem would be useless because it would give rise to a simple reallocation of funds. Member States would stop paying interest and principal to the Eurosystem, and this would stop passing the resulting profits back to the Member States. ECB profits are passed on to the national central banks and, together with those flowing directly to them, to the States. It is for this reason that this year the Bank of Italy paid the Treasury the substantial sum of 7.9 billion (excluding taxes), equal to 13% of the interest expenditure on public debt in 2019. Therefore, nothing would change in the income statement of the State. From the point of view of the balance sheet, gross debt would be reduced. However, there would be a parallel decrease in Eurosystem’s capital, due to the losses in the portfolios. If the capital reduction were significant, the States would have to put their hand into their pocket to recapitalise the ECB or the national central banks.
The second reason why the cancellation would not be a good idea is inflation. In the very remote case in which inflation raises its head, the ECB would not have a sufficient amount of securities to reabsorb the enormous mass of liquidity. In recent years, first Quantitative Easing and then the PEEP created massive liquidity to counter the effects of the pandemic on the economy. For some, this is precisely the advantage – the only one – of cancellation, because it would prevent the ECB from selling the securities on the market, which would put an end to the reallocation mentioned above. Moreover, it is said, a little inflation would not hurt at all. This is partly true, but it could become a cost. Many certainties on monetary theory and policy have crumbled in recent years. Still, there is a considerable amount of empirical and theoretical evidence that when central banks print money to meet the needs of States, people tend to lose faith in the currency. This is even more true in a fiat money system, not anchored to a real asset such as gold. Everyone accepts money because they think they can use it to buy goods in the future without losses; in turn, whoever sells the good must think that he too will be able to use the currency without suffering losses, and so on in an endless chain. To use the language of mathematicians, this is an unstable dynamic system for all values except for a special value defined, significantly, the saddle point: if you do not stay on top of the saddle you fall. Experience tells us that, to keep money in the saddle, some institutional arrangements are needed: independence of the central bank, its mandate to maintain price stability, the prohibition of monetary financing. It is also good to remember that the inflation tax is highly unfair and increases inequality. Perhaps for those who look with disenchantment at domestic developments, it has a single advantage: it is the only tax that is not decided by Parliament and therefore costs nothing to politicians. It seems to us at least very questionable that this is a plus point. Of course, it is not an argument that can convince the whole of the Eurozone. Politically too, these arguments are a big mistake. For Italy, especially at this moment, political capital must be spent to ensure that the Next Generation EU plan is approved. Furthermore, every subsequent effort must be channelled to make the investments that will be made effective, thus increasing economic growth. The revival of growth is the primary way to reduce public debt. Perhaps we should conclude like the great American humourist Mencken: “For every complex problem, there is an answer that is clear, simple and wrong”.
Il Sole 24 Ore